The Financial Accounting Standards Board (FASB) has issued two new accounting standards updates applicable to business combination accounting.
The new guidance is aimed at improving the consistency of financial reporting for business combinations and reducing complexity in accounting for contract assets and contract liabilities. It is expected to provide more useful information to investors and other financial statement users. The new standards are focused on two areas that have presented some diversity in practice over recent years.
Contract Assets and Contract Liabilities from Contracts with Customers Acquired in a Business Combination
The Accounting Standards Update 2021-08—Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers requires companies to apply ASC 606 to recognize and measure contract assets and contract liabilities from contracts with customers acquired in a business combination. This creates an exception to the general recognition and measurement principle in ASC 805 to recognize assets and liabilities at fair value at the date of the acquisition.
An acquirer shall measure the contract assets and contract liabilities of the acquired contract as if the acquirer had originated the acquired contract. Topic 606 specifies when certain assessments and estimates should be made, for example, as of contract inception or on a recurring basis. At the acquisition date, the acquirer shall make those assessments as of the dates required by Topic 606.
An acquirer may use one or more of the following practical expedients when applying the standard at the acquisition date:
- For contracts that were modified before the acquisition date, an acquirer may reflect the aggregate effect of all modifications that occur before the acquisition date when:
- Identifying the satisfied and unsatisfied performance obligations.
- Determining the transaction price.
- Allocating the transaction price to the satisfied and unsatisfied performance obligations.
- For all contracts, for purposes of allocating the transaction price, an acquirer may determine the standalone selling price at the acquisition date (instead of the contract inception date) of each performance obligation in the contract.
The guidance is effective for public companies for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For all other entities, the guidance is effective for fiscal years beginning after December 15, 2023, and interim periods within those fiscal years. The amendments should be applied prospectively to business combinations on or after the effective date of the amendments. Early adoption of the amendments is permitted, including adoption in an interim period. An entity that early adopts in an interim period should apply the amendments (1) retrospectively to all business combinations for which the acquisition date occurs on or after the beginning of the fiscal year that includes the interim period of early application and (2) prospectively to all business combinations that occur on or after the date of initial application.
Joint Venture Formations
Additionally, the Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) 2023-05-Business Combinations – Joint Venture Formations (Subtopic 805-60): Recognition and Initial Measurement, which provides guidance on accounting for joint venture formations. The ASU requires a joint venture to apply a new basis of accounting at its formation date by valuing the net assets contributed at fair value for both business and asset transactions.
The amendments in this Update require that a joint venture apply the following key adaptations from the business combinations guidance upon formation:
- A joint venture is the formation of a new entity without an accounting acquirer. The formation of a joint venture is the creation of a new reporting entity, and none of the assets and/or businesses contributed to the joint venture are viewed as having survived the combination as an independent entity—that is, an accounting acquirer will not be identified.
- A joint venture measures its identifiable net assets and goodwill, if any, at the formation date. The joint venture formation date is the date on which an entity initially meets the definition of a joint venture.
- Initial measurement of a joint venture’s total net assets is equal to the fair value of 100 percent of the joint venture’s equity. The amendments require that a joint venture measure its total net assets upon formation as the fair value of the joint venture as a whole. The fair value of the joint venture as a whole equals the fair value of 100 percent of a joint venture’s equity immediately following formation (including any noncontrolling interest in the net assets recognized by the joint venture).
- A joint venture provides relevant disclosures. The purpose of the disclosures is to help a user of a joint venture’s financial statements understand the nature and financial effect of the joint venture formation in the period in which the formation date occurs. Joint venture disclosure requirements upon formation are different from the requirements for business combinations.
The amendments in this Update permit a joint venture to apply the measurement period guidance in Subtopic 805-10 if the initial accounting for a joint venture formation is incomplete by the end of the reporting period in which the formation occurs. Additionally, a joint venture that is a private company may elect to apply the accounting alternative for the recognition of identifiable intangible assets and amortization of goodwill.
The guidance is effective prospectively for all joint venture formations with a formation date on or after January 1, 2025, and a joint venture that was formed before January 1, 2025 may elect to apply the amendments retrospectively if it has sufficient information. Early adoption is permitted in any interim or annual period in which financial statements have not yet been issued (or made available for issuance), either prospectively or retrospectively.
Conclusion
This new guidance is a significant change in accounting for business combinations and will require companies to carefully evaluate the impact of the new guidance on their financial statements.Companies should start preparing for the implementation of the new guidance well in advance of the effective date.
Contact Us
If you have any questions about how this guidance may impact your organization, please reach out to Withum’s Assurance and Accounting Services Team.
