Contingent Consideration in Accounting (2024)

FAQs

What is contingent consideration in accounting? ›

Contingent consideration, also known as an earn-out, is a form of consideration in an acquisition in which the acquirer agrees to pay additional cash consideration or equity interests to the former owners (sellers) if certain future events occur.

For event-related contingent consideration where systematic / market risk is zero, valuing contingent consideration can be as simple as estimating the cash flows that result from the event, the probability of the event occurring, and an estimate of the counterparty credit risk.

IFRS 3 defines contingent consideration as: 'Usually, an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met.

The key here is that the fair value of the contingent consideration will be given to you in the exam. Assuming that no amounts have already been recorded by the parent company, this needs to be included in the goodwill calculation on the date of acquisition with the double entry Dr Goodwill, Cr Provision.

Pending lawsuits and product warranties are common contingent liability examples because their outcomes are uncertain. The accounting rules for reporting a contingent liability differ depending on the estimated dollar amount of the liability and the likelihood of the event occurring.

Definition: A contingent liability is defined as a liability which may arise depending on the outcome of a specific event. It is a possible obligation which may or may not arise depending on how a future event unfolds. A contingent liability is recorded when it can be estimated, else it should be disclosed.

Contingent considerations should be recorded on the date of acquisition. They'll be listed at fair value either as a liability or equity. In most cases, you'll recognize the consideration as a liability. However, if a fixed number of shares is involved, the consideration would qualify as equity.

Contingent consideration generally represents an obligation of the acquirer to transfer additional assets or equity interests to the selling shareholders if future events occur or conditions are met.

In the case of contingent consideration, fair value represents the amount the reporting entity would have to pay a hypothetical counter-party to transfer responsibility for paying the contingent liability. This amount is basically the present value of the probability-weighted expected amount of the future payment.

Assuming that the loss contingency is “probable” and can be reasonably estimated, then a journal entry should be recorded to accrue the liability. The journal entry would be to debit legal expense and credit to record the legal liability.

Is contingent consideration taxable? ›

The settlement of contingent consideration in a nontaxable business combination often will be added to the outside tax basis as part of the amount paid for the acquiree.

Contingent assets are possible assets whose existence will be confirmed by the occurrence or non-occurrence of uncertain future events that are not wholly within the control of the entity. Contingent assets are not recognised, but they are disclosed when it is more likely than not that an inflow of benefits will occur.

An acquirer may obtain the right to receive contingent consideration from an acquiree that previously was the seller of a business. The acquirer should account for that acquired right to receive (or obligation to pay) contingent consideration as an asset (or liability) arising from a contingency (see Section 4.3. 6).

Consideration transferred is the sum of the acquisition-date fair values of: the assets transferred by the acquirer. the liabilities incurred by the acquirer to former owners of the acquiree. the equity interests issued by the acquirer in exchange for the acquiree.

Once valuation experts identify a contingent liability, they must assign a value to it based on estimates of their probability and dollar amount. In other words, how likely is it to occur, and what will the damage be to the company's value if it occurs?

An example of a contingent payment sale may occur when a company is under contract to purchase another company, but the sale will be completed several months out. The final sale price of the target company will be determined by the target company's sales for the remainder of the year.

Contingent assets are assets dependent on non-operating assets' performance. For example, a tract of land used for farming could be classified as a contingent asset. The value of the land is determined by the crops produced and sold. If the crops are good, the value will increase; it will decrease if they're not good.

Many business combinations include contingent consideration, often referred to as an 'earn-out clause' and defined as an obligation of the acquirer to transfer additional assets or equity interests to the acquiree's former owners if specified future events occur or conditions are met.