Beware of Disappearing Revenue in an Acquisition
Buying a technology company? Be careful--an accounting rule might dramatically reduce your company's revenue in periods after the acquisition. [ILLUSTRATION OMITTED] These days, it seems as if everyone wants to be a technology company--or to merge with one. Global merger-and-acquisition (MA the proprietary database has been created and does not require additional customization or other effort from Software Inc. to meet customers' needs. In the example, Software Inc. would recognize $120 of cash and deferred revenue on the first day of the contract. Software Inc. would then recognize $10 per month of revenue from this customer over each month of the one-year service period. For example, if the customer's subscription started on Jan. 1, at the end of April, Software Inc. would have recognized $40 of revenue in its income statement for the four months that ended April 30 and have $80 of deferred revenue on its April 30 balance sheet. In the ordinary course of business, a financial statement user would expect Software Inc. to have $80 of revenue over the next eight months (May through December). But what happens if Software Inc. underwent a change in control and was required to apply business combination accounting rules on May 1? When accounting for a business combination, liabilities (and assets) are generally recognized at fair value on the acquisition date (FASB ASC Paragraph 805-20-30-1). On May 1, the fair value of this deferred revenue would be minimal. As a result, the $80 of revenue that--under normal circumstances--would have been recognized from May to December will not be fully recognized by Software Inc. As part of the purchase accounting, the deferred revenue would be adjusted to fair value, which may be somewhere between $0 and $80, most likely closer to $0. As a result, the post-acquisition revenue would be much less than the original $80 in deferred revenue (see the sidebar, "Where Did the Revenue Go?"). THE BROADER ISSUE This issue can affect any entity acquired in a business combination that normally has deferred revenue--including technology companies and many service and telecommunications businesses. …