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Goliath Corporation purchased all of Masonry Corporation's outstanding stock on January \(1,1999,\) for 6,000,000 . The purchase price was paid as follows:Goliath Corporation issued 40,000 shares of its own common stock, par 1 dollar, with a market price of 102 dollar share, and cash paid of 1,920,000 dollar. The acquisition was accounted for as a purchase. Therefore, Masonry's income statement has been included with Goliath's since the acquisition date.The estimated fair value and carrying value of the assets purchased and the liabilities assumed totaled 7,600,000 dollar and 2,100,000 dollar. The excess of the purchase price over the fair value of the assets is being amortized over 40 years on a straight-line basis. a. Use the balance sheet equation to show how Goliath's financial statements will be affected by its acquisition of Masonry. (Assume that Masonry continues as a separate corporation.) b. Determine any goodwill inherent in this acquisition. c. Why did Goliath pay more than the fair value of Masonry's net assets?

Step by step solution

01

Calculation of Total Purchase Price

Firstly, compute the total purchase price of Masonry Corporation. This is made up of the cash paid (1,920,000 dollars) and the value of the shares issued by Goliath Corporation (40,000 shares times 102 dollars per share). In equation form, this is: \[Total Purchase Price = Cash + (Number of shares issued X Price per share)\]. By substituting the given values: \[Total Purchase Price = 1,920,000 + (40,000 X 102) = 1,920,000 + 4,080,000 = 6,000,000 dollars\].

02

Calculation of Goodwill

Goodwill is calculated by subtracting the net fair value of Masonry's assets (fair value of assets minus liabilities) from the total purchase price. This can be mathematically represented as: \[Goodwill = Total Purchase Price - Net Fair Value of Assets\]. Substituting the given values provides: \[Goodwill = 6,000,000 - (7,600,000 - 2,100,000) = 6,000,000 - 5,500,000 = 500,000 dollars\]. This indicates there is 500,000 dollars of goodwill inherent in this acquisition.

03

Discussion on Excess Payment

Goliath Corporation may have paid more than the fair value of Masonry's net assets for various reasons. This could be due to expected synergies from the merger, beliefs that the assets are undervalued, or perceived future earning potential and growth prospects for Masonry Corporation. Consequently, these factors and more can lead a company to pay a premium over the fair value of net assets when acquiring another company.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Purchase Price Allocation

When a company acquires another company, like in the example of Goliath Corporation acquiring Masonry Corporation, it involves assigning the purchase cost to different acquired assets and assumed liabilities. This is known as Purchase Price Allocation. It identifies the fair value of tangible and intangible assets, along with liabilities.

Here's how it works with our example:

• First, compute the total purchase price, which in this case, is $6,000,000. This includes both cash and shares issued.
• The fair value of Masonry's assets totals $7,600,000, while its liabilities stand at $2,100,000.
• Subtract the total liabilities from the value of the assets to get the net fair value of assets, which is $5,500,000.
• Any remaining purchase price above $5,500,000 is assigned as goodwill.

This allocation is vital for accurate financial reporting and helps to clarify the value of what is actually acquired.

Business Combinations

Business combinations indicate situations where two or more companies come together to form a single entity or operate as a single unit. They can occur in various forms, like mergers, acquisitions, or consolidations.

In the context of Goliath and Masonry Corporation, Goliath acquired all of Masonry's outstanding stocks. Therefore, it's an acquisition type of business combination. Here are some important aspects:

• Upon acquisition, Masonry's financial results blend into Goliath's financials, affecting revenue, expenses, and overall financial health.
• It also leads to strategic control, allowing Goliath to manage Masonry's operations, potentially realizing synergies and cost-saving processes.
• There may be adjustments in financial statements reflecting the consolidation of assets and liabilities.

Business combinations can transform company dynamics, expanding market reach and operational efficiencies.

Balance Sheet Equation

The Balance Sheet Equation, a fundamental principle in accounting, states that:
\[ \text{Assets} = \text{Liabilities} + \text{Equity} \]
When Goliath acquired Masonry, the equation balanced by reflecting new assets and liabilities. Here’s how it affects the equation,

• "Assets" will increase due to newly acquired assets from Masonry worth \(7,600,000.
• "Liabilities" will also increase by \)2,100,000 as Goliath assumes Masonry's debts.
• Any excess, like the goodwill of $500,000, is recorded as an intangible asset on the balance sheet.

This equation is crucial as it shows how Goliath's acquisition impacts its financial position, ensuring everything stays in balance and providing a clearer picture of the company's financial health post-acquisition.