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taxmanrog, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 743
Experience:  Licensed CPA, MA, MST with 31 years' experience. Teach Accounting and Tax courses at Masters level.
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Can you help me explain the impact of contingent liabilities

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Can you help me explain the impact of contingent liabilities on ASC 740 (accounting for income taxes)?
Hi! Welcome to Just Answers! Thanks for the chance to answer your question! I will be happy to help as best I can!

A contingent liability is one that has not yet met the all events test. In order to better answer this question, what is the type of contingent liability that you have in mind? It makes a difference, as the IRS has issued a couple of Rev Procs for different situations.

Thanks! I look forward to your reply!

Customer: replied 4 years ago.

We bought a company for $5million, asset purchase, and included in the agreement was a $1million contingent liability, payable to seller if certain thresholds are met by the newly acquired company, in installment of 5 years. How should we record for tax provision purpose the contingent liability at the date of purchase? What if the liability paid is only $500K?

OK. Contingent liabilities resulting from a purchase.

First, FASB ASC 740–10–25: Income Taxes–Overall–Recognition (previously “Accounting for Uncertainty in Income Taxes,” FASB Interpretation No. 48 (Norwalk, Conn.: FASB, 2006)) provides guidance on accounting for uncertainty in income taxes. FASB ASC 450–10: Contingencies–Loss Contingencies (previously SFAS No. 5) no longer applies to income taxes. GAAP regarding uncertainty in income taxes changes the threshold for recognition of tax positions from the most probable amount to the amount that has a “more likely than not” chance of being sustained upon examination. There are several more FASB that talk about calculating amounts for estimates, i.e., using present value of probable future cash flows.

ASC Glossary defines a contingency as “an existing condition, situation, or set of circumstances
involving uncertainty as to possible gain or loss to an entity that will ultimately be resolved when one or more future events occurs or fails to occur.” Under ASC 450, contingencies would be recognized as follows:

- Contingencies that might result in gains usually are not recognized as assets, since doing so might result in recognizing revenue before realization

- A loss contingency liability is recognized when the amount of loss can be reasonably estimated and it is probably that

- An asset has been impaired or a liability has been incurred

- Future events will occur confirming the loss.

However, the recognition and measurement guidance in ASC 450 does not apply to the acquisition date accounting for contingencies in a business combination. Instead, ASC 805 provides new measurement and recognition guidance for assets and liabilities arising from contingencies, a new term that is more descriptive of the new accounting requirements for business combinations.

ASC 805-20-25-19 requires a new approach for recognizing an asset or liability arising from a contingency and establishes different recognition thresholds for contractual and non contractual contingencies, as follows:

Contractual contingencies: Assets and liabilities that arise from acquired contingencies related to contracts are recognized at fair value on the acquisition date.

Non contractual contingencies: For all other (non contractual) contingencies, the acquirer recognizes the asset or liability only if it is more likely than not that the contingency gives rise to an asset or liability, as defined in Concepts Statement 6, as of the acquisition date. For example, a liability arising from a noncontractual contingency would be recognized as part of the business combination if, as of the acquisition date, it is more likely than not that the entity has incurred a present obligation to pay if a specified contingent event occurs. The probability that the entity will incur a gain or loss if the contingent event occurs would be reflected in the measurement of the fair value of the asset or liability to be recognized.

So, in your case, you have an contractual acquisition liability. So you would have to value the contingent liability at a fair value as of the date of acquisition, using an amount that would have a "more likely than not" chance of being sustained on examination, in other words, a conservative amount.

I hope this answers your questions! If not, I would be happy to help answer any more that you have! Just ask away! If this answer has helped you, please rate me highly! I would appreciate it!

Thanks! Have a good week!

Customer: replied 4 years ago.

So, for ASC 740 the liabilities are recorded at fair value, but for tax purpose the liabilities are not recorded because it is not fixed, yet. So, we created a deferred tax at acquisition date because of this difference? what if the amount paid is different than $1million?

You are correct. As far as the amount to record, you need to record it at your best estimate of the difference. I would use the number that is most likely to be correct. For example, if in a perfect world you would have to pay $1million, but there is an 85% chance that it will be $650k will be the final payment, I would book the $650k. Any adjustment can be made in year 5, as the All Events test would be satisfied at that point.

I hope this answers your questions! If not, I would be happy to help answer any more that you have! Just ask away! If this answer has helped you, please rate me highly! I would appreciate it!

Thanks! Have a good week!

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