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

In many acquisitions, part of the price depends on the target’s future performance — profits, revenue milestones, customer retention, or regulatory approvals. This variable component, known as contingent consideration or an earn-out, directly affects goodwill, subsequent profit or loss, and volatility in post-acquisition results. Both IFRS 3 and US GAAP (ASC 805) require recognizing contingent consideration at fair value on the acquisition date, but they diverge on subsequent remeasurement, classification, and where changes are recorded.

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Why contingent consideration exists and how it shapes the transaction

Earn-outs bridge valuation gaps between buyer and seller. The buyer limits upfront payment, while the seller gains upside if targets are met. For accounting purposes, contingent consideration forms part of the total purchase price, even though it is payable later and conditional on performance.

Its structure determines whether it behaves like equity or a financial liability:

• Equity-classified earn-outs are fixed in number or amount (e.g., shares issued if performance met).

• Liability-classified earn-outs depend on future variables and are remeasured at fair value each reporting period.

This classification determines whether changes hit equity or profit or loss.

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IFRS 3 accounting for contingent consideration

At the acquisition date:

• Measure contingent consideration at fair value, regardless of probability of payment.

• Include it in total consideration transferred for goodwill computation.

• Classify as liability or equity per IAS 32 definitions:

  • Liability → obligation to deliver cash or variable shares.

  • Equity → fixed number of own shares for fixed amount (no remeasurement).

Subsequent measurement (IFRS):

• Liabilities: Remeasured at fair value through profit or loss each reporting date until settled.

• Equity: Not remeasured after initial recognition.

• Changes in fair value do not adjust goodwill (unless within the measurement period).

Example (IFRS):

A buyer promises an additional €5 million if the target’s 2026 EBITDA exceeds €10 million. At acquisition date, fair value estimate = €3 million.

• Dr Identifiable Assets (FV) xx

• Dr Goodwill xx

• Cr Contingent Consideration Liability 3,000,000

• Cr Cash / NCI xx

If, by year-end, fair value rises to €4 million:

• Dr Loss on Remeasurement (P&L) 1,000,000

• Cr Contingent Consideration Liability 1,000,000

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ASC 805 accounting for contingent consideration

At acquisition date:

• Recognize contingent consideration at fair value in total consideration.

• Classification per ASC 480 and ASC 815:

  • Liability if settled in cash or variable shares.

  • Equity if settled in a fixed number of shares and meets equity criteria.

Subsequent measurement:

• Liability-classified earn-outs → remeasured at fair value, with changes in earnings until settlement.

• Equity-classified earn-outs → not remeasured; subsequent settlement recorded within equity.

Example (GAAP):

Contingent payment up to $6 million based on revenue growth; initial fair value = $3.5 million.

• Dr Assets / Goodwill xx

• Cr Contingent Consideration Liability 3,500,000

Next year, expected payout increases to $5 million:

• Dr Loss on Contingent Consideration 1,500,000

• Cr Liability 1,500,000

Same if fair value drops — record gain in earnings.

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Comparative framework — IFRS 3 vs ASC 805

Topic	IFRS 3	US GAAP (ASC 805)
Initial recognition	Fair value on acquisition date	Fair value on acquisition date
Classification	Liability (IAS 32) or equity	Liability (ASC 480/815) or equity
Remeasurement	Liabilities remeasured to FV; equity not	Same
Where changes go	P&L (unless measurement period)	Earnings (same principle)
Goodwill adjustment	Only within 12-month measurement period	Same
Equity earn-outs	No remeasurement after day one	No remeasurement
Disclosure focus	Fair value hierarchy, valuation techniques	Rollforward, valuation inputs

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Worked example — contingent consideration in goodwill computation

Facts (€, IFRS example):

• Consideration paid in cash €50m.

• Contingent payment: €10m max, fair value €3m.

• FV of net identifiable assets: €45m.

Goodwill calculation:= 50 + 3 − 45 = €8m.

Day-one entry:

• Dr Identifiable Assets 45,000,000

• Dr Goodwill 8,000,000

• Cr Cash 50,000,000

• Cr Contingent Consideration Liability 3,000,000

Year 1 remeasurement: fair value increases to €4.5m.

• Dr Loss on Remeasurement (P&L) 1,500,000

• Cr Contingent Consideration Liability 1,500,000

No goodwill adjustment; effect flows directly to earnings.

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Valuation methods and fair value hierarchy

Common approaches:

• Probability-weighted expected value: multiply possible payouts by probability of occurrence.

• Option pricing models: for non-linear payoff structures or market-based triggers.

• Monte Carlo simulations: for complex earn-outs tied to multiple variables.

Fair value hierarchy (IFRS 13 / ASC 820):

• Level 1 — quoted prices (rare).

• Level 2 — observable inputs (industry performance benchmarks).

• Level 3 — unobservable inputs (management projections, volatility).

Disclosure must specify which level applies, valuation technique used, and key unobservable assumptions (discount rates, volatility, probability).

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Special cases — settlement, modification, and cancellation

• Early settlement: difference between carrying amount and settlement amount → P&L (liability case) or equity adjustment (equity case).

• Modification: if the earn-out is renegotiated, treat as extinguishment of old liability and recognition of new one at fair value.

• Cancellation: derecognize liability and record gain in P&L.

• Non-market performance targets: update fair value each period based on revised probability and forecasts.

• Market-based targets (share price): reflect in expected volatility input, not management projections.

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Disclosure requirements

Entities must disclose:

• Description and key terms of contingent consideration.

• Range of outcomes and timing of potential payments.

• Carrying amounts, rollforward, and fair value hierarchy level.

• Gains/losses recognized in P&L for remeasurement.

• Judgments and assumptions used in valuation.

Example note (IFRS/GAAP):

The acquisition of Delta Medical included contingent consideration payable up to €10 million based on 2026 revenue targets. The liability was initially recognized at €3 million and remeasured to €4.5 million at year-end, resulting in a €1.5 million loss recognized in other operating expenses.

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Journal entries summary

At acquisition (liability type):

• Dr Identifiable Assets xx

• Dr Goodwill xx

• Cr Cash / Equity / NCI xx

• Cr Contingent Consideration Liability xx

Subsequent remeasurement:

• Dr / Cr P&L — Gain or Loss on Fair Value Re-measurement xx

• Cr / Dr Contingent Consideration Liability xx

At settlement:

• Dr Contingent Consideration Liability xx

• Cr Cash / Shares issued xx

• Difference → P&L (if liability).

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Impact on financial performance and ratios

• Earnings volatility: liability-classified earn-outs cause recurring fair-value gains/losses.

• EBITDA: often unaffected (below operating profit), but analysts adjust for volatility.

• Leverage: contingent consideration recognized as a liability increases net debt until settled.

• Cash flow timing: payments appear in financing activities if deemed part of purchase price.

• Goodwill trends: higher contingent liabilities inflate goodwill; later remeasurements do not affect goodwill but flow through earnings.

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Operational considerations

• Draft contracts with clear performance metrics and objective measurement bases to reduce fair-value noise.

• Involve valuation specialists to model scenarios consistently across reporting periods.

• Maintain a central schedule for all contingent consideration with triggers, caps, and settlement dates.

• Monitor for modifications or waivers that may reset accounting.

• Align disclosures and MD&A to explain earnings volatility from remeasurement.

Robust tracking of contingent consideration ensures transparency and prevents surprises as acquisitions mature and contingent obligations crystallize.

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