New accounting standards you should know, Part 4: Tweaks to your business combinations (ASC 805)

For anybody in the accounting world, one thing is clear: accounting standards never stay the same. In this multi-part series, “New accounting standards you should know,” I will catch you up on the latest accounting standard updates. Previously, we talked about simplifications to the accounting for complex debt and equity. This week, let’s look at some more improvements, this time in business combination accounting (ASC 805).

Surprise! We’ve seen a slew of recent updates to the accounting standards governing business combinations under ASC 805. While these are less significant than the new accounting models under ASC 606, ASC 842, and CECL, they are still very relevant considering the massive amount of M&A activity in the current business environment, and the many transactions that companies might be currently executing or contemplating. Believe it or not, the updates for this topic may end up simplifying the current guidance.  

The first update comes under Accounting Standards Update (“ASU”) 2017-01. Historically, companies have dealt with the headache of business combination accounting for virtually any purchase of a business or group of assets. This includes valuations required by third party experts, fair value adjustments for all assets and liabilities obtained through a transaction, and significant financial disclosures.

However, ASU 2017-01 provides a “screen test,” in which a company may be able to avoid business combination accounting if 90% or more of the fair value of acquired assets are concentrated in a single asset (or group of similar assets). In such a case, simpler accounting treatment of purchasing assets (such as buying a piece of equipment) will be applicable instead. This is particularly helpful for companies acquiring legal entities or assets with the overall focus of obtaining a single intangible, such as technology or customer relationships. This update has been effective since 2018, but many companies are not aware of the benefits that it may bring for certain transactions.  

The second update comes more recently, from ASU 2021-08. Prior to the ASU, many companies faced an unfortunate issue for their recently acquired companies with deferred revenue balances. When accounting for a business combination under US GAAP, companies were required to make a fair value adjustment to the acquiree’s deferred revenue balance as of the acquisition date. This often resulted in a significant “haircut” to the deferred revenue balance and as a result, the acquiring company could only recognize the reduced portion of that deferred revenue in its future profits and loss. Lower revenues to recognize meant skewed and less favorable impressions of the newly acquired businesses; bad news for forecasts and financials. However, with the new ASU, the fair value requirement is now gone; any deferred revenue will be measured and recognized in accordance with its treatment under ASC 606.

For our final part of the series, we will branch out from accounting-specific topics and to an upcoming change that could have a significant impact on other departments as well: reference rate reform and the global shift away from LIBOR.