Question

Using the acquisition method, how should Powell report this additional payment?

1) As an increase in the carrying amount of goodwill
2) As a reduction in the carrying amount of goodwill
3) As an expense in the income statement
4) As an increase in the carrying amount of the subsidiary

Answer 1

The additional payment made under the acquisition method should be reported as an increase in the carrying amount of goodwill if it is within the measurement period and relates to the initial purchase price allocation. Option 1 is correct answer.

Step-by-step explanation:

When using the acquisition method to account for a business combination, the additional payment made by the acquirer is evaluated to determine if it reflects new information about the facts and circumstances that existed at the acquisition date and should have been part of the initial purchase price allocation. If the additional payment is deemed to provide evidence about circumstances that existed at the acquisition date and is related to the acquired assets and liabilities, it may lead to an adjustment to the provisional values initially recognized during the purchase price allocation.

If the adjustment is related to goodwill, it should be treated as follows:

1. An increase in the carrying amount of goodwill if the additional payment exceeds the initially recognized amount and it is still within the measurement period (usually one year from the acquisition date).
2. A reduction in the carrying amount of goodwill if the additional payment is less than the initially recognized amount within the measurement period.
3. An expense in the income statement if the additional payment is made after the measurement period, which indicates that the payment is not part of the original business combination accounting.

In the scenario described, if the additional payment is made within the measurement period and reflects adjustments related to the initial estimates of the acquired assets and liabilities, the correct option to report the additional payment would be:

As an increase in the carrying amount of goodwill.

This would result in an increase in the total assets on the balance sheet and no effect on the income statement at the time of the adjustment. This action reflects the acquisition method's principle of capturing changes in the initial purchase price allocation that are identified within the measurement period.