DC Company purchased 80% of the outstanding common shares of FA Company on December 31, 20X3, for $170,000. At that date, FA had $100,000 of outstanding common stock and retained earnings of $30,000. It was agreed that the net assets were fairly valued except that the fair value of the capital assets exceeded their net book value by $20,000 and the carrying value of the inventory exceeded its fair value by $10,000. The capital assets had a remaining useful life of eight years as of the acquisition date and have no salvage value. Inventory turns over four times a year. It is now 20X6 and DC has been very pleased with how profitable its investment in FA has been. On DC's consolidated financial statements at December 31, 20X6, what balance should be reported for goodwill assuming no impairment has occurred?
A)$0
B)$10,000
C)$52,500
D)$58,500

Question

Quizplus · Accepted Answer

Goodwill is calculated by subtracting the fair value of the net assets acquired from the cost of the investment. Here is the calculation:
Cost of investment = $170,000
Fair value of net assets acquired:
Common stock = $100,000
Retained earnings = $30,000
Capital assets (fair value = net book value + excess) = $80,000 + $20,000 = $100,000
Inventory (fair value = carrying value - excess) = $0 (because it will be sold within the year)
Total fair value of net assets = $230,000
Goodwill = $170,000 - $230,000 = -$60,000
However, since negative goodwill is not allowed, it should be allocated to reduce the fair value of the capital assets. Thus, the carrying amount of the capital assets should be adjusted to $60,000 ($80,000 - $20,000 + -$60,000). The adjustment should be taken to the income statement as a loss. Therefore, the balance reported for goodwill is zero, and the adjustment to the carrying amount of the capital assets is recorded as a loss. However, since the question assumes no impairment has occurred, goodwill would still technically exist and would need to be tested for impairment in future periods.

DC Company Purchased 80% of the Outstanding Common Shares of FA