In the tech industry, pre- and post-acquisition revenues can differ due to fair value adjustments on deferred revenue. Learn how ASU 2021-08 preserves pre-acquisition deferred revenue.
Many professionals in the M&A world have seen it happen. A tech company has strong recurring revenues and large deferred revenue balances. Then the company gets acquired and its reported revenues drop inexplicably during the first few quarters after the acquisition. What happened?
Under existing accounting guidance, contract assets and contract liabilities (for example, deferred revenues) arising from revenue contracts initially are recognized at their fair value when a business combination occurs. For companies in the technology, media, and telecommunications (TMT) industries, this often can result in the post-acquisition combined entity recording – and ultimately realizing – materially lower balances of deferred revenues compared to what the acquiree would have realized without the acquisition.
This happens because the fair value of deferred revenue is calculated based largely on the remaining costs required to satisfy the underlying performance obligation, and, for companies in these industries, the costs remaining could be nominal. The key takeaway is that existing accounting guidance can make it difficult for investors to compare pre- and post-acquisition revenue trends of acquired companies with material deferred revenue balances because such balances may “go away” upon an acquisition.