The views in this summary are not Generally Accepted Accounting Principles until a consensus is reached and it is ratified by the Board.

Transcription

1 Memo No. Issue Summary No. 1, Supplement No. 1 * MEMO Issue Date September 13, 2018 Meeting Date(s) EITF September 27, 2018 Contact(s) Ryan Carter Project Manager, Lead Author (203) Jason Bond EITF Coordinator (203) Jane Lazzara Postgraduate Technical Assistant (203) Lawrence Dodyk EITF Liaison (973) Project Project Stage Date previously discussed by EITF Previously distributed Memo Number Issue No. 18-A, Recognition under Topic 805 for an Assumed Liability in a Revenue Contract Initial Deliberations June 7, 2018 Issue Summary No. 1, dated May 24, 2018 Memo Purpose 1. At the June 7, 2018 EITF meeting, the Task Force reached a consensus-for-exposure on the accounting issue related to the application of the recognition guidance in Topic 805, Business Combinations, to a revenue contract acquired in a business combination after the acquirer has adopted Topic 606, Revenue from Contracts with Customers (Issue 1 in Issue Summary No. 1). The Task Force also reached consensuses-for-exposure on the accounting issues related to measurement for an assumed liability in a revenue contract in a business combination (Topics #1 and #2 in Issue Summary No. 1) and on transition guidance. At its June 27, 2018 meeting, the Board ratified the overall consensus-for-exposure on this Issue and directed the FASB staff to draft a proposed Update reflecting the consensus-for-exposure for vote by written ballot. * The alternative views presented in this Issue Summary Supplement are for purposes of discussion by the EITF. No individual views are to be presumed to be acceptable or unacceptable applications of Generally Accepted Accounting Principles until the Task Force makes such a determination, exposes it for public comment, and it is ratified by the Board. Page 1 of 20

2 2. Task Force members subsequently identified potential unintended consequences of the consensus-for-exposure when reviewing a draft of the proposed Update and recommended that the Issue be discussed further by the Task Force prior to the issuance of the proposed Update. 3. The purpose of this memo is to update the Task Force on the additional outreach and research that the staff performed on this Issue and to present alternatives to address the potential unintended consequences of the consensus-for-exposure reached at the June 2018 EITF meeting. Background 4. The FASB staff received two questions from an accounting firm about the application of the guidance in Topic 805 to deferred revenue after the adoption of Topic 606. Before the adoption of Topic 606, a practice developed whereby entities generally applied the concept of legal obligation to determine whether deferred revenue is recognized in a business combination. The issuance and adoption of the new revenue standard (Topic 606) raised the question about whether the legal obligation concept should continue to be applied or whether the concept of a performance obligation included in Topic 606 should be applied to account for deferred revenue in a business combination under Topic 805. The other question raised by the accounting firm is how to measure the fair value of a contract liability (for example, deferred revenue) from a revenue contract acquired in a business combination after the adoption of Topic On March 28, 2018, the Board added this project to the EITF s agenda to address the recognition of a revenue contract with a customer that is acquired in a business combination after an entity has adopted Topic 606 (Issue 1 in Issue Summary No. 1). The Board added this project to reduce the number of diverse views on how an entity would apply the guidance in Topic 805 to a revenue contract accounted for under Topic 606. The Board also directed the EITF to provide educational information on measurement topics that may arise from the application of Topic 606 to a business combination (Education Topic #1 and Topic #2 in Issue Summary No. 1). 6. Therefore, the following issue and topics were included in Issue Summary No. 1, and discussed at the June 2018 EITF meeting: Issue 1: Recognition for an assumed liability in a revenue contract Topic #1: Carry-over basis and measuring the fair value of a Topic 606 performance obligation Topic #2: Costs to fulfill a performance obligation in measuring the fair value of a contract liability for a revenue contract under Topic 805. The two Education Topics were considered as part of the discussion on the measurement for an assumed liability in a revenue contract in a business combination. Page 2 of 20

