2.6 Contingent Consideration in a Business Combination

In business combinations, the parties often agree to contingent consideration (i.e., consideration that depends on future events or conditions). Contingent consideration arrangements permit the parties to proceed with a business combination without agreeing on the final purchase price. For example, the acquirer may agree to deliver a specified number of its own equity shares if the acquiree’s earnings exceed a specified target in the year after the combination. Other examples of events that may trigger contingent consideration payments include reaching a specified stock price or achieving a milestone in a research and development project.

In determining the appropriate classification of a contingent consideration arrangement, the acquirer considers the classification guidance in ASC 480 and any other applicable guidance (e.g., ASC 815-40). To measure the arrangement, however, the acquirer applies ASC 805-30 instead of ASC 480. Contingent consideration is part of the total consideration transferred for the acquiree and must therefore be measured and recognized at fair value as of the acquisition date under ASC 805-30. ASC 805-30-35-1 provides guidance on how to recognize changes in the fair value of contingent consideration other than measurement-period adjustments. Contingent consideration classified as equity is not remeasured, and its settlement is recognized in equity. Contingent consideration classified as an asset or liability is remeasured to fair value in each reporting period, with changes in fair value recognized in earnings, unless it qualifies for recognition in other comprehensive income under the hedge accounting guidance in ASC 815 (which would be unusual).

Under ASC 805, the acquirer recognizes as revisions to goodwill those adjustments made during the measurement period that pertain to facts and circumstances that existed as of the acquisition date. The acquirer must consider all pertinent factors in determining whether information obtained after the acquisition date should result in an adjustment to the provisional amounts recognized or whether that information stems from events that occurred after the acquisition date. For example, if earnings targets are met, share prices change, or FDA approvals are obtained after the acquisition date, resulting changes in fair value are recognized in earnings and not as adjustments to goodwill.