Final answer:
When ABC Corporation offers an earnings contingency to former shareholders of XYZ Company after a merger, this results in a contingent liability on ABC's balance sheet, impacting both assets and liabilities. The contingent liability is recorded based on the present value of expected future payments, and adjusted as needed until the contingency is settled.
Step-by-step explanation:
When ABC Corporation acquires XYZ Company in a statutory merger and offers the former shareholders of XYZ an earnings contingency, it likely results in a contingent liability on ABC's balance sheet. This contingency is dependent on future earnings of the merged company. The accounting treatment typically involves recognizing a liability that corresponds to the present value of the expected future payments to the former shareholders, with adjustments over time as the earnings and subsequently the contingent payments become clearer.
The entry to record the liability initially might look something like this:
- Dr. Goodwill or other intangible assets
- Cr. Contingent liability
If the contingency is settled, the changes would be:
- Dr. Contingent liability
- Cr. Cash/Settlement expense
These accounting entries reflect the creation and settlement of the earnings contingency promised to the former shareholders of XYZ by the ABC Corporation following the merger.