Assume that one of your clients asks for your assistance in allocating the $3,00
ID: 2417750 • Letter: A
Question
Assume that one of your clients asks for your assistance in allocating the $3,000,000 cost of a 100% acquisition of a competitor firm. You estimate the fair value of the net assets on the investee's balance sheet at $1,800,000. However, there is, in addition, an unrecorded trade name valued at $300,000. The trade name has an indefinite useful life. a. What amount of goodwill will be recorded? b. What will be the effect of the goodwill and trade name on the annual income statement? c. Now assume that the agreement between the investor and investee calls for an additional payment of $600,000 contingent upon the investee reaching a certain level of income within three years. You estimate the fair value of the potential payment at $300,000. What effect, if any, does the potential payment have on the amount of goodwill recognized?Explanation / Answer
Part (a)
Statement showing calculation of goodwill:
Part (b)
Treatment of goodwill on the annual income statement:
Goodwill will not be amortized under U.S. GAAP (FAS 142). The firm is required to determine fair value of reporting unit and compare it to carrying value of goodwill. If the fair value comes out to be lesser than carrying value (impaired), the goodwill value will be required to be reduced so that carrying value becomes equal to fair value. Then impairment loss so arising shall be reported as a separate line item on the income statement, and the new adjusted value of goodwill will be reported in the balance sheet.
Treatment of trade name on the annual income statement:
Intangible assets are amortized according to their respective life expectancy. But since in the given case trade name has indefinite useful live. Thus it will be reassessed each year for impairment. If an impairment loss occurs, then it will be recognized. The impairment loss will be determined by subtracting the asset's fair value from the asset's book/carrying value.
Part (c)
Statement showing calculation of goodwill:
Particulars Amount ($) Cost of acquisition 3000000 (-) Fair value of assets recorded in balance sheet 1800000 (-) Fair value of tradename not recorded in balance sheet 300000 Goodwill to be recorded 900000