Accounting & Reporting

ASC 805 and Contingent Consideration

Price and account for an earnout so that hitting the target does not blow a hole in your income statement, and so the auditors do not reclassify half of it as payroll.

  • Expert
  • 11 min total
  • 12 chapters

What decision this helps you make: How to structure, classify, value, and remeasure contingent consideration in an acquisition, and whether the arrangement is purchase price at all.

What this topic is

Contingent consideration is the part of an acquisition price that depends on what happens after closing: an earnout on revenue or EBITDA, a milestone payment on a regulatory approval, a price adjustment tied to a legal outcome. Under ASC 805, the acquirer records it at acquisition-date fair value as part of consideration transferred, then either leaves it alone forever or remeasures it through earnings every quarter, depending on how it is classified.

Why it matters

Earnouts are how deals get done when buyer and seller cannot agree on price. They are also the single most common source of post-close accounting surprises. A liability-classified earnout that goes well produces a charge to earnings; one that goes badly produces a gain. An earnout that a seller forfeits by leaving is compensation expense, not purchase price, and moves off goodwill and into operating costs. Getting either wrong distorts reported margin for years and is a standing item on SEC comment letters.

Who should learn it

Corporate development and deal teams, CFOs and controllers integrating an acquisition, valuation specialists, audit committees, and anyone modelling the post-close income statement of a serial acquirer.

What you will understand

  • How acquisition-date fair value is measured for an earnout, and why scenario-weighting and option pricing give different answers
  • The liability-versus-equity classification test and what it does to every quarter after closing
  • When a payment to a selling shareholder is compensation for post-combination services rather than consideration
  • What the one-year measurement period does and does not let you go back and change

Prerequisites

Common misconception

"The earnout is part of the price, so if we pay it, it just increases goodwill." It does not. Goodwill is frozen after the measurement period. A liability-classified earnout is remeasured to fair value every reporting period with the change running through earnings, so the better the acquired business performs, the larger the charge you book for the privilege. Serial acquirers routinely report operating results contaminated by earnout remeasurement in the opposite direction from the underlying performance.