Estimating goodwill. 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, 20X6 |
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Assets
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Liabilities and Equity
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|
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Accounts receivable
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$100,000
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Total liabilities
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$200,000
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Inventory
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100,000
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Capital stock ($10 par)
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100,000
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Land
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100,000
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Paid-in capital in excess of par
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200,000
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Building (net)
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220,000
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Retained earnings
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300,000
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Equipment (net)
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280,000
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Total assets
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$800,000
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Total liabilities and equity
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$800,000
|
Appraisals indicate that the inventory is undervalued by $25,000, the building is underva- lued by $80,000, and the equipment is overstated by $30,000. Past earnings have been consid- ered above average and were as follows:
Year Net Income
20X1 $ 90,000
20X2 110,000
20X3 120,000
20X4 140,000*
20X5 130,000
*Includes extraordinary gain of $40,000.
It is assumed that the average operating income of the past ?ve years will continue. In this industry, the average return on assets is 12% on the fair value of the total identi?able assets.
1. Prepare an estimate of goodwill based on each of the following assumptions:
a. The purchasing company paid for ?ve years of excess earnings.
b. Excess earnings will continue inde?nitely and are to be capitalized at the industry normal return.
c. Excess earnings will continue for only ?ve years and should be capitalized at a higher rate of 16%, which re?ects 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.