Identify when the contingent consideration in an acquisition is based on the acquirer issuing its shares to the seller, and tell how it should be contingency be reflected on the acquisition date.
Explanation of Solution
At the time of acquisition date, fair value of contingent consideration should be recorded on the parent’s books in any case of whether stock or cash is used to reconcile the earnout.
- Whether contingent consideration is classify as a liability or as equity depends on the feature of earnout. Earnouts are settled with a fixed number of shares will be classified as equity, if the earnout objective is based only on the buyer’s operations and cannot be based on any external index or comparisons with other companies or industries.
- If earnout is settled with a variable number of shares, equity classification is possible if the earnout is based on the parent’s stock price. Conversely if the number of shares offered in earnout is inversely associated to the parent’s stock price, the earnout would be classified as a liability.
Changes in the value of stock earnouts classified as a liability will be affected in earnings, whereas changes in the value of the stock earnouts classified as equity are not re-measured.
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