Question

FASB ASC RESEARCH AND ANALYSIS CASE—CONSIDERATION OR COMPENSATION?

NaviNow Company agrees to pay $20 million in cash to the four former owners of TrafficEye for all of its assets and liabilities. These four owners of TrafficEye developed and patented a technology for real-time monitoring of traffic patterns on the nation’s top 200 frequently congested highways. NaviNow plans to combine the new technology with its existing global positioning systems and projects a resulting substantial revenue increase.

As part of the acquisition contract, NaviNow also agrees to pay additional amounts to the former owners upon achievement of certain financial goals.NaviNow will pay $8 million to the four former owners of TrafficEye if revenues from the combined system exceed $100 million over the next three years. NaviNow estimates this contingent payment to have a probability adjusted present value of $4 million.

The four former owners have also been offered employment contracts with NaviNow to help with system integration and performance enhancement issues. The employment contracts are silent as to service periods, have nominal salaries similar to those of equivalent employees, and specify a profit-sharing component over the next three years (if the employees remain with the company) that NaviNow estimates to have a current fair value of $2 million. The four former owners of TrafficEye say they will stay on as employees of NaviNow for at least three years to help achieve the desired financial goals.

Should NaviNow account for the contingent payments promised to the former owners of TrafficEye as consideration transferred in the acquisition or as compensation expense to employees?

Answer 1

Refer the below images for the above asked case, in a detailed way of explanation.
Answer. According to FASB Ase (805 - 10- 55-25): E * If it is not clear whether an arrangement for payment to employees (on selling Shareholders is part of the exchange for the acquiree cov) is a transaction Separate from the busines) Combination, the acauiver Should consider the following the indicators: VROVY following a) continuing employment. The terms of continuing employment by the selling Shareholders who become key employees may be an indicator of the substance of a contingent consideration arrangemente The relevant terms of continuing employment may be incloded in an employment agreement, acajuisition agreement or some other document. A contingent consideration arrangement in the payments are automatically forfeited if employment terminates is compensation for post combination Sertices. Arrangements in by employment payments are which the the contingent contingent payments paym. termination may indicate that additional consideration rather are not affeded the contingent than compensation. b) Duration of continuing employment. If the period of required employment coincides with cor) is longer than the contingent payment period, that fact may indicate that the contingent payments are in substance, Compensation c) Level of compensation : situations other than the contingent payments comparison to that of other key entity may indicate that the additional consideration consideration in which employee compensation is at a reasonable level in employees in the combined contingent payments are rather than compensation.

d) Incremental al Day payments to employees. If Selling Shareholders do not become employees receive per Share basis than the Selling Shareholders who become of the combined entity, that fact may indicate that incremental amount of contingent payments to who become employees is compensation. ringent payments on a Shareholders who become employees indicate that the payments to the setting Shareholders ent e Nombers of shares owned. The relative number of shares on by the Selling Shareholders who remain as they employees may be an indicator of the substance of the contingent consideration arrangement For example, if the Selling Shareholders rre continue owned substantially all of the shares in the acquiree con as key employees, that fact may indicate that the arrangement Substance, a profit - Sharing arrangement intended to provide compensation for post combination Services • Alternatively, it selling Shareholders who continue as key employees owned only a small number of shares of the acquisce and all telling Shareholders receive the same amount of contingent consideration on a per Share basis, that fact may indicate that the contingent payments are additional consideration- The preacquisition ownership interests held by parties related to selling Shareholders who continue as Ikey employees, so family members, also should be considered. linlcage to the valuation. If the initial consideration transferred at the acquisition date is based on the low end of a range established in the valuation of the acquiree and the contingent formola relates to that valuation approach, that fact may indicate that the payments Contingent are additional consideration Alternatively, if the Contingent payment formula is consistent with prior Profit Sharing arrangements that may Tuggest that the substance of the arrangement is to provide compensation -

g) Formula for determining consideration & The formula osed to in helpful assessing the may be is intended formula Substance of the arrangement. contingent For example, if a payment is determined on the basis of a moltiple of earning that might Suggest that the obligation is contingent consial in the briness combination and that the formula is intene to establish Cory yority the fair value of the acaoiree contrast, a contingent payment that is a percentage specified of eachings might Suggest that the obligation to e is a profit - Sharing arrangement to compensate employees Serviced rendered. * in deration to be included In the the author's author's Judgement, sudgement the contingent the 84 million payment (fair value = $4 million) is contingent consideration to be inces the overall farv value Navi Now records for its acquisition of Traffic eye. This contingency is not dependent on continuing employment (criteria a.) and uses a formule based on a component of earnings (criteria g.) Even though the four former owners of Traffi Ege owned roor of the Shares (criteria e.) which sogget the $8 million is compensation, the averall fact pattern indicates consideration because no services are required for the payment. * The profit -sharing component of the employment contract appears to be compensation criterio g. Specifically identifics profit Sharing arrangements as indicative of compensation for service rendered. Criteria a. also gives that the employees would be unable to partiu pate in pretit - Sharing if they derminate employment. Although the employees receive non-profit Sharing compensation Similar to other employees (criteria (o) the overall pattern of evidence Suggorns that any payments made under the profit - Sharing arrangement should be recognized as compensation expense when incurred and not contingent consideration for the acquisition.