3 7. The Task Force reached a consensus-for-exposure on Issue 1 that would require an entity to use the Topic 606 performance obligation definition to determine whether an assumed contract liability from a revenue contract with a customer represents a liability assumed that is recognized in a business combination at the acquisition date. As part of that consensus-for exposure, the Task Force decided that the timing of the payment of consideration or payment terms should not affect the amount of revenue recognized by the acquirer related to the acquired revenue contract. Task Force members subsequently identified potential unintended consequences of that decision, which are discussed in Issue 1A below. 8. The Task Force voted to include implementation guidance on Topics #1 and #2 in the Codification and reached a consensus-for-exposure that it would be inappropriate for an acquirer to default to using a carryover basis (that is, recording the liability on the acquirer s balance sheet equal to the amount of deferred revenue on the acquiree s balance sheet immediately preceding the business combination date) when measuring an assumed liability in a revenue contract. The staff believes that no further deliberations on this measurement topic are necessary. 9. The Task Force also reached a consensus-for-exposure that an acquirer would consider the assets and liabilities in the acquired set when determining the fair value of an assumed contract liability. Some Task Force members subsequently identified potential unintended consequences of that decision, which are discussed in a new issue below (Issue 3). 10. The Task Force also reached consensuses-for-exposure that would require an entity to apply the proposed amendments prospectively to all business combinations that occur after the proposed amendments are effective and that would not require any disclosures in the period of adoption. The staff believes that the feedback raised after the June 2018 EITF meeting does not affect these conclusions related to transition, so the staff believes no further deliberations on these items are necessary. 11. Therefore, the following Issues will be presented to the Task Force at the September 27, 2018 meeting: Issue 1A: Payment terms and their effect on subsequent revenue recognition Issue 3: Costs to fulfill a performance obligation in measuring the fair value of a contract liability for a revenue contract under Topic 805. Issues Issue 1A Payment Terms and Their Effect on Subsequent Revenue Recognition Page 3 of 20

4 Question for the Task Force 1. Which accounting alternative does the Task Force want to select to address the potential implications of the consensus-for-exposure on payment terms? 12. After the June 2018 EITF meeting, the staff drafted the following paragraph to amend the Codification to reflect the Task Force s decision that payment terms should not affect the subsequent amount of revenue recognized (additions are underlined): C The payment terms (for example, timing of payment) of the acquired revenue contract with a customer shall not affect the subsequent amount of revenue recognized by the acquirer for the acquired revenue contract. 13. A Task Force member indicated that the original Issue raised to the Task Force was not intended to change practice because the financial reporting outcome may not be significantly different between using a legal obligation definition and using a Topic 606 performance obligation definition because Topic 805 requires a recognized liability to be measured at fair value and the fair value of the Topic 606 performance obligation (that is not a legal obligation) potentially may be minimal or zero. Some Task Force members indicated that the concept that payment terms of an acquired revenue contract should not affect the subsequent amount of revenue recognized by an acquirer could significantly change practice for some entities. For example, to have the same revenue recognized after a business combination for a contract that requires payment over the contract term as a contract that requires an upfront payment, the acquirer may need to recognize an identifiable asset for the contract that requires payment over the contract term representing the future consideration expected to be received that is in excess of the revenue to be recognized for the unfulfilled performance obligation. A Task Force member expressed concerns that this proposed guidance may be beyond the scope of what the Task Force was asked to address. In addition, under the proposed guidance, a Task Force member noted that an entity with a contract that includes a sales-based royalty may be required to estimate the amount of royalties it expects to receive and recognize that amount as a receivable on the date of the business combination because payment terms should not affect the amount of revenue recognized. Currently under GAAP, entities generally recognize revenue for sales-based royalties received after a business combination. The Task Force member noted that this raises a question as to whether additional guidance would be needed for sales-based royalties. 14. The staff developed the following example to illustrate how an entity might apply the proposed amendment in paragraph C: Entity A enters into a two-year service contract with a contract price of $100 and an expected cost of fulfillment of $60. The selling costs related to the contract are $14 and Page 4 of 20

5 a reasonable profit on those selling costs is $6. Assume a business combination occurs on Day 2 of Year 1. (Discounting and income taxes are ignored for simplicity.) Scenario 1: Payment is made upfront before acquisition In Scenario 1, payment is received on Day 1 of Year 1 (before the acquisition). Entity A determines that the fair value of the contract liability is $80 at the date of the business combination and, therefore, will recognize $40 of revenue in both Year 1 and Year 2, as follows. Year 1 Year 2 Revenue Costs (as incurred) (30) (30) Gross margin Related Journal Entries Dr. Cr. Year 1 Contract liability 40 Revenue 40 Year 2 Contract liability 40 Revenue 40 Scenario 2: No payment made before acquisition In Scenario 2, payment is due monthly in arrears, so no payments are received before the acquisition date. Entity A determines that the fair value of the contract liability is $80 at the date of the business combination and, therefore, will recognize $40 of revenue in both Year 1 and Year 2. To recognize the same amount of revenue as Scenario 1, Entity A would need to recognize an asset of $20 at the date of the business combination. A portion of the cash received each month would reduce that asset. Year 1 Year 2 Revenue Page 5 of 20

