Harrison, Inc. acquires 100% of the voting stock of Rhine Company on January 1, 2010 for $400,000 cash. A contingent payment of $16,500 will be paid on April 15, 2011 if Rhine generates cash flows from operations of $27,000 or more in the next year. Harrison estimates that there is a 20% probability that Rhine will generate at least $27,000 next year, and uses an interest rate of 5% to incorporate the time value of money. The fair value of $16,500 at 5%, using a probability weighted approach, is $3,142.
-Assuming Rhine generates cash flow from operations of $27,200 in 2010, how will Harrison record the $16,500 payment of cash on April 15, 2011 in satisfaction of its contingent obligation?

Question

Quizplus · Accepted Answer

Since Rhine has generated cash flows from operations of $27,200 in 2010 and met the contingency, Harrison needs to revalue the contingent payment obligation as of the balance sheet date. Using the probability-weighted approach, the fair value of the contingent payment is $3,142 (20% x $16,500). Therefore, Harrison should debit the Contingent performance obligation for $3,142 and recognize a loss of $13,358 ($16,500 - $3,142) in the income statement under "Loss from revaluation of contingent performance obligation." Finally, Harrison should credit cash for the full amount of $16,500.