Explain why the target's historical equity accounts are eliminated on the pro forma balance sheet rather than combined with the acquirer's.

What interviewers are really testing

The pro forma balance sheet question is the ultimate 'can you actually build the thing' test: it's less about a single formula and more about whether you can hold ten simultaneous moving pieces (cash use, new debt, wiped target equity, write-ups, new intangibles, DTL, goodwill-as-plug, fees) in your head at once and sequence them correctly.

What a strong candidate does differently: they build it in the right ORDER: start with sources & uses, identify what's cash-funded versus debt-funded versus stock-funded, wipe the target's equity and existing goodwill, apply the fair-value write-ups and new intangibles, book the new debt/DTL/earn-out liabilities, book the new equity issuance (if any) at the correct value, expense transaction fees through retained earnings, and ONLY THEN solve for goodwill as the plug that balances the sheet. Candidates who try to guess goodwill first, or who forget that fees are expensed (not capitalized), get caught immediately.

A favorite live-model test: interviewers give you a simplified acquirer and target balance sheet on a whiteboard/paper and ask you to walk through, live, which lines change and in which direction, for a stated financing mix. They are watching whether you say 'target's equity is wiped' and 'goodwill is the plug' unprompted, and whether you correctly distinguish fees that are expensed (advisory, legal) from fees that are capitalized and amortized (financing/underwriting fees on new debt).

Signal mastery by narrating the sources & uses table before touching the balance sheet, by explicitly separating fee types, and by stating that goodwill is solved LAST as the residual, never estimated first.

Common traps

Trap 1: Carrying the target's historical equity onto the combined balance sheet. All of the target's common stock, APIC, retained earnings, and AOCI are eliminated entirely: none of it survives the transaction.

Say it out loud: "The target's entire equity section is wiped out at close: none of its historical retained earnings or APIC carries onto the pro forma balance sheet; what replaces it is whatever new equity the acquirer issues, if any, plus the acquirer's own pre-existing equity."

Trap 2: Capitalizing transaction (advisory/legal) fees. Under ASC 805, deal advisory and legal fees are expensed as incurred, hitting the income statement and therefore retained earnings; they are NOT capitalized into goodwill or any asset.

Say it out loud: "Advisory and legal fees are expensed immediately, not capitalized; only financing fees on newly issued debt get capitalized and amortized over the life of that debt."

Trap 3: Solving for goodwill before making all other adjustments. Goodwill is a plug: it can only be correctly computed after every other asset, liability, and equity adjustment (write-ups, new debt, wiped equity, DTL, new intangibles) has been made.

Say it out loud: "I build every other adjustment first: write-ups, new debt, wiped target equity, the DTL, new intangibles, and goodwill is whatever residual is needed to make assets equal liabilities plus equity."

Trap 4: Forgetting the target's existing debt might not simply carry over at face value. If existing target debt is assumed (not refinanced), it may need to be marked to fair value if credit spreads have moved since issuance; carrying it at face value is only correct if fair value approximates face value or if it's being refinanced at close anyway.

Say it out loud: "If we're assuming the target's existing debt rather than refinancing it, I'd mark it to fair value if spreads have moved materially since issuance; otherwise book and fair value are close enough to ignore for a first pass."

Trap 5: Using the announcement-date share price for a stock deal's equity value. The equity purchase price (and therefore the shares issued in a fixed-exchange-ratio deal, or the dollar value in a fixed-share-count deal) is measured using the ACQUIRER's share price at CLOSE, not at signing/announcement.

Say it out loud: "Stock consideration is valued at the closing-date share price, not the announcement price, so the actual purchase price, and therefore goodwill, can move between signing and close purely from acquirer share price movement, unless there's a collar."