Answer to Question #163544 in Accounting for Willy

Question

Meck Company is considering the acquisition of another entity. The following data relate to the acquiree:

Shareholders’ equity 5,000,000

Earnings for prior three years 1,500,000

The acquiree has a valuable patent which is not recorded. If the entity is sold, the patent would be transferred to the buyer for P500,000. Other assets are properly appraised. The patent has a remaining life of 5 years. The earnings of the entity are expected to increase 10% more than the average earnings of the past three years before taking into consideration the amortization of the patent cost.

Compute for the goodwill under the following methods:

1. Average future earnings are capitalized at 8%

2. Goodwill is measured at the average excess earnings capitalized at 10% with normal rate at 8%.

3. Goodwill is measured at the present value of the average excess earnings discounted at 10% for four years with normal rate of 8%. The present value of an ordinary annuity of 1 for 4 years at 10% is 3.17.

Answer 1

$$Solution$$

$1. FV=PV(1+r)^n\\ 500,000=(1+0.1)^5\\ 500,000(1.6105)\\ =805250\\ Earnings=\frac{1.500,000}{3}\\ =500,000\ p.a\\ 10\%\ increase=\frac{110}{100}\times500,000=550,000p.a\\ 5years=5\times550,000\\ =2,750,000\\ Goodwill=Average\ profits\times\ no\ of\ years\\ Average\ profit=\frac{profit}{output}\\ =\frac{2,750,000}{275}=10,000$

$2. Average\ excess\ earnings=500,000\times\frac{110}{100}\\ 550,000\\ Excess=550,000-50,000\\ =50,000\\ Goodwill=50,000\times5=250,000\\ =\frac{250,000}{27000}\\ =1000$$3.PV=500,000\\ Average\ excess\ earnings\\ =5000000\times5\\ =25000000-250000\\ after discounting=2475000=\frac{8}{(1.1)^4}\\ 13,5236.6$