Chapter 12, Problem 7P

Hamilton Company’s balance sheet on January 1, 2019, was as follows:

Korbel Company is considering purchasing Hamilton (a privately held company) and discovers the following about Hamilton:

1. a. No allowance for doubtful accounts has been established. A $10,000 allowance is considered appropriate.
2. b. Marketable securities are valued at cost. The current market value is $60,000.
3. c. The LIFO inventory method is used. The FIFO inventory of $140,000 would be used if the company is acquired.
4. d. Land, included in property, plant, and equipment, which is recorded at its cost of $50,000, is worth $120,000. The remaining property, plant, and equipment is worth 10% more than its depreciated cost.
5. e. The company has an unrecorded trademark that is worth $70,000.
6. f. The company’s bonds are currently trading for $130,000.
7. g. The pension liability is understated by $40,000.

Required:

1. 1. Compute the amount of goodwill if Korbel agrees to pay $500,000 cash for Hamilton.
2. 2. Next Level What are the reasons that the book value of Hamilton’s net identifiable assets differ from their market value?
3. 3. Prepare the journal entry to record the acquisition on the books of Korbel assuming Hamilton is liquidated.
4. 4. If Korbel agrees to pay only $400,000 cash, how much goodwill exists?
5. 5. If Korbel pays only $400,000 cash, prepare the journal entry to record the acquisition on its books, assuming Hamilton is liquidated.

To determine

Calculate the amount of goodwill of Company H.

Explanation of Solution

Goodwill: Goodwill is the good reputation developed by a company over years. This is recorded as an intangible asset, and is quantified when other company acquires. Goodwill should be recorded only when one company is acquired by another company. Goodwill value would be impaired, if the book value of goodwill is less than fair market value.

Calculate the amount of goodwill of Company H:

Particulars	Amount ($)
Amount willing to pay	$500,000
Less: Identifiable net assets	$415,000
Goodwill	$85,000

Table (1)

Compute the identifiable net assets:

Assets	Amount ($)
Cash	$30,000
Accounts receivable (net) (1)	70,000
Marketable securities (short-term)	60,000
Inventory	140,000
Land	120,000
Plant Property &Equipment (2)	165,000
Trademark	70,000
Total assets  (a)	$655,000
Liabilities
Accounts payable	20,000
Bonds payable	130,000
Pension liability	90,000
Total liabilities (b)	$240,000
Identifiable net assets $\left(\text{a}-\text{b}\right)$	415,000

Table (2)

Working note (1):

Compute the accounts receivable (net):

$\begin{array}{c}\text{Accounts receivable net}=\text{Accounts receivable}-\text{Allowance}\\ =\text{\$80,000}-\$10,000\\ =\$70,000\end{array}$

Working note (2):

Compute the plant, property and equipment (net):

$\begin{array}{c}\text{Plant Property \&Equipment net}=\left(\begin{array}{l}\left[\begin{array}{l}\text{Plant Property \&Equipment}\\ -\text{Amount included in PPL}\end{array}\right]\times \\ \text{Depreciable cost}\end{array}\right)\\ =\left[\left(\$200,000-\$50,000\right)\right] \times \frac{110}{100}\\ =\$165,000\end{array}$

To determine

State the reason for the difference in the book value of Company H’s identifiable net assets from the market value.

Explanation of Solution

Identifiable intangibles: The identifiable intangibles are the intangible assets that can be easily separated from the company, and it would be sold, transferred, licensed, rented or exchanged. Examples: trademarks, patents, copyrights, franchises, customer lists and relationships, non-compete agreements, and licenses.

The book value of H Company’s identifiable net assets differs from its market value for the following reason:

• Some of the assets of Company H are listed on the balance sheet at amounts other than their market value. For instance: The marketable securities are listed at cost and not at a fair value, likewise the inventory is valued using LIFO, instead of FIFO. The land is reported at cost but not at its market value, if it would have reported at its market value, then the cost would be much higher. Equipment is reported at depreciated cost while its market value is much higher.
• Company H has a valuable internally developed trademark that is not recorded.
• An unidentifiable intangible asset (goodwill) exists. However, it is not reported on H Company’s books.

To determine

Prepare journal entry for the given transaction.

Explanation of Solution

Prepare journal entry in the books of Company K assume that Company H has been liquidated.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Cash		30,000
	Accounts Receivable		70,000
	Marketable Securities		60,000
	Inventory		140,000
	Land		120,000
	Property, Plant, and Equipment		165,000
	Trademark		70,000
	Goodwill		85,000
	Accounts Payable			20,000
	Bonds Payable			130,000
	Pension Liability			90,000
	Cash			500,000
	(To record the acquisition of company H)

Table (3)

To determine

Compute the amount of goodwill that exist, when Company K agrees pay only $400,000 cash.

Explanation of Solution

Compute the amount of goodwill that exist, when Company K agrees pay only $400,000 cash

Particulars	Amount ($)
Amount willing to pay	$400,000
Less: Identifiable net assets	415,000
Goodwill	(15,000)

Table (4)

To determine

Prepare journal entry for the given transaction.

Explanation of Solution

Prepare journal entry in the books of Company K assume that Company H had paid only $400,000.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Cash		30,000
	Accounts Receivable		70,000
	Marketable Securities		60,000
	Inventory		140,000
	Land		120,000
	Property, Plant, and Equipment		165,000
	Trademark		70,000
	Accounts Payable			20,000
	Bonds Payable			130,000
	Pension Liability			90,000
	Cash			400,000
	Gain on purchase of Company H			15,000
	(To record the gain on acquisition of company H)

Table (5)