Consideration or Compensation? Applying ASC 805

In under a minute

• Business combinations often are significant and inherently complex transactions, and one of the most challenging aspects is determining the appropriate amount of consideration transferred for the acquired business under Accounting Standards Codification (ASC) 805, “Business Combinations.”
• A core requirement of ASC 805 is distinguishing between amounts paid to obtain control of the acquiree and payments that are, in substance, separate transactions – most commonly, post-combination compensation.
• Payments or other instruments transferred subject to one or more contingencies often present challenges in making this distinction.
• When classification is unclear, ASC 805 directs preparers to assess specific indicators to determine whether contingent payments relate to consideration or separate arrangements.

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Background

The main objective of ASC 805 seems straightforward: Determine what the acquirer paid to obtain control of the acquiree, and allocate that payment to identifiable assets and liabilities, with any residual recorded as goodwill. In practice, however, transaction structures are anything but straightforward.

For example, business combinations frequently bundle together the purchase of the business with other transactions, including but not limited to incentive arrangements to keep key management in place and the settlement of preexisting contracts or disputes between the parties.

ASC 805 acknowledges this complexity. The guidance requires acquirers to evaluate arrangements entered into in connection with a business combination and determine which of the following they are:

• Part of the exchange for the acquiree (and therefore included in consideration transferred)
• Separate transactions that should be accounted for under other GAAP (for example, as compensation, contract settlement, or acquisition-related costs)

Reviewing and understanding the contractual terms of an acquisition transaction can be challenging, making it difficult to identify and evaluate whether such bundled transactions must be accounted for separately. Following are some practical considerations and examples to highlight some of the issues commonly seen in practice.

Start with total deal value, and then evaluate what is not purchase consideration

A disciplined approach is to begin with all payments and obligations arising from the transaction (for example, cash, equity, earnouts, notes, retention-style arrangements, and reimbursements) and then evaluate whether any portion is not attributable to acquiring the business, considering the reasons for, timing of, and initiator of the arrangement (ASC 805-10-55-18).

Following this approach, transactions that are accounted for separately from the business combination frequently involve payments to employees or selling shareholders tied to one or more contingencies.

Crowe observation: The objective of considering the timing of the transaction, who initiated the transaction, and reasons for the transaction is to determine who receives the primary benefit from the transaction. If the transaction is primarily for the benefit of the acquirer or the combined entity rather than the seller or acquiree before the business combination, the transaction is likely a separate transaction that should be accounted for outside the business combination. For example, if shortly before close the acquirer requests that the acquiree terminate a vendor contract so the acquirer can implement its post-close operating model and realize synergies, the primary beneficiary is the acquirer or combined entity; therefore, the contract termination is likely a separate transaction accounted for outside of the business combination.

Case 1: Contingent payments subject to potential forfeiture

Continuing employment generally is a persuasive indicator that a contingent payment is compensation for post-combination services. For example, a contingent payment might be forfeited if a seller fails to remain employed for a specified period of time following the acquisition. Agreement terminology and structures can vary, but the key is determining whether the substance of a forfeiture provision is to enforce service and retention or instead to protect the buyer from value erosion that is not service-related.

Why it matters: A contingent payment that is substantively compensation for post-combination services results in the acquirer recognizing compensation expense, whereas a contingent payment that represents purchase consideration is included in the acquisition consideration and allocated to the identifiable assets and liabilities, with any residual recorded as goodwill.

The following example demonstrates how changing just one fact can affect the conclusion.

Key takeaway: While it can be challenging to determine the substance of the terms and conditions of contingent payments, indicators in ASC 805-10-55-25 serve as a guide to help preparers assess whether the substance of the contingent payment represents compensation for continued employment.