6 Costs (as incurred) (30) (30) Gross margin Related Journal Entries Dr. Cr. Year 1 Cash 50 Identifiable asset 10 Revenue 40 Year 2 Cash 50 Identifiable asset 10 Revenue The staff understands that some entities recognize a customer-related intangible asset in a business combination that represents the selling costs and reasonable profit thereon. If that is the case, the revenue recognized in Scenario 2 would be the same if the customer-related intangible asset is amortized directly to revenue. However, the staff understands that there is diversity in practice for the amortization of customer-related intangible assets and most entities do not amortize the customer-related intangible asset directly to revenue. In addition, even if the customer-related intangible asset is amortized directly to revenue, the amortization pattern and period of the customer-related intangible asset may not match the period and pattern of revenue recognition, which would result in a different amount of revenue being recognized for contracts paid upfront compared to those paid over time. Stakeholder Feedback after the June 2018 EITF Meeting 16. The staff performed outreach based on the above example to understand current practice for the accounting for revenue contracts that are paid for over time, to confirm the outcome of the Task Force s consensus-for-exposure, and to gather feedback. The staff performed this outreach with business combination and valuation experts at four different audit firms, including Big 4 firms, and with the AICPA Business Combinations Task Force. Current Practice and the Outcome of the Task Force s Decision 17. In general, the feedback received from outreach participants confirmed that the accounting outcome under Scenario 2 (that is, the recognition of an identifiable asset) is consistent with what participants expected would be required under the consensus-for-exposure. Outreach participants Page 6 of 20

7 all agreed that the accounting outcome in Scenario 2 was not consistent with how acquired revenue contracts and their related assets are recorded in a business combination under current guidance, which is described in the following two paragraphs. 18. Outreach participants specifically noted that recognizing an individual contract-related asset (for example, a financial asset that is not amortized) according to the consensus-for-exposure differs from the guidance in paragraphs through on order or production backlogs and customer contracts and related customer relationship intangible assets, which state that those assets meet the contractual-legal criterion in Topic 805 to be recognized as intangible assets separately from goodwill. Outreach participants explained that those identifiable intangible assets are generally recognized and measured at acquisition-date fair value using specific valuation approaches that use the future cash inflows attributed to existing or future contracts as an input. Outreach participants noted that the cash flows of existing contracts would also be used as an input to determine the fair value of the individual contract-related asset in Scenario 2. Therefore, participants were concerned about the potential for double counting those future cash flows. They were not concerned that the cash flows and fair value of the asset in the example above was not being considered in the accounting for the business combination. One participant specifically noted that the future cash flows related to the asset in the example above would be included in the measurement of a customer backlog intangible asset. Therefore, if an individual contract-related asset is recognized, the value assigned to customer-related intangible assets under current practice, specifically customer backlog, would need to be reduced. 19. Outreach participants also noted that if the individual contract-related asset in Scenario 2 of the example above is determined to be a financial asset, the subsequent measurement would be different from the subsequent measurement of an intangible asset recognized under current practice. Customer-related intangible assets recognized under paragraphs through would be amortized while a financial asset would be reduced as cash payments are received. Participants noted that an entity also would apply a different impairment model to a financial asset than to an intangible asset. 20. In addition, outreach participants noted that the accounting outcome under Scenario 2 of the above example would necessitate tracking the individual contract-related assets on a contract-by-contract basis so that the future cash payments could be applied to the related assets. Outreach participants explained that in current practice, customer-related intangibles are not usually tracked at the individual contract level. Instead, the entire customer relationship (existing and potential future contracts with that customer) are often recognized and measured as a single asset and amortized accordingly. In some cases, separate assets are not recognized and measured for each individual customer, especially when a group of customers is relatively homogenous. In those cases, all of an acquiree's customer relationships are aggregated and recognized and measured as a single Page 7 of 20

