In accounting terms, deferred revenue is simply the cash received in advance of recognizing revenue because the seller still needs to fulfill on the deal, such as deliver the goods or perform some service. It’s a liability—common examples are prepaid subscriptions, license agreements, gift cards, and the like. Under ASC 805, acquired liabilities are measured at fair value in a business combination. Typically, the fair value of deferred revenue is less than its book (accounting) value—but how much less? Is there a common range of percentage reductions? That was one of the questions asked of the speaker during a recent BVR webinar on valuing deferred revenue.
Do your homework: “The haircuts are all over the board,” says Ray Rath (Globalview Advisors), and the reduction depends on the facts and circumstances in each case, so he urges valuation analysts to examine what makes up deferred revenue, in terms of types of revenue, terms, clients and other factors. Rath did mention that a firm that had deferred revenue on gift cards reduced book value by 50%, because many people don’t cash them in. Of course, there are items of deferred revenue that are much more complex, such as customer contracts with multiple elements and performance obligations.
In the supplemental reading material for the webinar, an article on the IT industry states that reductions between 40% and 70% are not uncommon. In some acquisitions, Oracle had reported the fair value of deferred revenue at a 60% reduction to book value. The article is “Deferred Revenue in the IT Industry,” from the August 2012 issue of Business Valuation Update.
During the webinar, Valuing Deferred Revenue, Rath also discussed the new revenue recognition rules, the methods of valuing deferred revenue (he prefers the bottom-up approach), and the published guidance on the topic.
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