Horse Corporation acquires all of Pony, Inc.for $300,000 cash.On that date, Pony has net assets with fair value of $250,000 but a book value and tax basis of $200,000.The tax rate is 40 percent.Prior to this date, neither Horse nor Pony has reported any deferred income tax assets or liabilities.What amount of goodwill should be recognized on the date of the acquisition?

Question

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We have to calculate the goodwill by subtracting the fair value of Pony's net assets from the purchase price.
Purchase price = $300,000
Fair value of Pony's net assets = $250,000
Goodwill = Purchase price - Fair value of net assets = $50,000
However, we also have to consider the tax implications. Since Pony's net assets have a tax basis of $200,000 but a fair value of $250,000, there is a potential for future taxable income when these assets are sold or otherwise disposed of in the future.
Therefore, we need to calculate the deferred tax liability resulting from the difference between the fair value and tax basis of the net assets. This is done with the following calculation:
Deferred tax liability = (Fair value - Tax basis) x Tax rate = ($250,000 - $200,000) x 40% = $20,000
The deferred tax liability reduces the amount of goodwill that can be recognized, since it represents a future tax cost to Horse Corporation. Therefore, the amount of goodwill to be recognized is:
Goodwill = Purchase price - Fair value of net assets - Deferred tax liability = $300,000 - $250,000 - $20,000 = $30,000.
However, this calculation assumes that Pony's net assets consist only of depreciable assets with differing tax bases and fair values. If any of the net assets are not depreciable, or have other tax considerations (such as tax credits), the calculation of the deferred tax liability would need to be adjusted accordingly.

Horse Corporation Acquires All of Pony, Inc