8 asset. Therefore, some outreach participants indicated that the Task Force s decision would result in a significant change in the way in which some acquirers record customer-related intangible assets in business combinations and could increase the costs of accounting for those assets. Feedback on the Task Force s Decision 21. Four out of five outreach participants expressed concerns about the consensus-for-exposure on payment terms and its accounting outcome (Scenario 2 of the example) and questioned whether the consensus-for-exposure on payment terms and its related consequences should be considered as a separate EITF Issue, if at all. Each of those four participants noted that this Issue was originally considered to be a narrow scope issue that was not intended to significantly change practice. They indicated that the Issue the Task Force was asked to address relates to the recognition of a liability in a business combination after the adoption of Topic 606 and was not intended to address assets recognized in a business combination. The addition of the guidance on payment terms also would raise other issues and questions about the recognition and subsequent measurement of customerrelated intangible assets that would need to be addressed. One participant noted that how the timing of payments affects revenue recognition is not a new issue that is specific to the adoption of Topic 606 and practice has developed acceptable approaches for it today. Another participant also observed that recording a financial asset from a customer for a revenue contract in a business combination would not be intuitive when the acquiree has not provided a good or service. 22. One participant continued to support the consensus-for-exposure and its accounting outcome, although that participant acknowledged it would result in a change in practice. That participant also acknowledged that the accounting outcome of the consensus-for-exposure (that is, the recognition of an asset under Scenario 2) was not considered in the Task Force s discussion about payment terms, but the participant indicated that characterizing the asset under Scenario 2 as a financial asset would better reflect the underlying economics of the contract and would result in the same amount of revenue recognized after the business combination for contracts with different timing of payments. The participant noted that this accounting change may not significantly affect the time or effort needed to account for a business combination because the value of the financial asset is already captured as an asset today (although its classification may be different) and acquirers need to evaluate each acquired revenue contract separately under current guidance. Therefore, that participant supported further analyzing how customer-related intangible assets should be recorded in a business combination. 23. Another participant commented that if the Task Force decides to confirm its decision on payment terms, the proposed guidance in paragraph C should be clarified. That participant noted that the guidance proposed by paragraph C is focused on the amount of revenue recognized, but Topic 805 is focused on the recognition of assets and liabilities at the date of the business combination. The participant expressed concerns that stakeholders may not Page 8 of 20

9 understand that the guidance proposed by paragraph C (that is, payment terms should not affect the amount of revenue recognized) would result in the recognition of an asset in some cases. If the Task Force decides to confirm its decision on payment terms, the participant would recommend providing guidance on the recognition of an asset or liability that would ultimately result in an entity recognizing the same amount of revenue irrespective of the payment terms of the contract. Alternatives for Payment Terms and Their Effect on Subsequent Revenue Recognition 24. The staff developed the following alternatives for the Task Force to consider: Alternative A Remain silent on how payment terms affect the amount of revenue recognized after the business combination Alternative B Provide guidance on the recognition and measurement of an individual contract-related asset for a revenue contract acquired in a business combination so that payment terms do not affect the amount of revenue recognized after the business combination. This alternative would require the staff to perform further research on the implications of this alternative to other guidance in Subtopic (for example, backlog and other customer-related intangible assets). 25. The staff does not believe that only stating that payment terms should not affect the amount of revenue recognized (the decision reached at the June 2018 EITF meeting) is a viable alternative because of the additional staff research and outreach described above. Staff Analysis and Recommendation Alternative A 26. Under Alternative A, the Task Force would remain silent on payment terms and proposed paragraph C would not be included in the proposed amendments resulting from this Issue. However, Alternative A would not address the issue that payment terms could affect the amount of revenue recognized after a business combination, so diversity in practice would continue. 27. Proponents of Alternative A note that including proposed paragraph C would represent a change in practice for all acquired revenue contracts, which was not the intent of this Issue. Proponents observe that the Task Force was asked to decide whether deferred revenue is an assumed liability in a business combination using the concept of a legal obligation or a performance obligation after the adoption of Topic 606, which would narrow potential diversity in practice relating to this Issue. Proponents note that this alternative would address the Issue without introducing the additional complexities and issues identified during the staff s research and Page 9 of 20

10 outreach and without significantly changing practice. Proponents also noted that Alternative A would allow the Task Force and Board to resolve this Issue in a more timely manner than under Alternative B. Because Topic 606 is already effective for some entities and will be effective for all other entities in the near future, proponents of Alternative A note that it would be helpful to provide guidance on this Issue as soon as possible. Alternative B 28. Under Alternative B, the Task Force would provide guidance on the recognition and measurement of an individual contract-related asset for a revenue contract acquired in a business combination so that payment terms do not affect the amount of revenue recognized after the business combination. The staff would need to perform further research and outreach to evaluate and analyze the implications of this guidance on other guidance in Subtopic (for example, backlog and other customer-related intangible assets). The staff also would need to consider how the potential guidance would affect various acquired revenue contracts and the potential costs of the guidance. 29. Proponents of Alternative B note that it would address the issue that payment terms could affect the amount of revenue recognized after a business combination and would eliminate the potential diversity in practice that currently exists. In addition, proponents support this alternative because, in their view, it would better reflect the economics of the contract. Staff Recommendation 30. The staff recommends that the Task Force remain silent on how payment terms affect the amount of revenue recognized after the business combination (Alternative A). The staff notes that the objective of the Issue is to reduce diversity in practice for recognizing deferred revenue for an acquired revenue contract after the adoption of Topic 606. Initial outreach indicated that any guidance provided would not significantly change practice and would most likely affect revenue contracts with licenses to symbolic intellectual property (IP) and those that include goods or services provided as a customary business practice. The staff believes that Alternative A would reduce the diversity in practice without introducing additional complexity into the accounting for business combinations. 31. The staff is concerned that Alternative B would result in a significant change in practice and would affect all acquired revenue contracts, including contracts that require payment as the good or service is provided. The staff believes that Alternative B also would likely necessitate a change in the guidance on the accounting for customer-related intangible assets. The staff notes that stakeholders have not raised practice issues related to the accounting for customer-related Page 10 of 20

