Question

Dosmann, Inc., bought all outstanding shares of Lizzi Corporation on January 1, 2016, for $700,000 in cash. This portion of the consideration transferred results in a fair-value allocation of $35,000 to equipment and goodwill of $88,000. At the acquisition date, Dosmann also agrees to pay Lizzi’s previous owners an additional $110,000 on January 1, 2018, if Lizzi earns a 10 percent return on the fair value of its assets in 2016 and 2017. Lizzi’s profits exceed this threshold in both years. Which of the following is true?
A. The additional $110,000 payments is a reduction in consolidated retaining earnings
B. The fair value of the expected contigent payment increases goodwill at the acquisition date.
C. Consolidated goodwill as of January 1, 2018, increases by $110,000.
D. The $110,000 is recorded as an expense in 2018.

Answer 1

Answer:

B) The fair value of the expected contingent payment increases goodwill at the acquisition date.

Explanation:

Goodwill refers to the excess paid over fair market value by a company that buys another company. In this case Dosmann Inc. paid a higher value than fair market value for the acquisition of Lizzi Corporation.

Dosmann agreed to pay an extra $110,000 to Lizzi's previous owners if the company earned more money than expected (over 10% rate of return over  fair value of assets). Since Lizzi actually did earn more than the expected RoR, then Dosmann must pay the extra money to Lizzi's previous owners. This extra $110,000 will increase the goodwill that Dosmann paid for Lizzi.