Merger model question - Deferred revenue write-down
Hi all,
Have a question pertaining to the merger model.
1) Why is there a need to write-down the value of deferred value to avoid "double-counting" revenue?
From an accounting perspective, given that Dr and Cr should all balance, I don't see how a double counting can arise. Please see entries below:
Step A - Upon receipt of cash
Dr Cash
Cr deferred revenue
Step B - Upon performance of service
Dr Deferred revenue
Cr revenue
2) How exactly do you write-down this deferred revenue? I had a look at (https://www.macabacus.com/merger-model/deferred-r…). It seems like they charged the write-down to the income statement (see final product here: https://www.macabacus.com/merger-model/perpetuity…). But I can't figure out whether the corresponding leg went to.
Also, given that we would be Dr Expense and Cr XXX
I fail to see how the Cr would "write-down" the deferred revenue given that itself is a Cr balance. See Step A above.
Many thanks!
You are oversimplifying deferred revenue. It isn't always about cash and unperformed services. Could be the recognition was deferred due to questions about collectability or in TMT a lack of vendor specific objective evidence that supports the valuation and recognition of certain streams of a multiple element contract. Or it could be that the services were performed and cash was collected but the client hasn't formally accepted delivery or signed off on software or equipment meeting customized requirements.
As is the case with assets in an acquisition, you also have to measure the assumed liabilities at fair value. If there is no future performance obligation or the acquirer has VSOE that remeasures the amount booked, you have to take that into account.
You are confusing the timing of the journal entries. These adjustments are made during purchase price allocation and will impact goodwill.
Hi dr.copper,
Thanks for the clarification. I am clear about question 1 but don't really understand question 2 still.
If I could trouble you to look at the model, see GAAP tab (https://www.macabacus.com/merger-model/perpetuity-growth-method), the purchase price allocation section does not factor into account the deferred revenue adjustments.
Thanks!
bump
Merger Model Question: Deferred Revenue Write-Down (Originally Posted: 10/26/2015)
Hi WSO Community,
I had a question about the impact of Deferred Revenue Write-Downs through the three financial statements following the transaction.
From reading various accounting journals, I understand that deferred revenue is written down due to Fair Market Valuation (e.g., a bottoms-up approach for costs with an additional profit margin) differing from the book balance. However, what line items change in the financial statements once the Deferred Revenue Write-Down occurs? I understand deferred revenue would decrease, but what other line items are affected?
I have seen from the Maccabus model that the write-downs affect the Income Statement, but would they affect the COGS/OPEX line items or be below EBIT?
Let's say amount of write-down is $10M..
IS: Write down of $10M above the line; tax shield of $4M; so net change is -$6M CF: you add back the write down since it is a paper loss; net change in cash ceteris paribus = +$4M BS: Assets: Cash goes up $4M; Liab: Deferred revenue goes down $10M; SE: down $6M of retained earnings
Balance sheet now balances $4M on asset side and $4M on SE and Liab side.
This is just like a merger model question I got. I believe you are absolutely right. To add to the last question. i believe it should appear in the non recurring expense section like restructuring and the like of the income statement. It might appear below EBIT and you can have adjusted EBIT to normalize operation of the business.
I appreciate the response! And I think you are right about the write-downs affecting EBIT, I see a Q&A-related post about this subject from M&I.
For the Income Statement, would you happen to know which line item these write-downs are typically embedded in? In reading through a few companies' filings and the pro-forma statement of operations, I noticed that deferred revenue write-downs are added back often to either the (1) net/revenue line item, (2) COGS, and/or (3) OPEX.
Does this mean that the Deferred Revenue Write-Offs affect the income statement by: (1) lowering imputed revenue due to the deduction in Deferred Revenue, (2) increasing COGS, and (3) increasing OPEX? And why would companies break up these write-offs into multiple items?
Sorry for the long question and appreciate the help!
Quick question--How does the balance sheet balance if Assets are UP by $4M, but Liab DOWN by $10M and SE DOWN by $6M?
Just a follow-up on this topic, I might be missing something but it's still not too clear how a deferred revenue haircut affects all three financial statements and ends up with a balanced BS.
From what I've researched:
1) Deferred Revenue write-down is done after the transaction closes and is not included in the "initial" pro forma Balance Sheet "Note that the new goodwill creation, intangibles write-up, PP&E write-up, new deferred tax liability creation, and write-down of the deferred tax asset all occur “at the instant” of the transaction, whereas deferred revenue is written down after the transaction closes." from: Breaking into Wall Street Merger Model Cheat Sheet -
2) DR write-down is not included in the Purchase Price Allocation and doesn't affect Transaction DTL see rows 35-49 and 71-81 from "GAAP" tab from Macabus merger model (the perpetuity growth linked in earlier posts)
3) DR write-down affects Income Statement either on top-line or as an expense (see row 47 from "PF P&L" tab from Macabus model and public filings This doesn't quite match what was mentioned in earlier posts about a pre-tax gain.
4) Haircut is an accounting adjustment, not really affecting cash.
Given these assertions, how does a haircut flow through the pro forma statements? I'm currently stuck in the following steps:
Assumptions: - Haircut of DR of $20M - Let's assume no taxes to make it easier
IS: -$20M decrease either on revenue or as expense, resulting in -$20M change on net income CF: -$20M from net income; add back +$20M since not a cash expense; changes from Deferred Revenue on BS don't affect Changes in Working Capital line item since it's an accounting adjustment. Results in net change of $0M. BS: -$20M decrease on DR liability; -$20M on shareholder's equity from net income; cash increased by $0M. This results in an unbalanced BS (-$40M difference on right side of BS)
What am I missing?
Deferred revenue is a cash inflow but doesn't meet the criteria for revenue recognition. This results in a liability. According to ASC 805, all assets and liabilities assumed in a transaction are to be recorded at FV. A write down of the liability increases earnings which is offset by an increase in retained earnings.
If, in an acquisition, it's determined that the fair value of the DR is less than its recorded value, the impact would be to goodwill (less goodwill).
Does this answer your question or no?
Thanks for the help - I'm struggling with this for a while. So, in an acquisition:
1) DR haircut affects Goodwill? If so, it happens in the Purchase Accounting? (isn't this in contradiction with BIWS's comment that "DR write down happens after the transaction closes" and Macabus model?)
2) "A write down of the liability increases earnings which is offset by an increase in retained earnings." Wouldn't a DR write down lower revenues and therefore reduce earnings? (I can't post a link but if you google for "HEALTHSTREAM ANNOUNCES FOURTH QUARTER & FULL YEAR 2016 RESULTS", that's a filing where DR haircut reduces Net Income.)
1) Yes, the fair value of assets and liabilities assumed in an acquisition, in connection with the purchase consideration, impacts goodwill. Higher asset value = less goodwill and vice versa. A marked-down liability increases goodwill. This is only in the context of a transaction.
2) Your income rises as you earn the unearned revenue. The liability declines and it's offset by an increase in retained earnings. I'll look into that post to see what it's in reference to.
I've read the article you linked to. I see the dilemma. Might make sense to reach out to a CPA for info. I think the disconnect might be between reported revenue and forecasted (pro forma) revenue.
bump
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