It is a sort of payment known as contingent consideration is one that is made in a commercial combination, but only if specific requirements are completed. For instance, if the firm being purchased achieves specific financial goals within a given time frame, the acquiring corporation may agree to earn additional compensation.

Contingent consideration is accounted for on the acquirer’s balance sheet as a liability. This requires the acquirer to calculate the contingent consideration’s fair value and account for it as a liability on its balance sheet. The chance that the requirements for payment will be satisfied determines the fair value of the contingent consideration, which is commonly calculated using a discounted cash flow analysis.

Liability is updated to reflect altered probability of payment as requirements for payment of contingent compensation are satisfied. For instance, the obligation for contingent consideration would grow to reflect the greater chance of payment if the acquired firm accomplishes its financial goals and the probability of payment rises.

Here is an illustration of how contingent consideration may be taken into account in a company merger:

  • Under the terms of the acquisition agreement, Company B is entitled to an additional payment of $100,000 if certain financial targets are met within the following year.
  • Based on the likelihood that the financial targets will be met, the fair value of the contingent consideration is estimated to be $50,000.
  • Company A purchases 100% of the outstanding stock of Company B for $500,000;

In this example, the following journal entry would be made to record the acquisition and the contingent consideration:

In this case, the acquisition and the contingent consideration would be recorded using the following journal entry:

Cash ($500,000) is debited. Debit: Purchased assets ($450,000) Credit: $50000 worth of Company B stock Credit: Assumed Liabilities ($450,000) Debit: $50,000 in contingent consideration

This journal entry reveals that $50,000 of contingent consideration was recorded as a liability on the balance sheet and that the purchaser, Company A, paid $500,000 to acquire the assets and liabilities of Company B. The obligation will be modified to reflect the updated probability of payment as the requirements for payment of the contingent consideration are satisfied.

In conclusion, contingent consideration is sort of payment paid in a commercial combination, but only if particular requirements are completed. It is accounted for as a liability on the acquirer’s balance sheet, and the likelihood that the terms of payment will be satisfied is used to assess its fair value. When generating their financial statements, businesses should adhere to the pertinent accounting rules and principles since accounting for contingent consideration can be complicated.