Question

20. If there is contingent consideration in an acquisition, where the total amount paid will depend on the future earnings of the acquired company, as of the acquisition date what would be the amount of the liability, if any, shown in the consolidated financial statements?

a. Zero, since the amount is not yet known

b. The minimum that could contractually be paid

c. The fair value of the consideration, which would normally be the present value of the expected amount to be paid

d. The maximum that might contractually be paid.

Answer 1

Contingent consideration often involves the buyer transferring additional consideration to the seller if certain performance targets are met in the future. This allows the buyer to share the risk associated with the future of the business with the seller by making some of the consideration contingent on future performance

Valuation methods for contingent consideration range from discounted cash flow analyses to more complex Monte Carlo simulations. The terms of the arrangement and the payout structure will influence the type of valuation model the acquirer uses. Most valuation methods require an approach incorporating some form of option pricing techniques to incorporate the potential variability in outcomes

Contingent consideration is classified as a liability or equity and is measured at fair value on the acquisition date. Contingent consideration that is classified as a liability is remeasured to fair value at each reporting date, with changes included in the income statement in the post-combination period. Contingent consideration that is classified as equity is not remeasured in the post-combination period

In the particular question, the answer is c

The fair value of the consideration, which would normally be the present value of the expected amount to be paid