What happens to the target's existing goodwill and its historical equity accounts on the pro forma balance sheet, and why?

What interviewers are really testing

Purchase accounting questions test whether you can keep a system of moving parts straight under pressure: it's the M&A analogue of the three-statement walkthrough, and at elite boutiques it's asked with numbers.

The goodwill formula, cold. You must produce 'equity purchase price minus fair value of net identifiable assets' instantly, and then run the expanded bridge: wipe target book equity, kill old goodwill, add write-ups and new intangibles, add the DTL, solve for the residual. The single most common numerical form: 'Buyer pays $X for a target with $Y of book equity; PP&E is written up by $A, identifiable intangibles of $B are created, tax rate t: compute goodwill.' Practice until the signs are reflexive.

Conceptual precision on what goodwill IS. Weak answers: 'goodwill is the premium over book value.' Strong answers: over fair value of net identifiable assets: the write-ups and new intangibles come first, goodwill is what's left, and it represents unidentifiable value (workforce, synergies, going concern) or overpayment.

Old goodwill dies. Interviewers routinely check whether you know the target's existing goodwill is eliminated and replaced by the new residual. Missing this is a common screen-out.

The downstream links. Expect follow-ups tying PPA to EPS (deal amortization is a recurring GAAP drag; goodwill itself is not amortized but impairment-tested) and to the three statements (an impairment walkthrough: non-cash, usually non-deductible, added back in CFO).

Signal mastery with sequencing language: 'First I size the consideration, then I mark identifiable assets and liabilities to fair value (including intangibles the target never recognized) then set up deferred taxes on the write-ups, and goodwill is the residual that makes the balance sheet balance.' Naming residual and identifiable is what separates a memorized formula from understanding.

Common traps

Trap 1: Defining goodwill as price over BOOK value. Goodwill is price over the fair value of net identifiable assets. If you skip the write-ups and new intangibles, you overstate goodwill and miss the entire PPA exercise.

Say it out loud: "Goodwill is the equity purchase price minus the fair value of net identifiable assets, so I first write assets up to fair value and recognize new intangibles, and goodwill is only the residual after those allocations."

Trap 2: Carrying the target's old goodwill onto the pro forma balance sheet. Pre-existing goodwill is eliminated: it was the residual from someone else's deal at a different price.

Say it out loud: "The target's existing goodwill is wiped out in the allocation; the new goodwill is recalculated from scratch off the price we're paying."

Trap 3: Forgetting the DTL raises goodwill. In a stock deal, write-ups create a deferred tax liability, which is a new liability assumed; it reduces net identifiable assets and therefore increases goodwill.

Say it out loud: "Because the write-ups aren't deductible for tax in a stock deal, I book a DTL equal to the write-up times the tax rate; that's an assumed liability, so goodwill goes up by the same amount."

Trap 4: Saying goodwill is amortized. Under current US GAAP for public companies, goodwill is not amortized: it's tested for impairment at least annually. Finite-lived identifiable intangibles ARE amortized.

Say it out loud: "Goodwill isn't amortized: it's impairment-tested annually. It's the acquired identifiable intangibles, like customer relationships, that amortize and create the recurring deal-amortization drag on GAAP EPS."

Trap 5: Treating a goodwill impairment as a cash or tax event. An impairment is a non-cash charge, added back in cash flow from operations, and in most stock deals it is not tax-deductible.

Say it out loud: "An impairment cuts net income but it's non-cash (I add it back in CFO), and since goodwill from a stock deal generally isn't tax-deductible, there's usually no tax benefit; the real signal is that we overpaid."

Trap 6: Forgetting the equity purchase price is the consideration at FAIR VALUE. Stock consideration is valued at the acquirer's share price at close (not announcement), and earn-outs go in at fair value on day one.

Say it out loud: "Consideration is measured at closing fair value: the stock component at the close-date price and any earn-out at its estimated fair value, so the goodwill number can move between signing and closing."