Direction Find Company agrees to pay $25 million in cash to the three former owners of Traffic

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Question:

Direction Find Company agrees to pay $25 million in cash to the three former owners of Traffic Flow for all of its assets and liabilities. These three owners of Traffic Flow developed and patented a technology for real-time monitoring of traffic patterns on the nation’s top 300 frequently congested highways. Direction Find 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, Direction Find also agrees to pay additional amounts to the former owners upon achievement of certain financial goals. Direction Find will pay $9 million to the three former owners of Traffic Flow if revenues from the combined system exceed $125 million over the next four years. Direction Find estimates this contingent payment to have a probability adjusted present value of $5 million.

The three former owners have also been offered employment contracts with Direction Find 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 four years (if the employees remain with the company) that Direction Find estimates to have a current fair value of $3 million. The three former owners of Traffic Flow say they will stay on as employees of Direction Find for at least four years to help achieve the desired financial goals.

Requirements:

In the form of an interoffice memorandum, you are to prepare responses to Direction Find Company’s CFO addressing the following issues.

*Based upon your research using the Accounting Standards Codification (ASC), carefully analyze each element discussed in the case, determining if it should be classified as compensation or consideration. Include summarized citations from the ASC to support your statements. Wherever possible, you are to specifically connect the standards to the case facts.

* Based upon your research using the ASC and your responses to part 1, prepare an overall opinion as to the most appropriate treatment of the contingent payments. Support your final opinion with summarized citations from the ASC or specifically connecting the case facts to the ASC.