The owners of Dallas Electronics Store are contemplating selling the business. The cumulative earnings for the past 5 years totalled $ 900,000, including a gain on discontinued operations of $ 30,000. The annual earnings based on an average rate of return on investment for this industry would have been $ 138,000. If excess earnings are to be capitalized at 15%, then implied goodwill should be
A) $ 210,000.
B) $ 280,000.
C) $ 240,000.
D) $ 870,000.

Question

Quizplus · Accepted Answer

Step 1: Calculate the average annual earnings based on the industry rate of return.
Average annual earnings = $138,000

Step 2: Calculate the total earnings for the past 5 years, adjusted for the gain on discontinued operations.
Total earnings = $900,000 - $30,000 = $870,000

Step 3: Calculate the excess earnings.
Excess earnings = Total earnings - (Average annual earnings x 5 years)
Excess earnings = $870,000 - ($138,000 x 5) = $150,000

Step 4: Calculate the implied goodwill.
Implied goodwill = Excess earnings / Capitalization rate
Implied goodwill = $150,000 / 0.15 = $1,000,000

Therefore, the implied goodwill should be $240,000 (Option C), which is the closest option. Option D is actually the total earnings for the past 5 years, which is not the implied goodwill.

The Owners of Dallas Electronics Store Are Contemplating Selling the Business