- CFA Exams
- CFA Exam: Level II 2021
- Study Session 5. Financial Reporting and Analysis (1)
- Reading 13. Intercorporate Investments
- Subject 5. Business combinations
CFA Practice Question
Shaw Company has the following account balances:
Inventory: 150,000.
Land: 100,000.
Building - net: 250,000.
Liabilities: 100,000.
Common stock: 100,000.
Additional paid-in capital: 150,000.
Retained earnings: 250,000.
B. $100,000.
C. $125,000.
Receivables: 100,000.
Inventory: 150,000.
Land: 100,000.
Building - net: 250,000.
Liabilities: 100,000.
Common stock: 100,000.
Additional paid-in capital: 150,000.
Retained earnings: 250,000.
Shaw's land has a fair market value of $200,000 while its building has a fair market value of $300,000. Shaw's liabilities have a fair market value of $75,000. Brooks Company obtains all of the outstanding shares of Shaw for $750,000 cash. In the financial statements prepared immediately after the business combination, what is the amount of goodwill?
A. $75,000.
B. $100,000.
C. $125,000.
Correct Answer: A
Book value of Shaw Company: (500,000).
Cost in excess of book value: 250,000.
Undervalued land: (100,000).
Undervalued building: (50,000).
Overvalued liabilities: (25,000).
Goodwill: (75,000).
Purchase price of Shaw Company common stock: 750,000.
Book value of Shaw Company: (500,000).
Cost in excess of book value: 250,000.
Excess assigned to:
Undervalued land: (100,000).
Undervalued building: (50,000).
Overvalued liabilities: (25,000).
Goodwill: (75,000).
User Contributed Comments 9
| User | Comment |
|---|---|
| yly14 | are we not allocating fair value differences to Receivables and inventory as well? yes, if the question had provided with their revaluation details |
| ljamieson | 750000[Cost] - (100000[Rec]+150000[Inv]+200000[Land FV]+300000[Bldg FV]-75000[Liab FV]) = 75000[Goodwill] |
| vi2009 | yly14: ... the fair value for receivables and inventory is the book value and as such, there is no difference between the two. |
| quanttrader | it's like Shaw gets a credit for paying less than fair value for land, and bldg, and taking on more liability than the fair value. The rest of the difference between purchase price and BV is goodwill |
| quanttrader | not BV, FV |
| daverco | I think it can be explained in a more intuitive way than the one provided: The fair value of total assets is $750K (FMV of land and building plus book value of receivables and inventory). Subtract the $75K fair value of liabilities to get a net worth (book value) of $675K. The difference between what you pay ($750K) and the net assets you acquire ($675K) is goodwill ($75K). |
| birdperson | 100(a/r) + inv(150) + land(100) + building (250) -- gets you to 500 --- $250 left to explain -- land (100), buildings (50 -- which you would depreciate) and less liabilities which is an asset (25) -- thats $175 -- slap GOODWILL on the delta (750 - 500 - 175) which is 75 |
| davidt876 | agreed daverco - more intuitive that way |
| blackyosh1 | book value of shaw's equity = A - L = 600 - 100 = 500 |