A Contingent Consideration Problem Parent Company acquires 100 % of Sub Company

Question

A Contingent Consideration Problem

Parent Company acquires 100 % of Sub Company for by exchanging 100,000 shares of its $1 par value common stock with a current market value of $35 per share. The agreement contains a provision that:

If the subsidiary earns a net income of more than $500,000 during the first year following the acquisition, an additional cash payment for 30% of the excess over $500,000 will be paid at that time, and

If the price per share of Parent Company’s stock is below $35 on the first anniversary date of the acquisition, an additional 10,000 shares will be handed over.

On the acquisition date the parent company calculates the probability-adjusted present values at $20,000 for the cash contingency and $50,000 for the contingency related to its share price. Prepare the Parent Company journal entry to record the acquisition.

A year later, the subsidiary reported net income of $700,000 for the first year after the acquisition and Parent Company’s share price was $30. Prepare the Parent Company journal entry for the settlement of the contingencies.

If instead of the facts in (b) the subsidiary reported net income of $400,000 and the Parent Co.’s share price was $36 what would Parent Company’s journal entry for the settlement of the contingencies have been?

Explanation / Answer

At the time of acquisition Investment AC Dr 70000 Liability for contingencies Cr 20000 Equity Cr 50000 (Being Contigent Considertaion recognised at the time of acquisition) At year end Liability for Contigencies Dr 20000 Profit and Loss AC Dr 40000 Cash Cr 60000 30% of (700000-500000) (Being Liability settled at year end as the contignet condition met in favour of subisdiary

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