Let me please give you an example to explain the final special consideration in intercorporate investments, earnouts. Firm A acquires all shares of Firm T from $10 per share on January 1st, 2022. Firm T has 100 shares issued and outstanding on January 1st, 2022. Firm T's net assets' values approximate their fair values. On January 1st, 2022, Firm A contracts with Firm T shareholders to pay extra $200 cash on March 30th, 2023, if Firm T fiscal year 2022 net income exceeds $500. At the acquisition date, the fair value of this contingent payment consideration is $90. Assume that Firm T Net Income in Fiscal Year 2022 is 700. Question 1 asks to provide the accounting entry on (a) transaction worksheet on January 1st, 2022. We will start with calculating total investments. We know that (the) acquiring firm purchases 100 shares of the target firm from $10 each, meaning that the initial amount of the investment is $1,000. We also include $90, which is the fair value of this contingent payments consideration. Why do we do this? This is because Firm A purchases Firm T from Firm T shareholders by not only paying $1,000, but also making the promise to pay a certain sum in the future if Firm T performs well. Therefore, fair value of the promise today is also included in the investment. In the transaction worksheet, cash goes down by $1000, investment is created as 1090, and a contingent liability is created with an amount of $90 on the balance sheet. The second question asks to provide accounting entry on (a) transaction worksheet on December 31st, 2022, and March 30th, 2023. On December 31st, Firm A knows that it has to pay $200 to Firm T shareholders because Firm T net income in fiscal year 2022 exceeds $500. Therefore, in the second line of the transaction worksheet, we increase contingent liability by $110, so the total contingent liability is 200. We also create a loss on earnout, on the income statement of $110. We then close the accounts and reflect 110 loss recorded on the income statement on retained earnings. On March 30th, 2023, Firm A pays $200 to Firm T shareholders, so cash decreases by $200 and the contingent liability is eliminated by recording a negative $200. The third question asks to provide the accounting entry on a transaction worksheet on December 31st, 2022, and March 30th, 2023, if Firm T 2022 net income is actually less than $500. On December 31st, Firm A knows that it doesn't have to pay $200 to Firm T shareholders, because Firm T net income in fiscal year 2022 is less than $500. Therefore, in the second line of the transaction worksheet, we eliminate contingent liability account by recording negative 90. We also create a gain on earnout on the income statement of $90. We then close the accounts and reflect $90 gain recorded in the income statement on retained earnings. We do not record an accounting entry on March 30th, 2023. In summary, this module covered special considerations in intercorporate investments. Next module will introduce reverse acquisitions, step acquisitions, and disposals.
