Question

Green Company is considering acquiring the assets of Gold Corporation by assuming Gold’s liabilities and by...

Green Company is considering acquiring the

assets of Gold Corporation by assuming Gold’s liabilities and by making a cash payment. Gold

Corporation has the following balance sheet on the date negotiations occur:

Gold Corporation

Balance Sheet

January 1, 2016

Assets Liabilities and Equity

Accounts receivable . . . . . . . . . . . . $100,000 Total liabilities . . . . . . . . . . . . . . . . . $200,000

Inventory . . . . . . . . . . . . . . . . . . . . . 100,000 Capital stock ($10 par) . . . . . . . . . . 100,000

Land. . . . . . . . . . . . . . . . . . . . . . . . . 100,000 Paid-in capital in excess of par . . . . 200,000

Building (net) . . . . . . . . . . . . . . . . . . 220,000 Retained earnings . . . . . . . . . . . . . . 300,000

Equipment (net) . . . . . . . . . . . . . . . . 280,000

Total assets. . . . . . . . . . . . . . . . . . $800,000 Total liabilities and equity . . . . . . $800,000

Appraisals indicate that the inventory is undervalued by $25,000, the building is undervalued

by $80,000, and the equipment is overstated by $30,000. Past earnings have been considered

above average and were as follows:

Year Net Income

2011 $ 90,000

2012 110,000

2013 120,000

2014 140,000*

2015 130,000

*Includes a nonrecurring gain of $40,000.

It is assumed that the average operating income of the past five years will continue. In this

industry, the average return on assets is 12% on the fair value of the total identifiable assets.

1. Prepare an estimate of goodwill based on each of the following assumptions:

a. The purchasing company paid for five years of excess earnings.

b. Excess earnings will continue indefinitely and are to be capitalized at the industry normal

return.

c. Excess earnings will continue for only five years and should be capitalized at a higher rate

of 16%, which reflects the risk applicable to goodwill.

2. Determine the actual goodwill recorded if Green pays $690,000 cash for the net assets of

Gold Corporation and assumes all existing liabilities.

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