Exercise 1A-1 (LO 8) 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

 

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 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 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.