Unwinding discount

Deferred payment consideration is similar to lease payment In arrears.
You must refect the principle + unwind interest payable (interest accrued) every year.

Let’s say A acquired B on 1/8/07. The purchase consideration was made up of a deferred cash payment of $4million payable in 3 years. Cost of capital of 10% per annum. A hasn’t accounted this deferred consideration.
B/S date is 31/3/08

– You must computed Present Value of Deferred consideration @ acquisition 01/08/2007
PV (Deferred Consideration) = 4m x 1/(1+10%)^3 = 3m
3m is investment in B @ acquisition.

– So, for the year ended 31/3/08, A must accrue interest payable (interest accrued):
3m x 10% x 8/12 = 0.2m –> Profit A decreases by 0.2m –> Impact:

B/S:
+Group Reserve (RE of Group) – 0.2m (deduct to Parent ‘s reserve)
+On B/S, in Current Liability, you must add 1 line: Deferred consideration: 3m (principle) + 0.2m (unwind interest) = 3.2m

I/S:
+ In Parent Column, you must add unwind interest in Finance cost: 0.2m (add because A hasn’t accounted for this)

trangdh,

I also think your explanation is very helpful. Only one thing is in my mind which isn’t 100% clear for me.

So we discount the deferred consideration to the present value, that’s clear but how about that 10% interest increasing our (as aquiring firm) liabilities.

-Is that 0.2m what the seller could have gained on the consideration what we did not pay at once? So it is a kind of compensation from our side – actually it is the price of the deferred payment?

-Is it always needed to book it or depends on the acquisition contract?

-Will it be actually paid to the seller when the deferred consideration expires?

Many thanks for your kind answer.

If you want to look at it as compensation, then ok. Because we discount the deferred consideration to today’s value, the unrolling of the discount effectively reflects the amount of money that COULD have been earned by the selling shareholders if we had not deferred their payment

Yes, it is always needed to be reflected and the accounting is straight forward:-

Dr Finance costs (expense in Statement of Income)
Cr Deferred Consideration Obligation Account and show on the Statement of Financial Position as a long term debt (if due date for payment in >12 months away) or as a current liability where the deferred consideration is now due for payment within the next 12 months

-Will it be actually paid to the seller when the deferred consideration expires? Yes, of course it will. When we discount this future obligation, all we are doing is reflecting the obligation in today’s terms. Then, as each year rolls by, we unroll the discounted amount so that, at the due date for payment, we have unrolled the originally recorded obligation and have now arrived at the agreed amount payable