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Cash flow statement diagram

Cash Flow Statement Classification (ASC 230) – Contingent consideration payments

Posted on May 5, 2025 by | Tags: ASC 230, Classification of Cash Flows, Statement of Cash Flows,

If you are an auditor or if you prepare financial statements, let me start by asking you a few questions. Which financial statement is your primary focus? Which is the last that you focus on? Undoubtedly, the statement of cash flows ends up pretty far down the list and is often the one that receives the least attention from both a preparation and an audit perspective. Yet, it is often the statement that receives the most attention from investors and analysts. It has also received quite a lot of focus in recent years from the SEC, especially regarding cash flow statement classification for contingent consideration. From 2004 – 2023, cash flow statement classification was the third most cited issue in total restatements, equating to 12% of all restatements during that period according to a June 2024 report published by Audit Analytics.

The SEC has also issued numerous comment letters to companies regarding proper classification of cash flows and cited issues in this area in a number of speeches. Why? ASC 230, Statement of Cash Flows, was issued over 35 years ago and hasn’t changed much since. On top of that, there really are only three ways to classify: investing, financing, or operating! Sounds pretty easy, so why all the issues? The reasons are many, but one key reason is that the guidance isn’t always clear, and there are a lot of gray areas with certain types of cash flows. In this series of eight blog posts focused on classification of cash flows, we’ll explore a few specific areas where there have been challenges in practice but for which there is specific guidance in ASC 230. This includes cash flow statement classification for contingent consideration payments made after a business combination.

Areas covered

The eight areas that we will discuss in this series of blog posts are:

Let’s take a look at one of those eight areas, contingent consideration payments made after a business combination. The best way to explore this cash flow classification issue is through a scenario followed by a question and answer. But before we get started, let’s review a few things. According to the FASB Master Glossary, contingent consideration is usually an obligation of the acquirer in a business combination to transfer additional assets or equity interest to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. Note that it can go the other way too, with contingent consideration giving the acquirer the right to the return of previously transferred consideration if specified conditions are met. The obligation for contingent consideration will either be liability classified or equity classified. Now that we’ve covered the background, it’s time for our scenario which will involve a quick review of the overall accounting for contingent consideration in a business combination along with the guidance on classification in the statement of cash flows.

Scenario: Cash flow statement classification

Jackson Corp. acquired Solitary, Inc. in a business combination on October 17 for $300 million cash. In addition, if Solitary meets its forecasted results for each of the next two years, Jackson must pay an additional $25 million lump sum at the end of the two-year period. It is considered probable that Solitary will meet its forecasted results for the current year and the following year.

Questions and solutions: Cash flow statement classification

Question 1: What is the purchase price of this business combination of October 17?

Answer 1: $300 million plus the fair value of the contingent payments. Contingent consideration is included in the consideration paid (purchase price). The amount to include is measured at the acquisition date fair value, and not the expected payout at settlement date. The probability of meeting the forecasted results does not impact whether or not an amount is recognized, however, the estimate of fair value would take into consideration the probabilities of payment as well as the time value of money. The acquirer should classify an obligation to pay contingent consideration as a liability or equity in accordance other applicable GAAP. Since this example requires cash settlement, it would be liability classified. For purposes of this example, let’s assume that the fair value of the contingent consideration at acquisition is $23 million.

Question 2: How should the liability for the contingent consideration be subsequently accounted for?

Answer 2: It depends on what caused the change. If the change is as a result of additional information about facts and circumstances that existed at the acquisition date, then they are measurement period adjustments, assuming the change is within the measurement period. If the change results from events after the acquisition date, such as meeting an earnings target, this change should be accounted for as follows:

  • Contingent consideration classified as equity should not be remeasured and its subsequent settlement should be accounted for within equity
  • Contingent consideration classified as an asset or liability is remeasured to fair value at each reporting date until the contingency is resolved. Changes in fair value are recognized in earnings.

Question 3: Assume the targets are met and the contingent consideration liability is settled at the end of year two. How should this be accounted for?

Answer 3:The contingent consideration liability (which is has been remeasured to fair value) will be reversed and the cash payment made (Dr. Liability $25M, Cr. Cash $25M). Note that the FV on the date of settlement would be the payment of $25M.

Question 4: How should this cash outflow be classified in the statement of cash flows?

Answer 4: ASC 230 includes guidance that clarifies the classification of this payment, which can best be summarized in a flowchart:

Soon after is defined as a relatively short time but an explicit timeframe is not given in the standard. However, it is generally considered three months or less. In our example, $23M would be classified as financing outflow and $2M as an operating cash outflow since the payment was not made soon after the acquisition date.

Final Thoughts

We’ve now addressed one of the eight cash flow classification issues covered in this blog post series. Check out the additional blogs in this series for more cash flow classification issues and answers!

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Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.

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