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1. Initial classification
In simple terms, this is a fixed number of
How should the initial classification shares for achieving a specific outcome.
be determined when the contingent
consideration is based on the buyers Arrangements settled in a variable
shares? number of the buyer's shares are likely
to be classified as liabilities.
Classification is one of the most
important issues in accounting for An arrangement could involve a number
contingent consideration. The initial of performance targets, each with its own
classification may significantly impact potential share award. This arrangement
post-acquisition profit or loss. Fair value may still be classified as equity but only
changes from period to period of liability- if the arrangement is deemed to be a
classified arrangements will introduce an series of separate contracts for each
element of post-acquisition income performance target within that overall
statement volatility. contract rather than one overall contract.
No
Step 2: Payment in cash or another Yes
financial instrument?
No Financial liability
Yes
Step 3: Number of shares based on a
fixed amount? No
No
Yes Step 5: Multiple targets exist each with
Step 4: Overall arrangement results in a
variable number of shares? a fixed number of own equity shares?
No Yes
Equity Must assess if each
target can be viewed as
a separate contract1
1 Judgment is required to determine whether the unit of account should be the overall contract or
separate contracts within the overall arrangement. Refer to example 1.3 and 1.4.
A B C
Revenue forecast Probability weighted
(C millions) Probability Payment in shares number of shares
350 30% 0
450 45% 0
550 20% 2,000,000 400,000
650 5% 2,000,000 100,000
Total 500,000
C Probability weighted shares 500,000
D Share price 15
E Probability weighted value 7,500,000
F Acquirers cost of equity 15%
G Dividend year 1 125,000
G Dividend year 2 125,000
H Present value of dividend cash flow 203,214
I Present value of contingent consideration 7,296,786
C = sum of (A x B) G = 0.25 x C I = E-H
1The required rate of return on dividends would likely be less than the cost of equity in many cases
C = sum of (A x B)
E = 0.25 / 15
G = D x (1 + (F E))
H=CxG
I = H / (1 + F)
No
Step 1: Subsequent shares or cash No further analysis required
payments to selling shareholder(s)?
Yes
No
Step 2: Selling shareholder(s) provide(s) Consideration
services to buyer post-acquisition?
Yes
Yes
Step 3: Commercial substance of payment
Remuneration
arrangement explicitly or implicitly requires
continued services?
No
Period of employment same as, Duration of continuing Period of employment is less than
or longer than, contingent employment. the contingent payment period.
payment period.
Unreasonably low compared to Level of remuneration Reasonable or high compared to
other key employees. (excluding contingent other key employees.
payment).
Selling-shareholders who do not Incremental payments Selling-shareholders who do not
become employees receive fewer to employees. become employees receive
contingent payments (on a per- similar contingent payments (on a
share basis). per-share basis).
Selling-shareholders owned Number of shares Selling-shareholders owned a
substantially all of the shares in owned. small part of the business, and all
the acquiree (profit sharing in shareholders receive the same
nature). contingent payments (on a per-
share basis).
Acquisition-date consideration is Linkage to the valuation Acquisition date consideration is
at high end of valuation range, and formula for at low end of valuation range, and
and contingent formula is determining contingent formula relates to
consistent with profit-sharing. consideration. valuation approach.
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