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Good morning Sir,
Kindly explain what the accounting entry for fall in estimated value of contingent liability on the question below and reason why goodwill is not to be adjusted according to BPP answer.
On 1 April 20X3, Polestar acquired 75% of the 12 million 50 cent equity shares of Southstar. Southstar had been experiencing difficult trading conditions and making significant losses. Its retained earnings at the acquisition date were $14.3 million. In allowing for Southstar’s difficulties, Polestar made an immediate cash payment of only £1.50 per share. In addition, Polestar will pay a further amount in cash on 30 September 20X4 if Southstar returns to profitability by that date. The value of this contingent consideration at the date of acquisition was estimated to be $1.8 million, but at 30 September 20X3 in the light of continuing losses, its value was estimated at only $1.5 million. The contingent consideration has not been recorded by Polestar. Overall, the directors of Polestar expect the acquisition to be a bargain purchase leading to negative goodwill.
At the date of acquisition shares in Southstar had a listed market price of $1.20 each. The statements of profit or loss of both companies are as follows.
STATEMENTS OF PROFIT OR LOSS FOR THE YEAR ENDED 30 SEPTEMBER 20X3The estimated value of contingent consideration has fallen from $1.8m to $1.5m. How should this be accounted for?
DR Liability / CR Profit or loss
DR Profit or loss / CR Liability
DR Goodwill / CR Profit or loss
DR Profit or loss / CR GoodwillThank you for your time on this.
Also, I like to say thank you for your prompt response to my post few days ago. I tried to comment on it but was unable to because there was a comment under it that says the post is now closed for replies. I’m always grateful.L
“Kindly explain what the accounting entry for fall in estimated value of contingent liability on the question below …”
Whenever there is a contingent liability in the context of a consolidation exercise, that’s a liability that the soon-to-be-acquired subsidiary has not recorded
Your question would be less confusing if you had asked in the top line “Kindly explain what the accounting entry for fall in estimated value of contingent CONSIDERATION on the question below …”
To your credit (or is it debit?) the title of the post pre-empts some of that confusion
AS AT THE DATE OF ACQUISITION, a reliable estimate was made of the contingent consideration that would be paid.
Subsequent events have shown that that estimate was excessive, but that doesn’t change the fact that $1.8 million was the estimate on that key date
And Goodwill is calculated using the best information available AS AT THAT DATE OF ACQUISITION
The question states that Polestar has not recorded the contingent consideration
To record it needs the double entry:
Dr Cost of Acquisition Account $1.8 million
Cr Contingent Consideration Account $1.8 millionAt the year end, the adjustment required to the financial records will be to reduce that Contingent Consideration Account:
Dr Contingent Consideration Account $300,000
Cr Statement of Profit or Loss $300,000Thus, to answer your original question, option 1 is the correct answer
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