So here we could work out for the acquisition, including deferred consideration. We have Telaga, which is buying 100% of the equity of Lipe for $100 million. But as part of the deal Telaga agrees to pay an additional consideration in a year's time, amounting to $10 million based on the performance of Lipe. Now, the discount rate that they're going to use is 10% and Lipe's fair value of net assets are closing at $65 million. So here we've got the initial consideration the future value at 10 million and we've got a discount rate of 10%. So the first thing to do is to take that best estimate of deferred consideration, which is 10 million and that will be probability weighted already. And then we'll just divide that by one plus the discount rate of 10% and that will give us the amount of the deferred consideration that's going to go onto the balance sheet at the deal date.

So the present value of, or the present fair value of the consideration is gonna be a combination of the deferred consideration, present valued and the initial consideration, which is 109.1. Then what we need to do is calculate goodwill and the goodwill which is going to compare the present value or the present fair value of consideration of 109 and the 65 million. So the goodwill calculation includes the goodwill related to the deferred consideration as well. Now, if over time the future value of the deferred consideration is no longer 10 million let's say 8 million, then you would reduce the liability but you will not change the goodwill. The goodwill will only be changed if there's a permanent reduction in the overall subsidiaries valuation. So the deferred consideration and the goodwill are not linked together.

So the accounting entries at closing, what will happen is we will have cash going down by the 100 million at closing. The goodwill that we've just created is gonna be 44.1 million, and the net operating assets are the 65 million. So in total, assets will increase by 9.1 million and that will be matched of course by a liability on the basis that that 10 million is gonna be paid in cash the only time it would not be a liability and it'll be equity if the deferred consideration is going to be a number of shares as opposed to a dollar value. So that's not necessarily just paid in shares it's where the future consideration is defined as a number of shares. Now, 12 months later, the liability has to be increased to reflect the unwinding of the discount rate. Now the discount rate we know from above is the 10%. So I'm gonna pull that in and we have our beginning balance of the contingent liability of 9.1. And then to grow that, to get to the future value, we'll just take the 9.1, multiply it by the discount rate and that gives us 0.9, add that to the beginning balance. That will give us our ending balance, which of course because the earn out is just over a 12 month period is equal to the 10 million. Now let's do the accounting entries. So we've got the assets side here and we'll do the liabilities and equities side here. So the first thing that happens is we will expense the interest expense on the income statement and that means that the equity is going to fall by 0.9.

Now, that's going to be matched by an increase in the deferred consideration liability by that increasing by 0.9. And then when we actually pay off the liability, cash is going to fall by 10 million and the deferred consideration liability will also fall by 10 million. And that's how the balance sheet balances initially from the expensing of interest and the increasing the liability and then the liability being paid off. Now, let's go back and assume that just before you paid off the liability that we estimated the actual earn out has been adjusted upwards by 12 million what would the entries be here? If you go to liabilities and equity, so the first thing that would happen here is that we would increase the deferred consideration liability that would go up by 2 million, and we would need to because the liability's gone up, we need to reduce equity. So what we'd have in retained earnings, we would have a loss on the deferred consideration liability, and that would just be a negative two, and that would hit the equity as part of retained earnings. So this means the liability is now 12 million so when it gets paid off, cash will go down by 12 million and the deferred liability will also go down by 12 million and the balance sheet balances. So that's just giving you an example if we had to do a fair value adjustment, but you can see that the income statement is potentially hit from earn outs, both from the interest expense from the under-winding of the discount rate and losses, or potentially gains on the revaluation of the estimated payments. Now remember, everything is done on present values. So if it was an earn out that was more than one year to go then you'd still have to present value that readjusted expected payment back to the balance sheet date. So that in essence is how to deal with earn outs and deferred consideration liabilities.