ASU 2021-08: Contract Liabilities Acquired in a Business Combination, Entries and Audit Evidence

An acquirer buys a software or services company with $500,000 of customer prepayments on its balance sheet. For years, the acquirer revalued that deferred revenue to fair value on day one. Since ASU 2021-08, the acquirer carries it over using the revenue standard instead. The change moves goodwill and the revenue the acquirer reports after closing.

This guide explains the rule, the effective dates, the two practical expedients, a worked purchase price allocation and the evidence the auditor should expect. For the base acquisition entries, see /us/blog/asc-805-purchase-price-allocation-worked-journal-entries.

What does ASU 2021-08 change?

ASU 2021-08 creates an exception to the ASC 805 recognition and measurement principles. Contract assets and contract liabilities that arise from customer contracts under ASC 606 are no longer measured at fair value in the acquisition. The acquirer measures them under ASC 606 as if it had originated the contracts itself. The ASU directs the acquirer to apply the concept of a performance obligation.

The practical result: the acquired contract liability generally equals what the acquiree had recorded before the deal, if the acquiree prepared GAAP financial statements. Differences arise when the two companies use different revenue policies, when the acquiree did not follow US GAAP, or when the acquiree applied ASC 606 incorrectly. The scope also reaches contract liabilities from selling nonfinancial assets under ASC 610-20.

The ASU does not change how other acquired assets and liabilities are measured. Customer relationships and contracts with off-market terms are still recognized and measured under ASC 805.

When did it take effect?

For public business entities, the ASU applies to fiscal years beginning after December 15, 2022, including interim periods. For all other entities, it applies to fiscal years beginning after December 15, 2023, including interim periods within those years. Application is prospective, to business combinations with an acquisition date on or after the date of adoption. Early adoption was permitted. An entity that early adopted in an interim period applied the ASU retrospectively to all business combinations with an acquisition date on or after the start of the fiscal year that includes that interim period, and prospectively to those on or after the date of initial application.

A private company client with a December year end therefore applies the ASU to acquisitions closed in fiscal 2024 and later. An acquisition closed before adoption keeps the old measurement, so a file with several deals needs the adoption date noted on each.

What are the two practical expedients?

The ASU offers two expedients that simplify the carryover when contracts were modified before the deal. The acquirer may use one or both, elects them acquisition by acquisition, and applies each elected expedient consistently to all contracts acquired in the same business combination.

1. Aggregate modifications. For contracts modified before the acquisition date, the acquirer may reflect the aggregate effect of all those modifications when identifying satisfied and unsatisfied performance obligations, determining the transaction price and allocating the transaction price.
2. Selling prices at acquisition. For all contracts, when allocating the transaction price, the acquirer may determine each performance obligation's standalone selling price at the acquisition date instead of at contract inception.

An entity that uses an expedient discloses which ones it used and, to the extent reasonably possible, a qualitative assessment of the effect.

Constrained variable consideration stays out of the acquired contract asset until the constraint lifts. Its fair value can still show up in the customer-related intangible assets.

Worked journal entries

An illustration with round numbers. A client acquires a services business for $2,000,000 cash. At the acquisition date the target has these identifiable items at fair value: cash $100,000, receivables $400,000, equipment $600,000 and customer relationships $900,000. It also has a contract liability of $500,000 for prepaid services not yet delivered, measured under ASC 606 on the target's books.

Under ASU 2021-08, the contract liability carries over at $500,000. Net identifiable assets are $1,500,000, so goodwill is $500,000:

Compare the old approach. Suppose a fair value measurement of the same obligation had come to $300,000. Net identifiable assets would be $1,700,000 and goodwill $300,000. The difference of $200,000 moves between goodwill and the liability. Higher contract liabilities can produce more goodwill than the prior approach.

The follow-on entry is the revenue. As the acquirer delivers the prepaid services, it recognizes revenue from the $500,000 contract liability:

The acquirer's post-closing revenue generally matches what the target would have recognized. Under the old approach, revenue from the same obligation would have been lower because the liability started lower.

Audit angle

The auditor tests the carryover, not a new valuation. A useful workpaper set:

1. Check the adoption date. Agree the effective date to the entity's fiscal year, or the early adoption election, and tie each deal to the right rule.
2. Trace to the target's records. Agree the acquired contract liability to the target's closing balance sheet and deferred revenue rollforward, see /us/blog/deferred-revenue-schedule.
3. Test policy differences. Where the acquirer's revenue policies differ from the target's, recompute the contract liability under the acquirer's policies. Where the target did not apply ASC 606 or US GAAP, test the conversion.
4. Review expedient elections. Inspect the documentation, consistent application to all contracts in the deal, and the disclosure.
5. Separate the intangibles. Customer relationships and off-market terms stay under ASC 805 measurement, so check that they are not double counted with the contract liability.
6. Follow the revenue. Check that post-closing revenue releases the liability as performance obligations are satisfied. Revenue testing is covered in /us/blog/asc-606-revenue-recognition.

Common misstatements: remeasuring the deferred revenue to fair value out of habit, applying the ASU to a deal that closed before adoption, recording both a contract liability and a negative intangible for the same obligation, and an unsupported goodwill figure after the liability changes.

CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.

Sources

• Forvis Mazars, Refresher on contract assets and liabilities in a business combination: https://www.forvismazars.us/forsights/2023/09/refresher-on-contract-assets-liabilities-in-a-business-combination
• Grant Thornton, ASU provides guidance on revenue contract assets and liabilities acquired in a business combination: https://grantthornton.com/insights/articles/audit/2021/snapshot/november/asu-provides-guidance-revenue-contract-assets-liabilities-acquired-business-combination
• FASB, ASU 2021-08 (PDF): https://storage.fasb.org/ASU%202021-08.pdf

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error