Question

Seashell Corp. was organized to consolidate Sea Company and Shell Company in a business combination. Seashell issued 25,000 shares of its newly authorized $10 par value common stock in exchange for all of the outstanding common stock of Sea and Shell. At the time of the consolidation, the fair value of Sea's and Shell's assets and liabilities are equal to their book values. The shareholders' equity accounts of Sea and Shell on the date of the consolidation were:

	Sea	Shell	Total
Common stock, at par	$100,000	$200,000	$300,000
Additional paid-in capital	50,000	75,000	125,000
Retained Earnings	22,500	47,500	70,000
Totals	$172,500	$322,500	$495,000

Which one of the following is the amount of goodwill Seashell would recognize upon issuing its common stock to effect the consolidation?

	$-0-
	$50,000
	$195,000
	$245,000

You Answered Correctly! (Answer is A, $0)

Explanation:

Since Seashell's stock is newly issued to effect the consolidation, it has no prior market value. In the absence of a market value, the fair value of Seashell's stock is determined by the fair value of the net assets acquired in the consolidation. Therefore, the consideration given (common stock issued) is equal to the fair value of net assets acquired, and no goodwill is recognized

For this problem what would be "the fair value of the net assets acquired in the consolidation" as stated in the answer explanation above? Also, please explain as simple as possible why goodwill is not recognized because I still can't seem to understand why it isn't with the explanation above?

Answer 1

Ans:

As mentioned in the question above, on the date of consolidation Fair Market value of assets and liabilities is Equal to the book value of the assets and liabilities of both the companies.

Book Value : Book Value is the reported value of assets and liabilities on the date of event. In our case consolidation of companies.

Fair Market Value : Fair Market value of asset means the actual market value of reported assets and liabilities in the books.

If Fair Market value is Higher than the book value than Goodwill should be recognised, not in any other case.

Let understand this with an exmple:

Suppose net assets value of Company A in the books is $20,000 but its Fair Market Value (means if sold in the market) is $30,000. So anyone who will purchase all the assets of company A will be ready to pay $30,000 because this is what the market value of assets of company A. In such case all assets will be recognised in the books of purchaser at $20,000 and the additional amount paid for $10,000 should be recognised as Goodwill.

If both are equal than no Goodwill can arise.

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