How contingent consideration in business combinations is measured and remeasured under IFRS 3 and ASC 805

In many acquisitions, part of the price is deferred and depends on future performance—earnouts, milestone payments, or seller notes tied to EBITDA, revenue, users, or regulatory approvals. Under IFRS 3 and ASC 805, contingent consideration is recognized at fair value on the acquisition date and then tracked through either profit or loss or equity, depending on how it will be settled and whether post-combination changes are measurement-period adjustments or true subsequent remeasurements.

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How contingent consideration structures create accounting complexity

Deals commonly include:

• Cash or share earnouts based on post-combination metrics over 1–3 years.

• Regulatory or milestone payments in life sciences triggered by trial phases or approvals.

• Seller retention instruments that look like earnouts but actually compensate post-combination service—these are compensation under IFRS 2/ASC 718, not contingent consideration.

Contract terms drive classification, initial fair value, and where subsequent changes hit the financial statements.

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Acquisition-date recognition and classification

IFRS 3 and ASC 805 require the acquirer to recognize contingent consideration at fair value as part of consideration transferred.

• If the arrangement will be settled in cash or other financial assets, recognize a financial liability.

• If the arrangement will be settled by issuing a fixed number of the acquirer’s own shares and meets equity criteria (fixed-for-fixed under IAS 32 / equity under GAAP), recognize equity.

• If terms indicate the payment is remuneration for continuing employment (e.g., forfeiture on termination, service cliff), account for it as compensation expense, not as part of consideration.

Acquisition-date entry (simplified):

• Dr Identifiable Assets at FV xx

• Dr Goodwill (balancing) xx

• Cr Identifiable Liabilities at FV xx

• Cr Cash / Shares issued xx

• Cr Contingent Consideration (liability or equity) xx

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Subsequent measurement and where changes go

IFRS

• Liability-classified contingent consideration → remeasure at fair value each reporting date, with gains/losses in profit or loss (IFRS 9).

• Equity-classified contingent consideration → no remeasurement; settle in equity when due.

• Measurement period (up to one year from acquisition date): adjustments based on new information about facts and circumstances existing at the acquisition date adjust goodwill retrospectively, not P&L.

US GAAP

• Liability-classified contingent consideration → remeasure at fair value through earnings each period.

• Equity-classified → no remeasurement post-acquisition.

• Measurement period adjustments (ASC 805) similarly adjust goodwill if tied to acquisition-date facts.

Key practice point: once outside the measurement period, changes from performance outcomes or updated forecasts go to P&L for liabilities under both frameworks.

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How to separate earnouts from compensation for service

Signals that an arrangement is compensation, not purchase price:

• Payment forfeited if the employee-seller leaves before the earnout date.

• The service period mirrors the earnout measurement period.

• Earnout not contingent on broad business performance but on individual targets.

If any of these dominate, recognize share-based or cash compensation expense over the service period (IFRS 2/ASC 718), not as contingent consideration.

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Worked example — EBITDA earnout with liability classification

Facts:

• Consideration at closing: €80,000,000 cash.

• Earnout: up to €20,000,000 cash if Year-1 EBITDA ≥ €25,000,000; probability-weighted fair value at acquisition = €12,000,000.

• Net identifiable assets at FV = €75,000,000.

Acquisition-date entries (IFRS/GAAP):

• Dr Identifiable Assets at FV 75,000,000

• Dr Goodwill 17,000,000

• Cr Liabilities at FV —

• Cr Cash 80,000,000

• Cr Contingent Consideration (Liability) 12,000,000

Year-end (outside measurement period):

• Updated fair value of earnout = €15,000,000.

• Recognize €3,000,000 loss in P&L:

  • Dr Fair Value Loss – Contingent Consideration 3,000,000

  • Cr Contingent Consideration Liability 3,000,000

Settlement:

• Actual payout = €16,000,000.

• Settle liability and recognize final €1,000,000 loss:

  • Dr Contingent Consideration Liability 15,000,000

  • Dr Loss on Settlement 1,000,000

  • Cr Cash 16,000,000

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Worked example — equity-classified share earnout

Facts:

• Earnout payable in a fixed number of shares if revenue threshold is met; acquisition-date FV = €8,000,000.

• Classified as equity under IAS 32 / GAAP equity rules.

Accounting:

• Recognize €8,000,000 in equity at acquisition; no remeasurement afterward.

• On settlement (issue shares):

  • Dr Contingent Consideration – Equity 8,000,000

  • Cr Share Capital / APIC 8,000,000

No P&L volatility after day one.

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Comparative framework — IFRS 3 vs ASC 805 for contingent consideration

Topic	IFRS 3 / IFRS 9 / IAS 32	ASC 805 / ASC 815 / equity guidance
Acquisition-date measurement	Fair value included in consideration transferred	Fair value included in consideration transferred
Liability vs equity	IAS 32 tests; liabilities remeasured through P&L	Equity classification similar; liabilities remeasured through earnings
Measurement period	Up to 1 year; adjust goodwill if acquisition-date facts	Same concept; goodwill adjusted during measurement period
Post-period changes	Liabilities: P&L; Equity: no remeasurement	Liabilities: earnings; Equity: no remeasurement
Service-linked clauses	Likely IFRS 2 compensation	Likely ASC 718 compensation

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Journal entries summary

At acquisition (general):

• Dr Identifiable Assets at FV xx

• Dr Goodwill xx

• Cr Identifiable Liabilities at FV xx

• Cr Cash/Shares issued xx

• Cr Contingent Consideration (Liability or Equity) xx

Subsequent remeasurement (liability):

• Dr / Cr P&L – Fair Value Change xx

• Cr / Dr Contingent Consideration Liability xx

Settlement:

• Cash: Dr Liability / Cr Cash

• Shares (equity-classified): Dr Equity – Contingent Consideration / Cr Share Capital & APIC

Compensation-type earnout:

• Dr Compensation Expense xx

• Cr Cash / Equity-settled SBP xx

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Disclosure package investors expect

• Nature and terms of contingent consideration, including metrics, caps, floors, and timeframes.

• Carrying amount at period end and reconciliation of movements (opening, additions, remeasurements, settlements).

• Sensitivity of fair value to key assumptions (probabilities, discount rates, volatility).

• Judgments used to distinguish purchase price from compensation for services.

Clear disclosures help users separate acquisition economics from post-deal operating performance.

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Impact on financial performance and ratios

• Earnings volatility: Liability-classified earnouts can introduce material P&L swings as forecasts change.

• EBITDA presentation: Remeasurement gains/losses are typically below EBITDA, but check policy and local guidance.

• Leverage and equity: Equity-classified earnouts avoid P&L volatility but inflate equity at day one; liability earnouts increase debt-like exposure.

• Tax: Fair value movements may have no immediate tax effect; assess deferred taxes on acquisition-date recognition if tax basis differs.

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Operational considerations

• Build a fair value model (Monte Carlo for revenue paths, probability-weighted scenarios for milestones, appropriate discounting).

• Document compensation vs consideration analysis early with HR/legal to avoid later reclassification.

• Establish governance for forecast updates and ensure finance, FP&A, and deal teams align on remeasurement triggers and controls.

• For equity-settled earnouts, confirm fixed-for-fixed criteria and avoid features that create derivative liabilities.

Robust modeling and crisp disclosures prevent surprises and keep post-acquisition performance distinct from valuation noise.

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