Goodwill

As far as F3/FFA paper is concerned, always remember that in consolidation, we take FULL amount of both Share Capital and Share Premium. This is because the consideration paid by parent + NCI at acquisition equals the Equity (Net Assets) of the subsidiary. The excess amount is declared goodwill i.e They paid excess amount than equity in order to buy the goodwill as well.

Hope it helps.

1st Question:
P acquired 80% of S’s shares via a 2 for 1 share exchange.

S’s share capital is $400 $0.5 shares.
$400/$0.5 = 800 shares
It means S has 800 shares in issue (800 shares x $0.5 = $400)

Now, P acquired 80% of these shares.
800 x 80% = 640 shares

Now, lets understand the 2 for 1 share exchange.
In order to acquire shares of S, P needs money. For this purpose, he offered his own shares in the market at a market price of $2 per share. He obtained 1 share in S by offering his own 2 shares to the market (2 shares of P sold, 1 share of S purchased).
So,
1 share of S purchased = 2 shares of P sold
640 shares of S purchased = 2×640 shares of P sold
640 shares of S purchased = 1,280 shares of P sold

Market Price of P’s share was $2. It means that P obtained $2,560 (1,280 x $2) and this amount was PAID to acquire S’s 640 shares.

Conclusion: P acquired 80% of S’s shares (640) by paying $2,560. This money was obtained by offering P’s shares (1,280) to the market at a price of $2/share.

3rd Question:
This ones a very very tricky question. Although the examiner can ask a question like this, I cannot expect such questions under normal circumstances. It cannot be solved within 2.4 minutes.
Since practise is the key to perfection, we’ll prefer practising it anyway.

A acquired 51,000 shares in B (85%). The consideration was paid in 2 ways:
$1.25 for every share in B.
3 for 2 share exchange (2 shares of B purchased = 3 shares of A sold)
The sum of both these methods will equal $239,700.

A’s shares were sold at Fair Value of $2.30. After earlier 2 questions, i hope & expect you to solve it easily.

@thezadzzz said:
Hi

Can you please provide an ‘understandable’ definition of Goodwill. I know the calculation of how to attain it but I don’t understand what it actually is and the purpose it.

Goodwill represents the value over and above the book value of the net assets acquired.

Let’s take a simple example. Business A buys Business B for £20m cash which has net assets of £10m. In simplified terms, the accounting double entry for Business A is:

Cr Cash £20m
Dr Assets £10m (in real life this will be many different assets and liabilities, but the sum total will be a debit of £10m)
Dr Goodwill £10m

Think about what would happen if you DIDN’T have goodwill. If you don’t have goodwill, to complete the journal you would have to debit something else. You can’t debit any other assets as there isn’t anything else which exists. Therefore you would have to debit the P&L £10m. This means you just made a £10m loss when you bought the business! Surely that can’t be right?

When a business buys another business, they buy it because it will make them money. Therefore, a business will often pay more than the value of the net assets to buy it. Business valuation techniques are covered in later exams, but in our example, if Business B generates profits of £2m per year, and Business A’s cost of capital is 10%, Business B would be valued at £20m.

Therefore, when Business a buys Business B for more than the sum of its net assets, it is buying it because it expects Business B to generate profits. This has to be capitalised as an asset and that it what goodwill represents.