Contingent Payment Contracts
BACKGROUND
A contingent payment contract is an agreement between two or more parties in which settlement by one party is dependent on a future event. For example, a deferred underwriting commission may be payable to the underwriter upon completion of a future merger transaction by a SPAC. The commission is calculated as a percentage of the proceeds received in the SPAC’s initial IPO. Another example is a contract for legal services, where payment is contingent upon a successful IPO or future acquisition transaction.
EXECUTIVE SUMMARY
Some reporting entities have asked a question of how to account for contingent payment contracts under U.S. GAAP. Liabilities arising from these contracts are considered contractual or legal liabilities rather than contingent liabilities. The probability of payment is irrelevant when determining the timing and measurement of these liabilities. This understanding is consistent with the updated definition of liability provided in Chapter 4 of CON 8, which does not include a specific assessment of probability threshold. Legal liabilities should be recognized when due, according to contract terms and measured at full contract value.
A contingent underwriting commission liability would likely be recognized at the contract amount by crediting liability and debiting equity issuance cost. Legal services with contingent payments would likely be recorded by crediting accounts payable and debiting APIC for legal services provided in connection with an equity transaction. If the services are for ongoing legal representation, the recipient of the service would have to debit earnings, not APIC. Contractual liabilities are recorded at full contractual amounts, regardless of estimated probability of payment.
This accounting treatment may result in counter-intuitive recognition practices, as certain contractual liabilities are recognized even when settlement is unlikely. This differs from contingent liabilities, which are not recognized when the “probable” criterion is met. Addressing the above issue is likely to require developing specific accounting guidance for contingent payment contracts. The guidance may differ depending on specific terms or type of the contract.
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