Acquired sales backlog

What Is Acquired Sales Backlog?

Acquired sales backlog refers to the portion of a company's order book or unfulfilled customer contracts that is recognized as an asset or liability on the balance sheet following a business combination. In financial accounting, specifically under the acquisition method, when one company acquires another, the acquirer must identify and measure all assets acquired and liabilities assumed at their fair value as of the acquisition date. This includes the acquiree's existing customer contracts and related future revenue streams.¹⁴, ¹⁵

This concept falls under the broader category of financial accounting, particularly concerning the intricacies of mergers and acquisitions (M&A). The process involves a detailed analysis to determine the value attributable to these future sales, which may be adjusted from the acquiree's original recorded amounts for deferred revenue or unbilled receivables. It is distinct from organically generated backlog because its recognition is driven by the accounting rules governing business combinations.

History and Origin

The accounting treatment for acquired sales backlog is rooted in the evolution of accounting standards for business combinations. Historically, different methods like "pooling-of-interests" and "purchase accounting" were used. However, with the issuance of Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, by the Financial Accounting Standards Board (FASB) in 2001 (later codified into ASC 805), the acquisition method became the sole method for accounting for business combinations.¹², ¹³ This standard mandated the recognition of identifiable intangible assets, including customer-related intangibles like acquired sales backlog, at their fair value.

Subsequent updates, such as ASU 2021-08, further clarified how an acquirer should recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606, Revenue from Contracts with Customers.¹¹ The Securities and Exchange Commission (SEC) also provides interpretive guidance on business combinations through its Staff Accounting Bulletins (SABs), emphasizing proper accounting and disclosure practices.⁸, ⁹, ¹⁰

Key Takeaways

• Acquired sales backlog is the fair value of unfulfilled customer contracts recognized after a business acquisition.
• It is a result of applying the acquisition method of accounting for business combinations, where assets and liabilities are recorded at fair value.
• This backlog may be treated as a contract asset or contract liability depending on whether payment has been received or is due.
• The valuation considers remaining performance obligations and associated profitability.
• Proper accounting for acquired sales backlog impacts future revenue recognition and the acquirer's financial statements.

Formula and Calculation

The valuation of acquired sales backlog, as part of customer-related intangible assets, often employs an income approach, such as the Multi-Period Excess Earnings Method (MPEEM) or the Distributor Method.⁷ While there isn't a single universal formula, the core principle involves calculating the present value of the future cash flows expected from fulfilling the acquired contracts.

For illustrative purposes, the general idea of valuing the remaining performance obligations (the backlog) involves:

Where:

• (\text{Projected Revenue}_t) = Estimated revenue from fulfilling the acquired backlog in period (t).
• (\text{Projected Costs}_t) = Estimated costs directly associated with fulfilling the acquired backlog in period (t). This might include cost of goods sold, direct labor, and fulfillment expenses.
• (r) = The appropriate discount rate that reflects the risks associated with the cash flows, often a weighted average cost of capital or a return on assets.
• (N) = The remaining term over which the backlog is expected to be fulfilled.

This calculation considers the remaining performance obligations as defined under revenue recognition standards and discounts the expected net cash inflows.

Interpreting the Acquired Sales Backlog

Interpreting acquired sales backlog involves understanding its impact on financial reporting and future performance. When a company acquires a business, the purchase price allocation process requires assigning the total consideration transferred to the identifiable assets acquired and liabilities assumed, including acquired sales backlog.⁶

If the acquiree had a substantial order book or contracts where performance obligations had not yet been met, and particularly if advance payments were received, the acquirer may recognize a "contract liability" (often referred to as deferred revenue) or a "contract asset" (unbilled revenue) related to this backlog. The key is that the fair value allocated to this backlog might be less than its contractual face value if, for example, the acquirer expects to incur significant costs to fulfill the obligations or if there are uncertainties regarding customer retention or contract completion. Understanding this valuation is critical for analysts assessing the true profitability and future revenue streams of the combined entity.

Hypothetical Example

Assume TechSolutions Inc. acquires SoftwareCo for $500 million. SoftwareCo has existing customer contracts with a total future revenue value of $100 million. However, based on an independent valuation, the fair value of this acquired sales backlog is determined to be $80 million, reflecting estimated future fulfillment costs and a discount for the time value of money.

On the acquisition date, TechSolutions records the $80 million as a contract liability (or deferred revenue) on its balance sheet, effectively "writing down" the face value of the backlog by $20 million. As TechSolutions fulfills these contracts over time, the $80 million will be recognized as revenue on its income statement.

