Favourable contracts and order backlog are contract-based intangible assets recognised under IFRS 3 and ASC 805. They represent the contractual right to receive future economic benefits that exceed market terms (favourable contracts) or the contractual commitment of customers to purchase goods or services that have not yet been delivered (order backlog).
These assets are often overlooked in purchase price allocations because they tend to have short useful lives and relatively modest values compared to customer relationships or technology. However, in certain industries — construction, defence contracting, managed services, and enterprise software with large committed deal pipelines — they can represent a significant portion of the acquisition value.
Favourable contracts and order backlog are separate assets with different valuation considerations. Favourable contracts derive their value from terms that are better than current market conditions. Order backlog derives its value from committed future revenue. Both require careful coordination with the customer relationship valuation to prevent double-counting.
A contract is favourable when its terms are better than current market terms for an equivalent arrangement. The "favourability" is the excess of the contract's value over its market value — the premium the acquirer receives by inheriting a contract that no longer reflects current market pricing.
Common sources of favourability include:
| Source | Example |
|---|---|
| Below-market lease terms | Office lease at £30/sqft in a market now at £45/sqft |
| Above-market selling prices | Long-term supply agreement at prices above current market |
| Below-market procurement costs | Raw material contract locked in before price increases |
| Below-market licensing fees | IP licence at rates below current market royalty |
| Favourable employment contracts | Key personnel on below-market compensation packages |
The income approach is standard for favourable contracts. The value equals the present value of the excess economic benefit over the remaining contract term:
Identify the revenue or cost savings under the existing contract terms for each remaining period.
Estimate what the revenue or costs would be if the contract were negotiated today at current market rates.
The difference between the actual contract terms and the market-equivalent terms for each period.
Apply a discount rate that reflects the risk of the contracted cash flows — typically at or slightly below WACC, since contracted terms reduce uncertainty.
Unfavourable contracts — where terms are worse than current market conditions — should also be recognised separately as intangible liabilities. This is often forgotten but is required under IFRS 3 for material unfavourable arrangements. The liability offsets the favourable asset recognition and ensures the PPA accurately reflects the economics of the acquired contracts.
An order backlog is recognised as a separate intangible asset when there are firm, binding orders or contracts from customers for goods or services that have not yet been delivered at the acquisition date. The key word is "binding" — non-binding letters of intent, pipeline opportunities, and expected orders do not qualify.
Order backlog is valued using the income approach — specifically, the present value of the expected earnings from fulfilling the committed orders:
| Component | Source |
|---|---|
| Committed revenue | Order book or contract schedule |
| Cost to fulfil | Standard margins for the product/service |
| Fulfilment timeline | Expected delivery schedule |
| Discount rate | Low — contracted revenue carries minimal risk |
The discount rate for order backlog should be lower than for other intangible assets because the revenue is committed. A rate at or slightly below the risk-free rate is common for backlog with creditworthy customers and firm delivery schedules.
The useful life of order backlog equals the expected fulfilment period. A construction company with a 2-year project backlog has a 2-year useful life for that asset. A SaaS company with annual prepaid subscriptions has a backlog useful life of the remaining subscription term.
The most common error in valuing favourable contracts and order backlog is double-counting with the customer relationship asset. The customer relationship value represents the ongoing economic benefit from the customer base; the backlog represents specific committed transactions. If the backlog revenue is also included in the customer relationship cash flows, it is counted twice.
| Period | Customer Relationship MPEEM | Backlog |
|---|---|---|
| Backlog fulfilment period | Exclude backlog revenue | Include backlog revenue |
| Post-backlog period | Include all customer revenue | No value remaining |
This coordination is absolutely critical. In a SaaS business with 12-month prepaid subscriptions, the next 12 months of committed subscription revenue might be allocated to either the backlog or the customer relationship — but not both. The PPA team must decide the allocation before beginning either valuation.
Defence contractors often have multi-year order backlogs worth billions. These backlogs are highly valuable because they provide revenue visibility and are typically backed by government appropriations. The discount rate should reflect the creditworthiness of the government customer (effectively risk-free) but should include a premium for programme execution risk.
Construction backlogs represent committed projects with defined scope, timeline, and pricing. The value depends heavily on the margin embedded in the contracts. A large backlog with thin margins may have less value than a smaller backlog with healthy margins.
SaaS backlogs include committed subscription revenue from existing contracts. Annual and multi-year contracts create backlog; monthly subscriptions generally do not because they can be cancelled at any time.
Long-term outsourcing and managed services contracts create significant backlogs with useful lives of 3-7 years. These backlog values can be substantial — particularly for contracts with committed minimum revenue levels.
Favourable contracts and order backlog are distinct intangible assets that deserve careful valuation — especially in industries where committed revenue represents a significant portion of enterprise value. The critical discipline is coordination: ensure that backlog revenue is not double-counted in the customer relationship valuation, and that both favourable and unfavourable contract terms are recognised. The Opagio Calculator models backlog and favourable contract valuations with automatic coordination against customer relationship cash flows. Start your PPA analysis.
Tony Hillier is an Advisor at Opagio with 30 years of experience in structured finance, M&A advisory, and asset valuation. His career at NM Rothschild involved structuring transactions around long-term contract portfolios across multiple industries. Meet the team.
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