Contingent consideration definition
/What is Contingent Consideration?
Contingent consideration is an obligation of the acquiring entity to transfer additional assets or equity interests to the former owners of an acquiree. The amount of this consideration can be significant, depending on the subsequent performance of the acquiree. The terms under which this consideration will be calculated and paid is part of the acquisition agreement. The consideration will only be paid if specified future events occur or conditions are met.
Advantages of Contingent Consideration
There are several advantages to the use of contingent consideration, which are as follows:
Price reduction. A buyer can use it to avoid paying too much for a target company. If the buyer suspects that the seller’s forecasts are too high, then achieving the forecast can be tied to contingent consideration.
Reduced cash payout. The buyer does not need to pay as much cash up-front. Instead, some of the purchase price is delayed until the actions tied to the contingent payment are achieved.
Seller incentive. The prospect of an additional payout at a later date is an excellent incentive for the sellers to continue working for the business after it has been sold.
Accounting for Contingent Consideration
Contingent consideration is recognized at the acquisition date as part of the purchase price in a business combination. It is initially measured at fair value based on expected future outcomes. Liability-classified contingent consideration is remeasured at fair value each reporting period with changes recognized in earnings. Equity-classified contingent consideration is not subsequently remeasured.
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FAQs
What is the difference between contingent consideration and deferred consideration?
Contingent consideration depends on the occurrence of future events, such as performance targets or milestones, and is measured based on expected outcomes. Deferred consideration is a fixed amount that is payable in the future regardless of performance or other conditions. As a result, deferred consideration involves timing risk, while contingent consideration involves outcome uncertainty.