CIMA F1 Mini Lesson: How to deal with contingent consideration

 

Unfortunately when students self-study for their CIMA exams it tends to lead to years of frustration, months of wasted effort and days sat there at your study desk in confusion.

Why?

Because even with excellent study technique, when you’re self-studying,  you’re having to teach yourself the study material.   So if you get stuck and don’t understand what you are learning, there is no expert tutor to guide you through it.  Or solve any queries that you have.

That’s why I wanted to create a platform for you to get all your CIMA exam questions answered.

Like today’s student question which is about contingent consideration in business combinations, on the CIMA F1 paper.  Before we dive into the question, let’s just summarise what the term means…

What is contingent consideration?

This is when the parent company MAY OR MAY NOT have to pay an amount in the future as part of the consideration for the subsidiary.  This is usually dependent on the subsidiary meeting a certain criteria over a period of time.   For example, achieving certain profits levels of subsequent years.

Student Question

“I came across contingent consideration in business combinations. Wonder whether you can help me to understand with the following problem:

P-the acquiring company guarantees to pay S-acquiree $10,000 in 2 years from now if the latter makes profits in excess of $15,000 p.a. for the next 2 years.

Fair value of the payment now is $8,500 and $9,200 a year after.

How do I calculate contingent consideration as part of P’s business combination value and the double entries for the consideration for 2 years?”

– Venkatesh

Solution

According to IFRS 3, contingent consideration should always be brought in at fair value at the acquisition date. Any subsequent changes to this fair value, post acquisition, should go through the income statement.

So, we know that fair value of the contingent consideration now (at the acquisition date) is $8,500. This is recorded in P’s Statement of Financial Position as both a non current asset (added to the original investment in S) and a non current liability (money owed to S).

As the fair value of the amount owed increases until the payment date (from $8,500 to $9,200 and then to $10,000), we need to increase (credit) the liability and expense (debit) the adjustment through the income statement in accordance with IFRS 3.

The double entries are as follows:

Year 0

Dr investment in subsidiary 8500

Cr liability  8500

Year 1

Dr income statement 700 (9200 – 8500)

Cr liability  700 (9200 – 8500)

Year 2

dr income statement 800 (10000 – 9200)

dr liability 9200

Cr bank 10,000

Next Step

Think you’ve got this covered?  Test your knowledge with these CIMA F1 practice kit questions.

And then when you’ve covered the whole CIMA F1 syllabus in depth, attempt these computersied, exam-standard  CIMA F1 Mock exams to ensure you are ready for the real thing.

If you’re struggling with this paper or would prefer to learn with personalised tutor support, video lectures, a structured study plan, and a forum to chat with other students – as well as all the study and exam practice materials you need – then I recommend you take advantage of this CIMA F1 online course.

Or if time is really against you ahead of your exam, then you can cover all the important areas of the syllabus in approximately 10 hours with these recorded CIMA F1 revision classes

Have a CIMA exam question of your own that you’d like answered?

Or got a topic that’s proving difficult to get your head around?

Let me know in the comments section below and I’ll try and provide the solution promptly

Good luck with your studies,

Matt

 

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