Accounting Help - deferred revenue adjustment

August 08, 2019

by a searcher from University of Pennsylvania - The Wharton School in San Francisco, CA, United States

Hi I am working with a broker to try and understand a deferred revenue adjustment. The business is cash and sells prepaid contracts in which 70% of costs are incurred in the first year. The broker is arguing to only amortize 30% of the revenue which seems wonky, but I could really use a CPA to help me look at this issue and eventually work with us on a QOE once this is signed up. Leave a comment and I will message you back.

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Reply by a searcher
from Harvard University in San Francisco, CA, USA

Recovered/inactive CPA here. This sounds like a stock purchase if you're inheriting deferred revenue. If so, you've identified your risk that you will need to fulfill obligations for which the seller has already received all of the cash. I'd take a step back from the accounting aspects of this and just figure out the relationship between all of the outstanding obligations you would inherit vs what has already been paid (which it sounds like you're nearly there) and then adjust purchase price accordingly. For ex: using your numbers, if this business only had 1 customer on a 2-year contract and you were buying the business at the end of year 1, where 70% of the costs have been incurred, then the seller has already "earned" 70% of the contract and you'd expect to assume 30% of the cost of that contract while the seller has already received 100% of the cash. You should seek to somehow be compensated for that 30% via purchase price or working capital adj. Feel free to email me if I need to clarify or can otherwise be helpful. Good luck

Reply by an investor
from Western Washington University in Key West, FL 33040, USA

It sounds like you may have found a good company. Businesses where customers pay in advance are great. The faster you grow the more cash you will have flowing in the door. Not quite sure I understand your questions. It sounds like either the broker is trying to argue some of the deferred revenue should go to the seller or you should increase the purchase price for the deferred revenue on the books? There should not be any deferred revenue adjustment. All cash on the books for services to be provided in the future (i.e. deferred revenue) by you should come with the business and should NOT add to the purchase prices. That is your future revenue and you will have to provide that service, and thus that is future income that you are already paying a multiple for. Adding it to the purchase price would be double-counting. Letting the seller keep it means that you would be providing future services at a loss. The great news is you won't need much if any working capital for this deal. Good luck.

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