11 intangible assets to the staff. If there is a need to improve the accounting for contract and customerrelated intangible assets in a business combination, the staff believes that those issues should be addressed more broadly in the context of Subtopic instead of in a narrow-scope issue on deferred revenue in a business combination. 32. In addition, the staff notes that Alternative B would delay the issuance of guidance on this Issue, which is time sensitive given that Topic 606 is already effective for some entities and will soon be effective for all other entities. Issue 3 Costs to Fulfill a Performance Obligation In Measuring the Fair Value of a Contract Liability for a Revenue Contract under Topic 805 Question for the Task Force 2. Which accounting alternative does the Task Force want to select to address the potential implications related to the consensus-for-exposure on the costs to fulfill a performance obligation in measuring the fair value of a contract liability for a revenue contract under Topic 805? 33. After the June 2018 EITF meeting, the staff drafted proposed paragraph C to reflect the Task Force s decision that an acquirer would consider the assets and liabilities in the acquired set (hereinafter referred to as acquired set) when determining the fair value of an assumed contract liability as follows (additions are underlined): C When measuring the fair value of a contract liability from a revenue contract with a customer, the acquirer shall consider the assets and liabilities in the acquired set. Stakeholder Feedback after the June 2018 EITF Meeting Task Force Member Feedback 34. The Task Force made the decision on the acquired set in the context of a contract liability related to a license to symbolic IP. Feedback from some Task Force members indicated that the guidance proposed by paragraph C would be required to be applied to all contract liabilities, not just those related to licenses to symbolic IP. Those Task Force members indicated that without further context, the phrase consider the assets and liabilities in the acquired set could be misinterpreted or misapplied to revenue contracts besides those considered by the Task Force. One Task Force member acknowledged that there would be further explanation and clarification in the basis for conclusions of any proposed Update, but the Task Force member observed that the language in the Codification would be unclear without also reading the basis for conclusions. Several Task Force members suggested that the guidance include an example or examples to help illustrate the consensus-for-exposure on the acquired set (and other decisions included in the Page 11 of 20

12 consensus-for-exposure). Those Task Force members indicated that an example would clarify what is intended by the guidance and illustrate how it should be applied. 35. One Task Force member provided an example of a potential misapplication of the guidance in which an acquiree has a contract to deliver a certain number of widgets and also has finished goods inventory to fulfill that contract. The customer in this example paid for the widgets in advance. The acquirer in a business combination could misapply the guidance proposed by paragraph C by concluding that the measurement of the liability for the unfulfilled performance obligation of delivering widgets should be zero because the acquirer is not required to incur any additional costs to fulfill that unfulfilled obligation (that is, the acquirer already owns the completed widgets because they are part of the acquired set). The Task Force member noted that, in this example, there are costs to fulfill the obligation (that is, the inventory that will be used to fulfill the contract) that should be included in the measurement of the contract liability. AICPA Business Combination Task Force Feedback 36. Following the June 2018 EITF meeting, the staff also performed outreach with the AICPA Business Combinations Task Force (AICPA Group) and discussed the language in paragraph C on the acquired set. The focus of this outreach was to gain an understanding of the types of transactions, besides licenses to symbolic IP, that could be affected by the acquired set guidance and how the guidance would affect current practice for those transactions. 37. While the AICPA Group agreed with the conclusion reached for a license to symbolic IP (that is, the measurement of a contract liability for an in-process license arrangement to symbolic IP would not include the costs for a market participant to purchase the related IP), it is concerned that the acquired set guidance could be misapplied to other fact patterns, which would result in outcomes that are inconsistent with the principles of Topic 820 on fair value measurement. 38. The AICPA Group provided examples of the potential misapplication of this guidance, including an example that was similar to the inventory example previously described. The AICPA Group also provided an example of a contract to dig a ditch to illustrate how the guidance could be interpreted. The contract to dig a ditch is acquired as part of a business combination, and the customer paid the fee for the service upfront. The acquirer determines that it will need to use a backhoe for five hours to fulfill the performance obligation, but a backhoe was acquired in the business combination (that is, it is part of the acquired set). The AICPA Group noted that excluding the cost associated with using the backhoe (because it is part of the acquired set) from the estimate of the fair value of the contract liability would be inconsistent with the principles of Topic 820. That is because Topic 820 requires the measurement of the fair value of a liability to be the price at which a market participant would pay to transfer the liability. In this case, a market participant would consider all the costs associated with fulfilling the performance obligation, including the cost of using a backhoe, to estimate the price it would have to pay to transfer the liability. Page 12 of 20

