IFRS 3 Contingent Consideration: Earnouts, Remeasurement & Accounting

Contingent consideration is any obligation of the acquirer to transfer additional assets or equity to the former owners of an acquired business if specified future events occur or conditions are met — the classic "earnout". IFRS 3.39 requires the acquirer to recognise it at its acquisition-date fair value as part of the consideration transferred, exactly like the cash and shares paid up front. The hard part is not day one; it is what happens afterwards. Whether a rising earnout becomes an expense that punishes the buyer for the target's success, or disappears into goodwill, or never hits earnings at all, depends entirely on two upfront decisions: how the arrangement is classified (liability versus equity, IAS 32), and whether a later movement reflects new information about acquisition-date facts (a measurement-period adjustment) or a genuine change in estimate. This guide works through the mechanics, three worked examples with journals, the ISA-anchored audit red flags, and a real earnout remeasurement disclosed in a public filing.

What Is Contingent Consideration Under IFRS 3?

Contingent consideration is an acquirer's obligation (or, occasionally, right) to transfer additional consideration to the former owners of a business if future events occur or conditions are met. Under IFRS 3.39 the acquirer includes the acquisition-date fair value of that obligation in the consideration transferred, which in turn feeds the goodwill calculation; and under IFRS 3.40 that obligation is classified as either a liability or equity at the outset. Common forms include revenue or EBITDA earnouts ("pay a further £10m if Year 1 revenue exceeds £50m"), milestone payments ("pay £5m on regulatory approval"), and share-based earnouts settled in the acquirer's own equity instruments.

The measurement itself follows IFRS 13. Because most earnouts have no observable market, they are Level 3 fair values built from unobservable inputs — typically a probability-weighted expected payout, discounted for the time value of money and for the risk that the target is missed (IFRS 13.B). The two building blocks that dominate every subsequent debate are therefore the probability distribution of outcomes and the discount rate, both of which are management estimates that an auditor will challenge hard under ISA 540. A probability-weighted expected value — not a single "most likely" number — is the default technique where the payout varies continuously with performance, because only the full distribution captures the option-like asymmetry of a capped earnout.

Is an Earnout a Liability or Equity?

An earnout is classified as a liability if it obliges the acquirer to deliver cash, other assets, or a variable number of its own shares; it is classified as equity only if it will be settled by delivering a fixed number of the acquirer's own shares and meets the "fixed-for-fixed" condition (IFRS 3.40, applying the definitions in IAS 32). This single decision, made once at the acquisition date, determines whether the arrangement is ever remeasured again.

The IAS 32 Classification Test

IFRS 3.40 sends you straight to IAS 32. If the acquirer has a contractual obligation to pay cash, or to issue whatever number of shares equals a fixed monetary amount, the arrangement fails the fixed-for-fixed test and is a financial liability. If instead the seller will receive a set number of shares regardless of the acquirer's share price — a fixed-for-fixed exchange — the arrangement is equity. A "pay £5m in shares" clause is a liability (variable number of shares for a fixed value); a "issue 500,000 shares if the target is hit" clause is equity (fixed number of shares).

Why Classification Drives Everything

A liability-classified earnout is remeasured to fair value at every subsequent reporting date, with the change recognised in profit or loss (IFRS 3.58(b)); a financial-liability earnout is measured at fair value through profit or loss under IFRS 9, so the remeasurement never touches goodwill after day one. An equity-classified earnout, by contrast, is not remeasured at all (IFRS 3.58(a)) — its subsequent settlement is accounted for within equity, and whatever the shares are ultimately worth on settlement is irrelevant to profit or loss. The same commercial deal can therefore produce years of earnings volatility or none whatsoever, purely on the classification.

How Is an Earnout Measured at the Acquisition Date?

At the acquisition date, contingent consideration is measured at fair value and added to the consideration transferred (IFRS 3.39), which increases goodwill by the same amount. Fair value is normally a probability-weighted expected payout discounted to present value using a rate that reflects both the time value of money and the risk of the specific payout (IFRS 13). Where the earnout is settled after more than a year, or the probability of the outcome is itself uncertain, both discounting and risk-adjustment are mandatory, not optional refinements.

Worked Example 1: Initial Recognition

How Is a Liability-Classified Earnout Remeasured Afterwards?

A liability-classified earnout is remeasured to fair value at each reporting date and the movement is recognised in profit or loss, never in goodwill (IFRS 3.58(b)). Because it meets the definition of a financial liability, IFRS 9 governs the mechanics: it is carried at fair value through profit or loss, so both the unwinding of the discount and revisions to the probability of payout flow through earnings. The line is often labelled "change in fair value of contingent consideration" and is one of the most volatile numbers in an acquisitive group's income statement.

The counter-intuitive result: when an acquired business performs better than expected, the earnout liability rises, and the increase is an expense. The buyer is, in accounting terms, penalised for the target's success — and rewarded (a gain) when the target underperforms and the liability shrinks. This is exactly what caught out many buyers and is a frequent source of "why did our great acquisition create a charge?" conversations.

Worked Example 2: Subsequent Remeasurement Through P&L

Measurement-Period True-Up vs Change in Estimate

The single most-litigated distinction in earnout accounting is whether a post-acquisition movement is a measurement-period adjustment or a change in estimate. A measurement-period adjustment (IFRS 3.45–.49) arises only when the acquirer obtains new information about facts and circumstances that existed at the acquisition date — and it is recognised retrospectively against goodwill, as if the acquisition accounting had been correct from the start. Anything else — a change driven by events or performance after the acquisition date — is a change in estimate that goes to profit or loss (IFRS 3.58), full stop.

