A publicly traded company acquired a competitor on January 1, Year 1, for $500 million. The fair value of the identifiable net assets acquired was $400 million. The acquisition agreement included a contingent consideration arrangement, requiring an additional payment of $20 million if the acquired company's revenue exceeds a certain threshold in Year 1. At the acquisition date, the fair value of this contingent consideration was estimated to be $15 million. By December 31, Year 1, the acquired company's revenue threshold was met, and the contingent consideration liability was re-measured to a fair value of $22 million. What is the amount of goodwill recognized by the acquiring company at the acquisition date?
- A$120 million
- B$115 million
- C$100 million
- D$80 million
Show answer & explanationAnswer & explanation
Correct answer: B. $115 million
Goodwill is calculated as the consideration transferred plus the fair value of any noncontrolling interest, minus the fair value of identifiable net assets acquired. In this case, the consideration transferred includes the initial acquisition price of $500 million and the fair value of the contingent consideration at acquisition date, which is $15 million. So, Total Consideration = $500M + $15M = $515M. Goodwill = Total Consideration - Fair Value of Identifiable Net Assets = $515M - $400M = $115M. The subsequent re-measurement of contingent consideration affects post-acquisition earnings, not the initial goodwill.
Why the other options are wrong
- A. This incorrectly uses the actual payment of contingent consideration or a later re-measurement in the initial goodwill calculation.
- C. This only considers the initial $500M payment less the identifiable net assets, ignoring contingent consideration.
- D. This calculation is not consistent with the accounting for goodwill.
Goodwill in Business Combinations
Goodwill is the excess of the consideration transferred (plus noncontrolling interest and previously held equity interest) over the fair value of identifiable net assets acquired in a business combination.
- Recognized at acquisition date.
- Contingent consideration is included at fair value at acquisition date.
- Subsequent changes in contingent consideration fair value affect earnings, not goodwill.
Memory trick: Purchase price plus fair contingent value, minus net assets, equals goodwill's true value.