13 39. The AICPA Group noted that it would be inappropriate to consider the full cost of the backhoe to estimate the fair value of this contract liability because a market participant would only consider the costs associated with using the asset that are necessary to fulfill the performance obligation (which, in this example, is five hours). 40. The AICPA Group noted that, based on these examples, the acquired set guidance would likely reduce the amount of the contract liabilities recorded in a business combination under current practice. Therefore, the AICPA Group recommended not including the guidance on the acquired set as part of the consensus-for-exposure because they indicated that guidance is inconsistent with Topic 820. They noted that the acquired set guidance would result in an appropriate conclusion in the example of a license to symbolic IP, but it would not result in an appropriate conclusion for other revenue contracts. The AICPA Group suggested that any guidance provided on measuring the fair value of a contract liability should instead specify that an acquirer should only consider activities the acquirer will perform after the business combination that directly relate to the acquired contract. That is, it would not consider the overall activities the acquirer would undertake irrespective of the acquired contract or activities already performed by the acquiree that the acquirer would not perform. The AICPA Group noted that this guidance would sufficiently clarify the measurement of a contract liability. 41. The AICPA Group noted that the question raised about licenses to symbolic IP results from confusion about what the unfulfilled performance obligation is. They explained that measurement of the fair value of a contract liability for a license to symbolic IP would not consider the cost of the underlying IP, not because the IP was included in the acquired set, but because the IP had already been delivered to the customer by the acquiree before the business combination. The acquirer would not be required to deliver the IP to the customer again after the business combination. Some stakeholders have disagreed with that view because a license to symbolic IP is a single performance obligation in which the licensor has granted the customer a right to access the underlying IP and must continue to support or maintain the IP throughout the term of the license. Therefore, the performance obligation is fulfilled over time under Topic The staff notes that a license to symbolic IP provides a customer with a right to access the underlying IP, but Topic 606 is clear that an entity performs two activities to fulfill its promise in a license to symbolic IP, as stated in paragraph : A customer s ability to derive benefit from a license to symbolic intellectual property depends on the entity continuing to support or maintain the intellectual property. Therefore, a license to symbolic intellectual property grants the customer a right to access the entity s intellectual property, which is satisfied over time (see paragraphs A and C) as the entity fulfills its promise to both: a. Grant the customer rights to use and benefit from the entity s intellectual property Page 13 of 20

14 b. Support or maintain the intellectual property. An entity generally supports or maintains symbolic intellectual property by continuing to undertake those activities from which the utility of the intellectual property is derived and/or refraining from activities or other actions that would significantly degrade the utility of the intellectual property. 43. The above paragraph indicates that there are two separate activities performed by an entity to fulfill a performance obligation for a license to symbolic IP. The AICPA Group noted that the acquirer s only remaining activity required to fulfill its performance obligation for a license to symbolic IP after a business combination is to support or maintain the intellectual property because the acquiree granted the customer the right to use the IP before the business combination. Paragraph (b) refers to the overall activities that an entity would undertake to support and maintain its symbolic IP, which, as noted in paragraph , could include its ordinary business activities. However, the AICPA Group noted that the fair value of an assumed contract liability would only consider activities to support or maintain the IP that are specific to or incrementally required by the contract. The staff notes that this would not include activities that the entity would perform irrespective of the acquired contract, such as ordinary business activities. Other Feedback 44. The staff also performed further outreach with business combination and valuation experts at four audit firms to obtain feedback on how the acquired set guidance could affect other transactions. The feedback received was consistent with the feedback received by Task Force members and the AICPA Group. However, outreach participants provided additional considerations related to current valuation practice. 45. One outreach participant noted that the acquired set guidance would not change current practice for acquired contracts that include licenses to symbolic IP. Another participant stated that they were not aware of much diversity in practice for measuring the fair value of licenses to symbolic IP, which is consistent with the feedback and analysis in Issue Summary No. 1. However, that participant indicated that they believe that the acquired set guidance was included in the consensus-forexposure to prohibit an entity from grossing up the contract liability so that it could recognize more revenue after the business combination. 46. Another participant explained that they believe that the acquired set guidance is inconsistent with the way in which valuation professionals determine the fair value of other liabilities in a business combination that requires the use of assets that were also acquired in the business combination. The participant noted that in the examples provided by other outreach participants (inventory and the backhoe), the measurement of the fair value of the liability reflects the cost of the use of the asset that is necessary to fulfill the obligation, and the measurement of the fair value of the related asset is not affected by the revenue contract. In addition, the participant noted that when an entity Page 14 of 20