The measurement period ends as soon as the acquirer has the information it was seeking, and in any case cannot exceed one year from the acquisition date (IFRS 3.45). The distinction is not about when the adjustment is made but why: even inside the twelve months, a movement caused by the target's post-acquisition trading is a P&L change in estimate, not a goodwill true-up. Conflating "within 12 months" with "goes to goodwill" is one of the most common errors auditors correct.

Worked Example 3: The Contrast That Trips People Up

When Is an Earnout Actually Remuneration (B55(a))?

Not every "earnout" is consideration for the business. IFRS 3.B55(a) says that a contingent payment which is automatically forfeited if the selling shareholder leaves employment is remuneration for post-combination services, not part of the consideration transferred — and it is expensed in profit or loss over the service period, outside the business-combination accounting altogether. The clause "you get £5m if you stay and hit targets for three years, but nothing if you resign" is compensation, however it is labelled in the sale agreement.

This matters in both directions. Structuring a genuine deferred purchase price as employment-linked lets a buyer keep it out of goodwill and spread it as an expense; dressing up what is really compensation as "consideration" avoids the P&L charge and inflates goodwill instead. IFRS 3.B55 lists further indicators — the linkage to continued employment being decisive (B55(a)) — alongside factors such as the level of payment relative to other employees, and whether the payment per share exceeds what non-employee sellers receive. Getting this wrong is a favourite target of both auditors and regulators, because the two treatments look nothing alike in the accounts.

Auditor Red Flags & ISA Focus

Contingent consideration is a fair-value accounting estimate, so ISA 540 (Auditing Accounting Estimates) is the primary standard in play, supported by ISA 500 (Audit Evidence) and ISA 315 (Risk Assessment). The following are the recurring findings.

Red flag 1 — Optimistic probabilities with no evidence (ISA 540)

Management assigns a 90% probability to an ambitious EBITDA target with nothing behind it. Under ISA 540 the auditor evaluates the method, assumptions and data behind the estimate, tests management's point estimate against the target company's historical performance, the deal model used to justify the price, and industry benchmarks, and develops an independent range or point estimate to challenge management bias. An unsupported probability that conveniently minimises the day-one liability (and maximises reported earnings later, when the liability is written down) is a classic indicator of management bias.

Red flag 2 — Misclassifying an earnout as remuneration, or vice versa (ISA 500 / ISA 315)

The most consequential error is on the B55(a) fence. A group facing a volatile liability-classified earnout has an incentive to re-characterise it as consideration that never touches profit, or to push a genuine deferred price into employment-linked remuneration to smooth it as an expense. Under ISA 500 the auditor reads the actual sale-and-purchase agreement — the forfeiture-on-leaving clause is the evidence, not management's label — and under ISA 315 identifies the arrangement as a significant risk requiring specific procedures. Misclassification here can move tens of millions between goodwill and expense.

Red flag 3 — Goodwill used as a dumping ground after the measurement period (ISA 540 / ISA 315)

An adjustment to the earnout is booked against goodwill eighteen months after acquisition, or a movement caused by post-acquisition trading is routed to goodwill inside the twelve months to avoid an earnings hit. Either is wrong: only new information about acquisition-date facts, obtained within the measurement period, may adjust goodwill (IFRS 3.45–.49). The auditor traces each adjustment to its underlying cause and confirms that performance-driven changes hit profit or loss (IFRS 3.58), because misrouting them protects earnings improperly.

Case Study: Hologic / Acessa Earnout Remeasurement

Frequently Asked Questions

Does a change in the fair value of contingent consideration adjust goodwill?

Almost never. Once the acquisition-date fair value is set, later changes in a liability-classified earnout go to profit or loss under IFRS 3.58(b). The only exception is a measurement-period adjustment — new information about facts that existed at the acquisition date, obtained within twelve months — which is recognised retrospectively against goodwill (IFRS 3.45–.49).

Is contingent consideration classified as a liability or equity?

It depends on how it will be settled (IFRS 3.40, applying IAS 32). Cash settlement, or settlement in a variable number of shares equal to a fixed value, makes it a financial liability. Settlement in a fixed number of the acquirer's own shares makes it equity. Liabilities are remeasured through P&L; equity is not remeasured at all.

Why does a successful acquisition create an accounting expense?

Because a liability-classified earnout is carried at fair value through profit or loss (IFRS 9, IFRS 3.58(b)). When the target outperforms, the expected payout rises, the liability increases, and that increase is an expense — even though the business is doing well. Conversely, underperformance shrinks the liability and produces a gain.

How long is the measurement period?

It ends when the acquirer has obtained the information it was seeking about acquisition-date facts, and cannot exceed one year from the acquisition date (IFRS 3.45). After it closes, all earnout movements are changes in estimate recognised in profit or loss, regardless of cause.

When is an earnout treated as remuneration instead of consideration?

When the payment is automatically forfeited if the selling shareholder leaves employment, it is compensation for post-combination services under IFRS 3.B55(a) — expensed over the service period, outside the business-combination accounting and outside goodwill.

What discount rate should be used for an earnout?

A rate that reflects both the time value of money and the risk specific to the payout (IFRS 13). Higher-risk, further-dated earnouts warrant higher rates. The rate and the probability distribution are the two inputs auditors challenge most under ISA 540.

Do equity-classified earnouts ever get remeasured?

No. Under IFRS 3.58(a) an earnout classified as equity is not remeasured; its subsequent settlement is accounted for within equity. Whatever the fixed number of shares is ultimately worth does not affect profit or loss.

About the author

Usman Qureshi is a Chartered Certified Accountant (ACCA) working in audit and advisory. He writes the IFRS, FRS 102 and US GAAP guides published on this site. Membership is listed on the ACCA public register.