What happens to the target's existing goodwill and its historical equity accounts on the pro forma balance sheet, and why?
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The answer
The target’s existing goodwill and its entire historical equity base are completely wiped out and do not appear on the pro forma balance sheet. Under purchase accounting, the acquirer records all of the target’s identifiable assets and liabilities at fair value, so the target’s old common equity, retained earnings, and APIC disappear because they represent the seller’s historical book basis, which is irrelevant to the buyer.
The same logic applies to the target’s pre-existing goodwill: it was simply a residual plug from a prior deal at a different price, so we eliminate it and do not carry it forward. Instead, we calculate a brand-new goodwill figure from scratch based on the price we are paying.
That new goodwill is the residual after we allocate the equity purchase price to the fair value of net identifiable assets, factoring in any asset write-ups, newly recognized intangible assets, and deferred tax liabilities. In short, the old equity and old goodwill are zeroed out and replaced by a fresh purchase price allocation that produces the acquirer’s own goodwill plug, making the balance sheet balance.
Balance sheet
| Cash | 150 |
| Accounts receivable | 120 |
| Inventory | 90 |
| Total current assets | 360 |
| PP&E, net | 400 |
| Goodwill | 150 |
| Other assets | 40 |
| Total assets | 950 |
| Accounts payable | 80 |
| Deferred revenue | 40 |
| Total current liabilities | 120 |
| Long-term debt | 380 |
| Total liabilities | 500 |
| Total equity | 450 |
| Total liabilities & equity | 950 |
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- You pay $2,400M for a target with $900M of book equity including $250M of old goodwill. Write-ups: PP&E +$180M, new intangibles +$420M; stock deal; tax rate 25%. Compute the DTL, the fair value of net identifiable assets, and goodwill, then recompute goodwill assuming a 338(h)(10) election and explain the difference.
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- You acquire a distressed lender for $350M when the fair value of its net identifiable assets is $520M. Walk through the required accounting steps, compute the income statement effect, and explain how you would treat this item in year-one accretion/dilution and in your advice to the board.
- A CFO argues the deal model should amortize goodwill over 10 years 'to be conservative.' Explain what current US GAAP actually requires, what the private-company alternative allows, and how you would model the deal's EPS impact both ways for the board.
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The rest of this topic
Purchase accounting: goodwill, write-ups and the tax basis