Crowe observation: Many other variants of contingent payments exist. For example, an employee-seller might receive a contingent payment in the form of the acquirer’s shares that, if the employee-seller does not remain employed for a specified period of time, the acquirer can repurchase at cost, which might be defined as the acquisition-date fair value of those shares. In this instance, the employee-seller is assured of receiving at least the acquisition-date fair value regardless of employment; however, the employee-seller must satisfy a service condition in order to vest in the “upside” of the shares. In fact patterns such as this, it is critical for preparers to identify all relevant terms of the arrangement and account for the arrangement based on its substance, which might entail more than one unit of account. For instance, an acquirer might account for a contingent payment arrangement as two separate units of accounts: one representing purchase consideration and another representing post-combination compensation expense.

Case 2: Last-man-standing rights

Some arrangements involve an earnout payable only to individuals who continue to provide services through a stated date or where the group allocation shifts to the remaining employees. These structures, often referred to as last-man-standing arrangements, can involve a variety of terms and conditions that, in some cases, might be challenging to analyze.

Why it matters: Last-man-standing rights often represent post-combination compensation because the arrangement behaves like a group retention arrangement.

Key takeaway: If earnout entitlement is based on who stays employed, the contingent payment generally represents compensation for post-acquisition services rather than consideration for the acquired business.

Case 3: Mixed seller populations (employee-sellers and nonemployee-sellers)

Some business combination transactions involve a mix of sellers who will continue as employees post close and sellers who are not employees.

Why it matters: ASC 805 highlights that if selling shareholders who become employees receive higher contingent payments per share than those who do not become employees, the substance of the incremental amount might be considered compensation for post-combination services. Importantly, in some cases, the acquirer might need to evaluate the payment arrangement’s unit of account to determine the substance of the arrangement (for example, a single earnout might contain multiple components, such that one portion is purchase consideration and another portion is compensation).

Key takeaway: When some sellers become employees and others do not, the acquirer should consider the earnout economics (for example, on a per-share basis) for employee-sellers versus nonemployee-sellers. Differences in payout economics, especially those contingent on continued employment, may indicate that part of the contingent payment should be treated as compensation rather than purchase consideration.

Other considerations

While contingent payments to sellers are a frequent source of accounting complexity, they are only one piece of a broader analysis of the business combination’s contractual terms. As entities evaluate contingent payments, they also should step back and identify other deal-related arrangements that might require separate accounting outside of the business combination, such as settlement of preexisting relationships, reimbursements of transaction costs, and other payments made at closing that might not represent purchase consideration. Identifying these items early and evaluating each arrangement at the appropriate unit of account helps minimize last-minute adjustments during the purchase price allocation process.

Crowe observation: Preexisting relationships often are overlooked. A practical technique is to pair the legal review of the purchase agreement with a targeted search of contracts, accounts receivable and accounts payable ledgers, and legal letters to uncover any prior relationships between the parties. Establishing a process that involves an analysis of preexisting relationships helps entities capture these items before finalizing the purchase price allocation.

Looking ahead

Determining the appropriate accounting for a business combination transaction requires a multifaceted assessment – often including complex, interrelated, and highly transaction-specific considerations that can be difficult to pin down. Because of the challenges such transactions present, entities entering or contemplating a business combination could benefit from the help of a team of experienced specialists.

Crowe observation: Because contingent payment structures are often used, classification decisions tend to repeat. Highly acquisitive entities should consider whether opportunities exist to standardize documentation across deals with similar terms. For example, using a common approach to evaluate contingent payment terms, preexisting relationships, cost reimbursements, and other items might enhance judgment consistency, simplify comparisons across acquisitions, and produce audit-ready documentation. In practice, this often means compiling the complete set of arrangements (purchase agreement and side letters, employment or consulting arrangements, and rollover equity terms), documenting the purpose and drivers of each payment (including who initiated it and when it was negotiated), and then applying the relevant indicators in a fact pattern manner to support the conclusion (and, if applicable, the service period or fair value measurement approach).

FASB materials reprinted with permission. Copyright 2026 by Financial Accounting Foundation, Norwalk, Connecticut. Copyright 1974-1980 by American Institute of Certified Public Accountants.