15 acquires a lessor of a building with in-place leases, the fair value of the lease liability includes the cost of using the building over the term of the lease, even when access to the building has been provided to the lessee before the business combination. In this fact pattern, the fair value of the building is not affected by the in-place leases. The participant noted that a license to symbolic IP is similar to the lease of a building, especially when the license to symbolic IP is an exclusive license. In this participant s view, the value of the IP should not be affected by a contract that grants a customer a license to the IP. Likewise, the participant indicated that the liability for the unfulfilled performance obligation should include a usage charge that represents the cost of using the IP for the term of the license. This participant acknowledged some Task Force members concern about the potential to recognize more revenue after the business combination under this approach. However, the participant questioned why there is inconsistent accounting among what the participant believes to be economically similar arrangements. 47. In response to this feedback, other outreach participants acknowledged that the fair value of a leased asset is not affected by in-place leases. However, they indicated that leases of tangible assets are different from licenses of intellectual property because not all licenses are exclusive, and an entity can continue to license its intellectual property even when it has issued licenses to other customers. Therefore, those participants indicated that recognizing a liability for the use of the intellectual property would not be appropriate. Summary of Alternatives for Costs to Fulfill a Performance Obligation In Measuring the Fair Value of a Contract Liability for a Revenue Contract under Topic Considering the additional feedback from Task Force members and staff outreach just described, the staff developed the following alternatives: Alternative A Affirm the previous consensus-for-exposure on the acquired set. The following paragraph would be included in the proposed Update (additions are underlined): C When measuring the fair value of a contract liability from a revenue contract with a customer, the acquirer shall consider the assets and liabilities in the acquired set. Alternative Aꞌ Affirm the previous consensus-for-exposure on the acquired set but add an example to illustrate how to apply the guidance to symbolic IP. (The example would illustrate the accounting for an acquired revenue contract that includes a non-exclusive license to symbolic IP in which the customer has paid the consideration for the license before the business combination. The focus of the example would be on how to apply the Page 15 of 20

16 acquired set guidance to the transaction and would be similar to the example presented in Issue Summary No. 1.) Alternative B Do not include proposed paragraph C in the consensus-forexposure but add an example to illustrate how to account for an acquired revenue contract that includes a license to symbolic IP. The example would state that a license to symbolic IP comprises two different activities, as explained in Topic 606, and would specify when the costs related to those activities were incurred. Alternative C Change the consensus-for-exposure to require entities not to consider the other assets and liabilities in the acquired set when determining the fair value of an assumed liability. Under this alternative, the measurement of a contract liability would include all the costs a market participant would consider that are necessary to fulfill the remaining obligation regardless of what assets are acquired in the business combination or are already owned by the entity. For example, if a contract liability is recognized in a business combination for an in-process license arrangement that has one year remaining, a market participant would include the cost of obtaining a one-year license to that underlying IP. Staff Analysis and Recommendation 49. The staff focused its analysis on the effect of the guidance on the acquired set and then evaluated each alternative against that analysis. Analysis of the Effect of the Acquired Set Guidance and Feedback 50. Under the acquired set measurement guidance, an acquirer would consider the assets and liabilities in the acquired set when measuring the fair value of the contract liability. The basis for the conclusion reached at the June 2018 EITF meeting was that the Task Force did not want to allow an acquirer to recognize higher revenue after a business combination because of a valuation technique used to measure a contract liability and ignoring an asset in the acquired set that is necessary to fulfill the liability would not be appropriate when the asset and liability have been acquired and assumed, respectively, together. As an example, if a contract liability is recognized for a license to symbolic IP, the measurement of that contract liability would not include the costs for a market participant to purchase the related IP because that IP was included in the acquired set. This would result in a net valuation of the liability as opposed to including an amount for the cost to obtain (or use) the IP in the liability and measuring the IP assuming there was no associated license. 51. The staff notes that the discussion at the June 2018 EITF meeting and the analysis in Issue Summary No. 1 focused on revenue contracts that include a license to symbolic IP and did not Page 16 of 20

