Question

On January 1, 2020, Adams acquires 100% of Baker in a transaction accounted for using the acquisition method. Adams will use equity accounting for its investment in Baker. Baker will remain a wholly owned subsidiary of Adams. The following is information about this acquisition. To pay for this purchase, Adams issues 20,000 shares of common stock with a $5 par and $20 market value. Legal and accounting costs were $50,000. Stock issuance costs were $20,000. If Baker has net income of $50,000 in 2021, Adams will pay an additional $100,000. At acquisition date there is a 40% probability of this occurring. The book value of net assets acquired of Baker was $200,000 at acquisition date. Adams was willing to pay in excess of book value to acquire Baker because Baker had a building (10 year life) with a book value of $300,000 and a fair value of $340,000. Baker has $40,000 in net income in 2020 and pays a dividend of $30,000. Adams has $100,000 of net income in 2020 and pays a dividend of $70,000. Prepare an investment analysis at date of acquisition, including the following: a. Calculate the amount debited to the investment b. Calculate the premium over book value c. Determine the amount of goodwill or if it is a bargain purchase d. How much is the excess depreciation that will be reflected as consolidation entry E in 2020 ?

Answer 1

The investment in Baker is debited by $400,000. The premium over book value is $240,000, and goodwill is likely recorded. The annual excess depreciation is $4,000 due to the fair value adjustment of Baker's building.

Step-by-step explanation:

When Adams acquires Baker, the investment amount debited to Adams's balance sheet would be based on the market value of the shares issued. Adams issues 20,000 shares at a market value of $20 each, totaling $400,000.

Thus, the investment in Baker is debited by $400,000. The legal and accounting costs of $50,000 and stock issuance costs of $20,000 are expensed and thus not included in the investment cost.

The premium over book value is the amount paid above Baker's net assets book value. The book value of Baker's net assets is $200,000. The fair value of Baker's building is $340,000, while its book value is $300,000; this results in a fair value adjustment of $40,000.

Without considering any contingent consideration (the additional $100,000), the premium over book value is $400,000 (price paid) - $200,000 (book value) + $40,000 (fair value adjustment for the building) = $240,000.

To determine the amount of goodwill or a bargain purchase, we must figure out the fair value of all of Baker's net identifiable assets and compare with the consideration transferred by Adams. If the price paid exceeds the fair value of net assets, that excess is recorded as goodwill. If the fair value of net identifiable assets exceeds the price paid, it's a bargain purchase.

However, in this scenario, given that we have a fair value adjustment for the building and may have additional contingent consideration, it's likely goodwill is created, calculated as the investment amount ($400,000) minus fair value of net assets acquired ($200,000 + $40,000 fair value adjustment).

The excess depreciation is the additional depreciation expense resulting from the fair value adjustment of Baker's building. Since the building is revalued upward by $40,000 and has a remaining life of 10 years, the excess annual depreciation is $4,000 per year. This $4,000 will be reflected as a consolidation entry E in 2020.