For example, if in the first year after the acquisition, TechSolutions fulfills $30 million of this acquired backlog, it will recognize $30 million in revenue. The remaining $50 million will stay on the balance sheet as a contract liability to be recognized in future periods. This demonstrates how the initial fair value adjustment impacts the timing and amount of recognized revenue post-acquisition, distinct from SoftwareCo's pre-acquisition revenue recognition practices.

Practical Applications

Acquired sales backlog plays a crucial role in mergers and acquisitions (M&A) due diligence and post-acquisition accounting. Analysts and investors pay close attention to how this backlog is valued and recognized, as it provides insight into the quality of the acquired entity's customer base and future revenue certainty. Companies performing M&A must ensure robust processes for identifying and valuing these intangible assets.

Moreover, the proper accounting for acquired sales backlog is a significant area of focus for regulatory bodies like the SEC. The SEC often reviews the allocation of consideration in business combinations, including the valuation of acquired intangible assets and liabilities, to ensure compliance with U.S. Generally Accepted Accounting Principles (GAAP).⁴, ⁵ Understanding the nuances of acquired sales backlog helps companies align their financial reporting with these requirements and provides transparency to stakeholders regarding the future performance of the combined entity. Effective integration strategies post-acquisition are also vital to maximize the value derived from this backlog.

Limitations and Criticisms

While essential for accurate financial reporting, the accounting for acquired sales backlog and other intangible assets in business combinations can present challenges and draw criticism. One primary limitation is the inherent subjectivity in determining the fair value of such assets. Valuation models often rely on future projections, discount rates, and assumptions about customer retention and fulfillment costs, which can be difficult to estimate accurately.³ Discrepancies between estimated fair value and actual future performance can lead to later adjustments, impacting reported earnings per share.

Another criticism arises when the fair value of the acquired backlog is significantly lower than its contractual amount, effectively creating a "haircut" on future recognized revenue from existing contracts. This can obscure the underlying operational performance of the acquired business post-acquisition, as the recognized revenue stream is lower than what the acquiree would have recorded. Furthermore, maintaining customer relationships through a merger is critical, as a decline in customer loyalty can directly diminish the value of the acquired backlog.¹, ²

Acquired Sales Backlog vs. Unearned Revenue

Acquired sales backlog and unearned revenue are closely related concepts in accrual accounting, but they arise from different contexts and have specific nuances in business combinations.

While acquired sales backlog is often recorded as a form of deferred revenue (a liability representing payments received for goods or services not yet delivered), its key distinction lies in the revaluation process at the time of acquisition. The acquirer must assess the fair value of the acquired entity's unfulfilled contracts, which may differ from the acquiree's book value of unearned revenue. This revaluation is a critical step in the acquisition method to ensure all acquired assets and liabilities are recorded at their current economic value.

FAQs

What is the primary difference between existing backlog and acquired sales backlog?

Existing backlog is typically generated by a company's ongoing operations, representing orders received but not yet fulfilled. Acquired sales backlog specifically refers to the backlog that an acquiring company takes on as part of a business combination, and it is revalued to its fair value at the acquisition date according to accounting standards.

How does acquired sales backlog affect a company's financial statements?

Acquired sales backlog is initially recorded on the acquirer's balance sheet at its fair value, often as a contract liability (deferred revenue) or, less commonly, a contract asset. As the acquiring company fulfills the underlying contracts, this amount is recognized as revenue on the income statement over time. It can also impact working capital calculations.

Is acquired sales backlog always a liability?

No, while it is often recorded as a contract liability (deferred revenue) because the acquired company may have received payments in advance for services not yet rendered, it could be a contract asset if the performance obligations are met before payment is due. The classification depends on the specific terms of the acquired contracts and the application of revenue recognition principles.

Why is fair value used for acquired sales backlog instead of the original contract value?

Accounting standards, particularly ASC 805 on business combinations, mandate that all assets acquired and liabilities assumed in an acquisition be recognized at their fair value on the acquisition date. This is because the acquisition is considered a new accounting basis for the assets and liabilities, and fair value best represents their current economic worth to the acquirer, considering factors like future costs and risks.

Does acquired sales backlog impact goodwill?

Yes, indirectly. During a purchase price allocation, if the total consideration paid for the acquired company exceeds the fair value of all identifiable net assets acquired (including acquired sales backlog and other intangible assets), the residual amount is recognized as goodwill. Therefore, the valuation of acquired sales backlog directly influences the amount of goodwill recorded.