Question

Goodwill

Composite Company is considering purchasing EKC Company. EKC's balance sheet at December 31, 2016, is as follows:

Cash	$56,000		Current liabilities	$65,000
Accounts receivable	71,000		Bonds payable	154,000
Inventory	110,000		Common stock	200,000
Property, plant, and equipment (net)	650,000		Retained earnings	468,000
	$887,000			$887,000

At December 31, 2016, Composite discovered the following about EKC:

No allowance for uncollectible accounts has been established. An allowance of $4,200 is considered appropriate.

The LIFO inventory method has been used. The FIFO inventory method would be used if EKC were purchased by Composite. The FIFO inventory valuation of the December 31, 2016, ending inventory would be $172,000.

The fair value of the property, plant, and equipment (net) is $760,000.

The company has an unrecorded patent that is worth $100,000.

The book values of the current liabilities and bonds payable are the same as their market values.

Required:

1. Compute the value of the goodwill if Composite pays $1,425,800 for EKC.

$

2. Why would the book value of a company's identifiable net assets differ from its market value?

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Answer 1

Goodwill is not an identifiable asset. It is generated when a company buys another company.

Goodwill is the difference between the purchase price of the acquired company and the estimated fair market value of the identifiable net assets acquired (tangible and intangible assets minus the liabilities).

Goodwill is created when one company acquires another for a price higher than the fair market value of its assets.

Reconstruct Balance sheet at Dec. 31, 2016
Cash	56,000	Current liabilities	65,000
Accounts Receivable	71,000	Allowance	4,200
Inventory	172,000	Bonds payable	154,000
Property, plant and Equipment (Net)	760,000	Common stock	200,000
Patent	100,000	Retained Earnings	468,000

Total assets = $1,159,000 ($56,000 + $71,000 + $172,000 + $760,000 + $100,000)

Total Liabilities = $223,200 ($65,000 + $4,200 + $154,000)

Since the Composite pays $1,425,800 for EKC

Goodwill = $1,425,800 – ($1,159,000 - $223,200)

Goodwill = $490,000

Book value is calculated from the balance sheet, and it is the difference between a company's total assets and total liabilities.

Market value is the value of a company according to the stock market. Market value is calculated by multiplying a company's shares outstanding by its current market price.