Question

Question: (Goodwill, Impairment) On July 31, 2017, Mexico Company paid \(3,000,000 to acquire all of the common stock of Conchita Incorporated, which became a division of Mexico. Conchita reported the following balance sheet at the time of the acquisition.

Current assets	\) 800,000	Current liabilities	\( 600,000
Noncurrent assets	2,700,000	Long-term liabilities	500,000
Total assets	\)3,500,000	Stockholders’ equity	2,400,000
		Total liabilities and stockholders’ equity	\(3,500,000

It was determined at the date of the purchase that the fair value of the identifiable net assets of Conchita was \)2,750,000. Over the next 6 months of operations, the newly purchased division experienced operating losses. In addition, it now appears that it will generate substantial losses for the foreseeable future. At December 31, 2017, Conchita reports the following balance sheet information.

Current assets	\( 450,000
Noncurrent assets (including goodwill recognized in purchase)	2,400,000
Current liabilities	(700,000)
Long-term liabilities	(500,000)
Net assets	\)1,650,000

It is determined that the fair value of the Conchita Division is \(1,850,000. The recorded amount for Conchita’s net assets (excluding goodwill) is the same as fair value, except for property, plant, and equipment, which has a fair value \)150,000 above the carrying value.

Instructions

1. Compute the amount of goodwill recognized, if any, on July 31, 2017.
2. Determine the impairment loss, if any, to be recorded on December 31, 2017.
3. Assume that fair value of the Conchita Division is \(1,600,000 instead of \)1,850,000. Determine the impairment loss, if any, to be recorded on December 31, 2017.

Prepare the journal entry to record the impairment loss, if any, and indicate where the loss would be reported in the income statement.

Short answer

Answer

1. Goodwill = $250,000
2. No impairment loss
3. Impairment loss = $200,000
4. Loss on the impairment account should be debited, and the Goodwill account should be credited.

Step-by-step solution

Meaning of Impairment Loss

A decrease in the carrying amount of an asset caused by a deterioration in its fair value is known as an impairment loss. The difference is written off when an asset's fair value falls below its carrying amount. The carrying amount of an asset is the purchase price less any depreciation and impairment costs.

(a) Computing the amount of goodwill  

Goodwill = Excess of the cost of the division over the fair value of the identifiable assets:

$$\begin{gathered} \text{Goodwill}=\text{Excess}\text{of}\text{cost}\text{of}\text{division}-\text{Fair}\text{value} \\ =\$3,000,000-\$2,750,000 \\ =\$250,000 \end{gathered}$$

(b) Determining the impairment loss, if any, to be recorded on December 31, 2017

Criteria for the reporting of impairment loss

When an asset's book value exceeds its recoverable value, an impairment cost should be specified.

In Conchita situation

Fair value = $1,850,000

Net asset = $1,650,000

It can be clearly seen that the amount of fair value exceeds the carrying amount of the net assets.

So, no impairment cost should be reported.

(c) Determining the impairment loss, if any, to be recorded on December 31, 2017

Computation of impairment

Implied fair value of goodwill = Fair value of division less the carrying value of the division (adjusted for fair value changes), net of goodwill:

The fair value of the Conchita division	$1,600,000
The carrying value of the division is $ 1,650,000
Increase in fair value of PP&E 150,000
Less: Goodwill 250,000
	(1,550,000)
The implied fair value of goodwill	50,000
Carrying value of goodwill	(250,000)
Impairment loss	($ 200,000)

Preparing journal entry  

Date	Particular	Debit ($)	Credit ($)
	Loss on Impairment	$200,000
	Goodwill		$200,000

Before the subtotal "income from ongoing operations," this loss will be shown as a distinct line item in income.