Contingent Consideration: FASB Deliberates Rules for Business Combinations

The M&A market is currently hot in many industries. However, due to uncertainty in the marketplace, many buyers are tying a portion of the purchase price to whether the company achieves prescribed financial benchmarks after the deal closes.

Subsequent reporting of so-called “contingent consideration” can be confusing, especially for companies new to the M&A arena. The Financial Accounting Standards Board (FASB) is evaluating ways to simplify the requirements, while preserving investors’ needs for robust information.

Recent discussions

In May, the FASB discussed its ongoing project on business combinations. The recent discussions focused on the subsequent reporting of contingent consideration, an accounting term related to transferring cash or stock to an acquired company if certain conditions have been met. Some FASB members suggested aligning accounting for contingent consideration in a business combination with the accounting for asset acquisitions.

“Investors want the contingent consideration at fair value, and they want the models for business combinations and asset acquisitions aligned. They believe it provides them with useful information. They also want improved disclosures on maximum payout, timing of payout,” said FASB member Gary Buesser.

Current guidance

The FASB defines contingent consideration as “an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met,” with the caveat that “ contingent consideration also may give the acquirer the right to the return of previously transferred consideration if specified conditions are met.”

Currently, when a company records acquired assets and liabilities on the balance sheet, the company recognizes contingent consideration at “fair value” on acquisition date. In subsequent reporting periods, the company marks the contingent consideration to fair value until that contingency is either paid out or no longer exists. Typically, the contingent consideration is based on earnings or meeting a product milestone. In mulling revisions to the subsequent reporting of contingent consideration, the FASB plans to address how often it should be remeasured, and, once remeasured, where it should be recognized.

Looking ahead

The FASB hasn’t yet made any standard-setting decisions about the subsequent reporting of contingent consideration. But additional deliberations on this topic are expected in the coming months. Contact us for the latest developments on this project — or if you have questions about how to report a recent purchase of a business interest or asset.

Asset acquisitions vs. business combinations

Accounting for business combinations is generally considered more cumbersome than accounting for a straight-up acquisition of an asset. Over the years, financial statement users have complained that the old accounting definition of a business was overly broad and captured too many day-to-day purchases of assets.

The Financial Accounting Standards Board (FASB) published guidance in 2017 to help clarify whether the purchase of an asset (or group of assets) qualifies as the sale or disposal of a business. The update provides a shortcut to help accountants make a quick call about when a set of assets isn’t a business: The set is not a business when substantially all the fair value of the gross assets acquired (or disposed of) is concentrated in a single asset or a group of similar identifiable assets.

The updated guidance also prescribes the following two elements that must be included for a set of assets to be considered a business:

  1. An input (such as people, intellectual property and raw materials), and
  2. A substantive process.

Together, the acquired inputs and process should significantly contribute to create outputs. The buyer’s ability to replace missing inputs or processes with its own is no longer enough to meet the updated definition of a business.

Although outputs aren’t required for an asset set to be a business, outputs generally are a key element of a business. Outputs typically are considered goods or services for customers that provide (or have the ability to provide) a return to investors in the form of dividends, lower costs or other economic benefits.

The updated guidance was the first stage of an ongoing FASB project. In May 2021, FASB members discussed ways to narrow the differences between the two accounting models for M&A deals: asset acquisitions vs. business combinations. Reducing the differences between the two sets of guidance could help reduce confusion and decrease the incentives for businesses to structure deals to avoid complex accounting rules for business combinations.