How do you account for contingent consideration in a business combination?

Full Explanation

Contingent consideration — such as earnouts, milestone payments, or performance-based adjustments — is a common feature of business acquisitions, particularly in technology and life sciences. Under IFRS 3, contingent consideration must be recognised at its acquisition-date fair value regardless of the probability of payment. This means even low-probability earnouts must be valued (often using probability-weighted scenarios or option pricing models) and included in the total purchase consideration. Subsequent measurement depends on classification: if the contingent consideration is classified as a financial liability (most common), it is remeasured to fair value at each reporting date with changes in profit or loss. If classified as equity (rare — only when it meets strict IAS 32 criteria), it is not remeasured. Under US GAAP ASC 805, the treatment is similar for liability-classified contingent consideration, but equity-classified contingent consideration is not remeasured — a key difference from IFRS. The implications for intangible asset valuations are significant: higher contingent consideration increases the total purchase price, which either increases identifiable intangible asset values or goodwill (or both). Earnout structures tied to specific intangible asset performance (e.g., technology milestones) may also provide evidence supporting the valuation of those specific assets.

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