ACT504 Chap.5 Consideration Transferred and What Stays Outside It
Consideration Transferred and What Stays Outside It
What the total is made of
Consideration transferred is measured at fair value on the acquisition date and is the sum of the fair values of the assets transferred by the acquirer, the liabilities the acquirer assumes and the acquirer's own shares issued. The forms it takes are cash and other monetary assets, non-monetary assets, equity instruments and contingent consideration.
Get the total wrong and goodwill is wrong by the same amount, which is why this step carries more teaching material than any other part of the acquisition method.
One date, every value
Every component is measured at its fair value on the acquisition date. For shares that means the quoted price on that date, not the price when the deal was announced, not a six-month high and not an average.
Examination questions supply a rival price on purpose, usually flagged with a phrase such as this price represented a six-month high, and a candidate who uses it has announced that the rule was not understood.
Writing the date beside the price in your working removes the trap entirely.
Deferred cash is discounted, and the gap is interest
Where part of the price is payable later, the fair value today of that promise is less than its face amount, so the deferred component is discounted to present value at the acquisition date using the acquirer's incremental borrowing rate.
The rate is the acquirer's because the deferred leg is in substance a loan from the seller on the buyer's credit. The difference between the face amount and the present value is not a discount on the purchase; it is interest, and it appears as interest expense as the liability unwinds.
Goodwill is computed on the discounted figure and the unwinding never touches the investment account.
Non-monetary consideration carries a disposal first
Where the acquirer hands over property, an investment, a licence or a patent, the asset is measured at its fair value on the acquisition date, and any difference against its carrying amount is a gain or loss recognised before the investment is recorded.
Two entries in that order: derecognise the asset and book the gain, then record the investment at the total fair value given.
Combining them into one step hides the gain and usually misstates it.
Contingent consideration is a probability, priced today
Contingent consideration is an amount the acquirer may have to pay the former owners depending on a future event, typically the acquired business hitting an earnings target or the acquirer's own share price holding a level.
It enters the total at the acquisition date, measured at fair value, which in the course's worked cases is the amount at stake multiplied by the assessed probability. A guarantee on a hundred thousand shares that the price will not fall below a stated level, with a ten per cent chance assessed of a two cent shortfall, produces two hundred.
The figures are deliberately small next to the rest of the price, and omitting the line still loses the mark, because the mark is for knowing that a contingent promise is part of the price rather than a disclosure.
Three costs that are not consideration, landing in three different places
Costs of issuing equity instruments, such as stamp duties, advisers' fees and underwriting or brokerage fees on a share issue, are an integral part of issuing that equity and are recognised directly in equity as a reduction of share capital.
Costs of issuing debt instruments belong to the borrowing itself and go into the amount at which the liability is first recorded. Acquisition-related costs, listed as fees for lawyers, for accountants, for valuers and for consultants and the cost of maintaining an internal acquisitions department, are period costs and are expensed.
None of the three enters consideration transferred, and a one-question check sorts them under pressure: did the former owners of the acquiree receive this, or could they.
What this chapter covers
- 01
The five components of the total, and the one date they share
- 02
Why a quoted price from last fortnight is never the one to use
- 03
Discounting deferred cash at the acquirer's incremental borrowing rate
- 04
The second-year entry, where the unwinding becomes interest expense
- 05
Non-monetary assets, and recognising the disposal gain first
- 06
Pricing a contingent promise as amount at stake times probability
- 07
Equity issue costs, debt issue costs and acquisition-related costs
- 08
The one question that sorts an excluded cost under time pressure
Price a mixed consideration package at the acquisition date
- 3Value the cash legs, discounting anything deferred.
- 2Value the shares, naming the price you used and why.
- 4Value the guarantee and the licence.
- 3State where the two excluded costs go, and give the total.
Key terms
- Consideration Transferred
- The fair value at the acquisition date of the assets transferred, the liabilities assumed and the equity instruments issued by the acquirer. It is the figure compared against net fair value to produce goodwill.
- Incremental Borrowing Rate
- The rate at which the acquirer could borrow the same amount over the same term. It discounts any deferred cash leg, because that leg is in substance a loan on the acquirer's credit.
- Contingent Consideration
- An amount the acquirer may have to pay the former owners depending on a future event. It is part of the consideration at the acquisition date, measured at the amount at stake multiplied by the assessed probability.
- Equity Issue Costs
- Stamp duties, advisers' fees and underwriting or brokerage fees on shares issued. They are an integral part of the issue and are recognised directly in equity as a reduction of share capital.
- Debt Issue Costs
- Costs integral to issuing a debt instrument. They go into the amount at which that liability is first recorded rather than being expensed or added to the consideration.
- Acquisition-related Costs
- Legal, accounting, valuation and consulting fees and the cost of an internal acquisitions department. They are period costs, expensed in the period incurred, and never part of the consideration.
- Non-monetary Consideration
- Property, investments, licences or patents handed over as part of the price. They are measured at fair value on the acquisition date, with any difference against carrying amount recognised as a gain or loss first.
Consideration Transferred and What Stays Outside It FAQ
Which share price do I use when the question gives me two?
The quoted price on the acquisition date, every time. Measurement of every component of the consideration is at fair value on the date control passed, so an announcement price, a six-month high or an average is irrelevant however prominently the question displays it. The rival price is there to test whether you know the rule. Writing the date next to the price in your working takes two seconds and makes the error impossible.
Is the interest on a deferred payment part of what we paid for the business?
No. The deferred leg enters the consideration at its present value at the acquisition date, discounted at the acquirer's incremental borrowing rate, and goodwill is computed on that discounted figure. The difference between the face amount and the present value unwinds as interest expense in later periods.
It is the cost of not paying on the day rather than part of the purchase price, and it never touches the investment account or goodwill.
Where do the legal fees go?
Into profit or loss as a period cost. Acquisition-related costs, which include fees for lawyers, for accountants, for valuers and for consultants and the cost of maintaining an internal acquisitions department, are expensed in the period incurred and are not part of the consideration. That is different again from share issue costs, which reduce share capital, and from debt issue costs, which are absorbed into the liability.
Three exclusions, three different destinations.
Exam move
Write out one consideration schedule per day for a week, inventing the facts but forcing each one to contain a deferred leg, a rival share price, a contingent amount and at least two excluded costs. Then check each against the single question of whether the sellers received the item. The schedule is short enough that repetition is cheap, and repetition is what makes the excluded costs obvious rather than recalled.
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