THE CPA JOURNAL

U.S vs. Global Auditing Standards

Moving Toward Convergence

Accounting for Deferred Revenue Liabilities

In PostBusiness Combination Statements
By:
Josef Rashty and John O'Shaughnessy
(April 2011)

Aaron Joy D. Putian

IV- BSA
Advanced Accounting and Financial Reporting Part 2

A. Summary

Business Combination guidelines impact on treatment of post business

combination accounts must be fully understand. Fair value accounting has been
expanded in business combinations in recent development of the GAAP.
The study focuses on deferred revenue liabilities in post business
combination accounts in the acquirers financial statements that focus mostly on
software companies applicable also in other industries as well.
According to FASB Accounting Standard Codification on Business
Combination, an acquirer should determine whether the liability recognized by
the acquiree represents a post business combination performance obligation for
the deferred revenue liabilities to be reflected in the financial statements at fair
value.
In accounting for Business Combination, acquirer shall measure the
identifiable assets acquired, liabilities assumed, and any noncontrolling interest in
the acquiree at their acquisition date fair values.
In terms of Accounting for Deferred Revenue of an Acquiree, recognition of
the liability occurs at performance of obligation and measured at fair value
estimate at the time of acquisition.
Deferred Revenues refers to revenue that has not yet been earned, but
represents products or services that are owed to the customer and because of
that the acquiree need to record it in its financial statements. Performance
obligation related to deferred revenue of the aquiree must be needed for it to be
able to record in post business combination liabilities.
In determining the fair value of Deferred Revenue Liabilities, there are two
methods which is the bottom up approach and the top down approach.
In Bottom up approach the deferred revenue liability is measured as 1) direct
costs, 2) any incremental costs (such as overhead), 3) a reasonable profit margin,
and 4) any additional premium for price variability. While in Top down approach,
relies on market indicators to estimate the expected revenues for deferred
revenue obligations. Under this approach, the acquirer measures the fair value of
the obligation based on the estimated selling price for the products and services,
minus any selling effort and profit thereon. Out of the two methods Bottom up
method is mostly used.
An acquirer may reacquire a right that it had previously granted to an
acquiree. In postbusiness combination accounting, the acquirer usually
recognizes such reacquired rights as intangible assets separate from goodwill.
When an acquirer reacquires a previously granted right, it should recognize and
measure its fair value based on the remaining life of the contract without taking

into account any expected renewals or extensions same as on Business

Combinations.
Valuation of reacquired rights, unlike other assets that are based on market
participation assumptions, is based on the estimated cash flows over the
remaining life of the contract.
B. Assessment
In recognizing deferred revenue liabilities in the post combination financial
statements, an acquirer must determine whether the liability recognized by the
acquiree represents a post-business combination performance before it should be
reflected in the financial statements.
Deferred revenues are the ones that represent upfront payments for services
or products that have not been delivered or payment for delivered goods and
services sold as part of a multiple element arrangement that cannot be
accounted for separately from undelivered items included in the same
arrangement.
In recording deferred revenue liabilities fair value at the acquisition date
should be use. For acquiree, deferred revenue liabilities represents those they
receive and not necessarily reflect the fair value at the time of acquisition while
for acquirer, it is generally the amount that they are willing to pay to a third party
to assume such liabilities.
In determining fair value of deferred revenue liabilities there are two
methods; bottom up approach and top down approach. In Bottom-up approach
measurement would be direct cost, any incremental cost, reasonable profit
margin and any additional premium for price variability while in Top Down
approach the acquirer measures the fair value of the obligation based on the
estimated selling price for the products and services, minus any selling effort and
profit thereon, it is less used compared to Bottom up. Bottom up approach is
more used than Top Down approach because it used cost as basis for
measurement of fair value of the deferred revenue liabilities which is more
convenient than Top Down approach that used selling price as its basis.
When it comes to fair value measurement of reacquired rights, acquirer can
reacquire a right that it had previously issued from the acquiree. In presentation
in regards to post business combination accounting, it is recognize as intangible
assets separate from goodwill. Measurement of reacquired rights must be based
on its remaining life of the contract. Valuation of reacquired right are based on
market participation assumptions and estimated cash flows over the remaining
life of the contract. Differences arise when valuing reacquired rights and these
differences may be favorable or unfavorable on an acquirers perspective.

Acquirer should recognize gain or loss for the effective settlement of a preexisting relationship based on the lesser of the following:

The amount by which the contract is favorable or unfavorable from the

perspective of the acquirer when compared with pricing for current
market transactions for the same or similar items. If the acquirer has
previously recognized an amount related to the reacquired right, the
settlement gain or loss related to the pre-existing relationship should
be adjusted for the previously recognized amount.
The amount of any stated settlement provisions in the contract
available to the counterparty to whom the contract is unfavorable. If
this amount is less than the amount mentioned above, the difference
should be included as part of the business combination accounting.

C. Conclusion
Deferred Revenues refers to revenue that has not yet been earned, but
represents products or services that are owed to the customer and because of that
the acquiree need to record it in its financial statements. Deferred Revenue Liability
must be recognized at its fair value estimate at the time of acquisition and there
must be existence of performance obligation.
In determining the fair value of deferred revenue liability there are two
methods which is bottom up approach (cost build up approach) and top down
approach (market indicators). Out of the two methods, Bottom up approach is
widely used though both approaches are acceptable.
An acquirer may reacquire a right that it had previously granted to an
acquiree.
In postbusiness combination accounting, the acquirer usually recognizes
such reacquired rights as intangible assets separate from goodwill. When an
acquirer reacquires a previously granted right, it should recognize and measure its
fair value based on the remaining life of the contract without taking into account
any expected renewals or extensions.
Therefore, there could be a difference between the values derived from market
participation assumptions (at market value) and fair values estimated based on
cash flows. This difference (off market value) makes a reacquired right favorable
or unfavorable from the acquirers perspective. As a result, the fair value of a
contract consists of an off-market element in addition to an inherent at-market
element.