Chapter 29, Problem 1CQ

Summary Introduction

To explain:-Purchase accounting method for mergers and its effect on cash flows and EPS.

Merger:

Merger occurs when the shareholders of two or more companies pool the resources of their company into one separate legal entity and as a result a new company comes into existence. Merger is basically the result of merge the two or more companies into one.

Answer to Problem 1CQ

• In the purchase accounting method the assets of the targeted company has to be recorded into the current market value in the books of acquiring company and goodwill assets account has to be created. Goodwill is the difference of current market value and purchase price.
• There will be no effect on cash flows.
• The EPS (earning per share) will reduce.

Explanation of Solution

• Goodwill is an intangible asset that cannot be touched or seen but it has some value because of the brand image of the company. It is a long term assets but it is never depreciated. When the value of acquired assets becomes lower than its original cost then the goodwill has to be written off.
• It does not have any effect on cash flow because Goodwill has no cash flow consequences.
• The EPS will get reduced because the number of outstanding shares will be increased and the amount of goodwill that has to be written off will decrease the earnings of the company.

Conclusion

There is no effect on cash flows and the EPS will get reduce.