17 focus on other revenue arrangements that could be affected by the acquired set guidance. Comments received by Task Force members during the drafting process and feedback from outreach participants indicated that other transactions could be affected by the acquired set guidance. In addition, some outreach participants indicated that the guidance is inconsistent with the guidance in Topic 820. Based on that feedback, the staff does not believe that the acquired set guidance should be applied to transactions other than licenses to symbolic IP. The staff agrees with outreach participants that under Topics 820 and 805 an acquirer would consider all the remaining costs to fulfill the performance obligation even if the asset necessary to fulfill the obligation was acquired as part of the business combination or already owned. 52. The staff acknowledges that the accounting outcome achieved by applying the acquired set guidance to licenses of symbolic IP (that is, the measurement of a contract liability for a license to symbolic IP would not include the costs for a market participant to purchase the related IP) is consistent with current practice. However, the staff notes that the accounting outcome can be supported by other guidance that is consistent with Topic 820. The staff believes that the same accounting outcome for a license to symbolic IP can be achieved by clarifying that an entity should only consider costs incurred to fulfill the performance obligation after the business combination when measuring the fair value of the contract liability. Costs incurred to fulfill the performance obligation before the acquisition date should be excluded from the measurement of the contract liability. The staff believes that Topic 606 is clear that an entity is required to perform two activities to fulfill its promise in a license to symbolic IP, one of which is to grant the customer the right to use the IP, and the costs incurred for this activity are generally incurred at the beginning of the license period when the IP is provided to the customer. For an existing license to symbolic IP (in which the license period has begun) that is acquired in a business combination, the costs to grant the customer the right to use the IP generally were incurred before the acquisition date. Thus, the fair value of the remaining performance obligation would only include the costs incurred to support and maintain the IP that are directly related to the acquired revenue contract. As discussed at the June 2018 EITF meeting, the fair value of the liability to support and maintain the IP may be minimal because it would only consider the incremental costs to support or maintain the underlying IP that directly relate to the acquired contract and would not consider the overall activities that the entity would undertake to support and maintain its underlying IP (for example, its brand) irrespective of the acquired contract. Analysis of the Alternatives 53. Alternative A would affirm the consensus-for-exposure, which would address the concern that an entity may gross up the contract liability for a license to symbolic IP so that it can recognize more revenue after the business combination. The staff notes that the basis for conclusions would specify that the intent of the guidance is to address the measurement of a contract liability for a license to Page 17 of 20

18 symbolic IP, but the staff is concerned that this alternative could have significant unintended consequences if entities apply the guidance to other types of revenue contracts. 54. Alternative Aꞌ would clarify the purpose and intent of the acquired set guidance by including an example that illustrates the application of the acquired set guidance to a license to symbolic IP. However, the staff believes that an entity could still misapply the guidance to other types of revenue contracts even when there is an example that illustrates the intended application of the guidance. 55. Alternative B would address the staff s concerns with Alternative A and Alternative A because there would be no explicit guidance on the acquired set in the consensus-for-exposure. The staff believes that Alternative B would also address the concern that an entity may gross up the contract liability for a license to symbolic IP so that it can recognize more revenue after the business combination because clarification would be provided in an example. 56. Alternative C would reverse the consensus-for-exposure, which would address the staff s concerns with Alternative A and Alternative Aꞌ. Alternative C also would eliminate the inconsistency between measuring the fair value of other liabilities in a business combination that require the use of assets that were also acquired in the business combination (for example, leases). However, Alternative C would result in an acquirer grossing up the contract liability for a license to symbolic IP and therefore recognizing higher revenue after the business combination, which was a concern of some Task Force members at the June 2018 EITF meeting. This alternative also would be inconsistent with current practice for measuring a contract liability for a license to symbolic IP. Staff Recommendation 57. Based on the additional feedback received and the above analysis, the staff recommends Alternative B to remove the proposed guidance on the acquired set and include an example in the Implementation Guidance and Illustrations subsection of Subtopic (see Appendix A for proposed amendments based on the staff recommendation). The staff notes that this approach does not require explicit guidance on the acquired set in the consensus-for-exposure because the principle that the fair value of a contract liability should only include costs incurred after the business combination that are directly related to the acquired revenue contract is consistent with the measurement principles in Topic 805 and Topic 820. The staff also notes that feedback indicated that this principle is commonly used in practice by valuation specialists. The staff believes that providing an example of how to apply the principles in Topic 805 to a license to symbolic IP could address the concerns of some Task Force members that an entity may gross up the contract liability for a license to symbolic IP so that it can recognize more revenue after the business combination. The staff also believes that this approach would address the potential unintended consequences that were raised about the acquired set guidance. Page 18 of 20