Problem

Prepare a memo as the CFO of the company who made the aquisition, answering the question. Should NaviNow account for the contingent payments promised to the former owners of TraficEye as consideration transferred in the acquisition or as compensation expense to employees?

The memo should be written on a Word document and include any supporting schedule if required should be embedded objects as part of the memo (Word document).

Case Study Details:

NaviNow Company agrees to pay $20 million in cash to the four former owners of TrafficEye for all of its assets and liabilities. These four owners of TrafficEye developed and patented a technology for real-time monitoring of traffic patterns on the nation's top 200 frequently congested high-ways. NaviNow plans to combine the new technology with its existing global positioning systems and projects a resulting substantial revenue increase.

As part of the acquisition contract, NaviNow also agrees to pay additional amounts to the former owners upon achievement of certain financial goals. NaviNow will pay $8 million to the four former owners of TrafficEye if revenues from the combined system exceed $100 million over the next three years. NaviNow estimates this contingent payment to have a probability adjusted present value of $4 million.

The four former owners have also been offered employment contracts with NaviNow to help with system integration and performance enhancement issues. The employment contracts are silent as to service periods, have nominal salaries similar to those of equivalent employees, and specify a profit-sharing component over the next three years (if the employees remain with the company) that NaviNow estimates to have a current fair value of $2 million. The four former owners of TrafficEye say they will stay on as employees of NaviNow for at least three years to help achieve the desired financial goals.

Should NaviNow account for the contingent payments promised to the former owners of TrafficEye as consideration transferred in the acquisition or as compensation expense to employees?