1intangiblesintangibles c hapter 11 an electronic presentation by douglas cloud pepperdine...
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IntangiblesIntangiblesIntangiblesIntangibles
Chapter11
An electronic presentation by Douglas Cloud
Pepperdine University
An electronic presentation by Douglas Cloud
Pepperdine University
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1. Explain the accounting alternatives for intangibles.2. Understand the amortization or impairment of
intangibles.3. Identify research and development costs.4. Explain the conceptual issues for research and
development costs.5. Account for identifiable intangible assets including
patents, copyrights, franchises, computer software costs, and trademarks and tradenames.
ObjectivesObjectivesObjectivesObjectives
ContinuedContinuedContinuedContinued
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6. Account for unidentifiable intangibles including internally developed and purchased goodwill.
7. Understand the disclosure of intangibles.
8. Explain the conceptual issues regarding intangibles.
9. Estimate the value of goodwill. (Appendix)
ObjectivesObjectives
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Characteristics that Characteristics that Distinguish IntangiblesDistinguish Intangibles
Characteristics that Characteristics that Distinguish IntangiblesDistinguish Intangibles
• There is generally a higher degree of uncertainty regarding the future benefits that may be derived.
• Their value is subject to wider fluctuations because it may depend to a considerable extent on competitive conditions.
• They may have value only to a particular company.
• Goodwill and intangible assets with indefinite lives are not expensed.
• There is generally a higher degree of uncertainty regarding the future benefits that may be derived.
• Their value is subject to wider fluctuations because it may depend to a considerable extent on competitive conditions.
• They may have value only to a particular company.
• Goodwill and intangible assets with indefinite lives are not expensed.
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Classification of IntangiblesClassification of IntangiblesClassification of IntangiblesClassification of Intangibles
Purchased
Identifiable
Capitalize the cost incurred to acquire an intangible assets with a finite life and amortize over its useful life.
Unidentifiable (i.e., goodwill)
Capitalize the cost incurred to acquire goodwill and review it for impairment at least annually.
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Classification of IntangiblesClassification of IntangiblesClassification of IntangiblesClassification of Intangibles
Internally Developed
Identifiable
Unidentifiable
Expense research and development costs as incurred
Capitalize certain costs incurred for an intangible asset with a finite life and amortize over its useful life
Capitalize certain costs incurred for an intangible asset with an infinite life and amortize over its useful life
Expense costs as incurred
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1. Purchased Identifiable Intangibles. A company may purchase an intangible asset from another company. The purchase is handled in the same manner as the acquisition of a single asset, in a group of assets, or in an exchange of similar or dissimilar assets.
Accounting for the cost of intangibles is discussed in FASB Statement No. 142 as follows:
Accounting for the cost of intangibles is discussed in FASB Statement No. 142 as follows:
ContinuedContinuedContinuedContinued
Accounting of IntangiblesAccounting of IntangiblesAccounting of IntangiblesAccounting of Intangibles
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2. Purchased Unidentifiable Intangibles. A company capitalizes the cost of a purchased unidentifiable intangible asset. The principal example of an unidentifiable intangible is goodwill.
Accounting for the cost of intangibles is discussed in FASB Statement No. 142 as follows:
Accounting for the cost of intangibles is discussed in FASB Statement No. 142 as follows:
ContinuedContinuedContinuedContinued
Accounting of IntangiblesAccounting of IntangiblesAccounting of IntangiblesAccounting of Intangibles
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3. Internally Developed Identifiable Intangibles. When a company internally develops an intangible assets, it can capitalize only certain costs. The expensing of research and development costs represents an exception to the general rule of capitalizing of internally developed identifiable intangibles.
Accounting for the cost of intangibles is discussed in FASB Statement No. 142 as follows:
Accounting for the cost of intangibles is discussed in FASB Statement No. 142 as follows:
ContinuedContinuedContinuedContinued
Accounting of IntangiblesAccounting of IntangiblesAccounting of IntangiblesAccounting of Intangibles
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Accounting of IntangiblesAccounting of IntangiblesAccounting of IntangiblesAccounting of Intangibles
4. Internally Developed Unidentifiable Intangibles. A company expenses the costs of internally developed unidentifiable intangibles as incurred even thought they may be expected to have benefits extending beyond the current period.
Accounting for the cost of intangibles is discussed in FASB Statement No. 142 as follows:
Accounting for the cost of intangibles is discussed in FASB Statement No. 142 as follows:
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Intangible Assets With a Finite Life Are Amortized.
Intangible Assets With a Finite Life Are Amortized.
The calculation of the amortization of intangible
assets follows the same principles as the depreciation
of tangible assets.
Amortization of IntangiblesAmortization of IntangiblesAmortization of IntangiblesAmortization of Intangibles
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Amortization of IntangiblesAmortization of IntangiblesAmortization of IntangiblesAmortization of Intangibles
A company purchases a patent for $85,000.A company purchases a patent for $85,000.
Patent 85,000 Cash 85,000
At year-end the patent is amortized over 10 years (no expected residual value).
At year-end the patent is amortized over 10 years (no expected residual value).
Amortization Expense (or Factory Overhead) 8,500
Accumulated Amorti- zation: Patent 8,500
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Impairment of an IntangibleImpairment of an IntangibleImpairment of an IntangibleImpairment of an Intangible
A company purchased a trademark several years ago for $60,000. As the company considered the trademark to have an indefinite life, the trademark
has a carry value of $60,000. At the end of the current year, the company determines that the fair
value of the trademark is $20,000. An entry is needed to record the $40,000 loss in fair value.
A company purchased a trademark several years ago for $60,000. As the company considered the trademark to have an indefinite life, the trademark
has a carry value of $60,000. At the end of the current year, the company determines that the fair
value of the trademark is $20,000. An entry is needed to record the $40,000 loss in fair value.
Impairment Loss on Trademark 40,000 Trademark 40,000
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Research and Development CostsResearch and Development CostsResearch and Development CostsResearch and Development Costs
• Research is the planned search or critical investigation aimed at discovery of new knowledge.
• Development is the translation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process.
• Research is the planned search or critical investigation aimed at discovery of new knowledge.
• Development is the translation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process.
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Research and Development CostsResearch and Development CostsResearch and Development CostsResearch and Development Costs
Costs associated with activities excluded
from R&D are either expensed or
capitalized according to normal
capitalization criteria.
Costs associated with activities excluded
from R&D are either expensed or
capitalized according to normal
capitalization criteria.
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Materials, equipment, and facilities Personnel Intangibles purchased from others Contract services Indirect costs—R&D includes a
reasonable allocation of indirect costs.
Research and Development CostsResearch and Development CostsResearch and Development CostsResearch and Development Costs
Expenditures for the following elements of R&D activities are included in R&D costs and thus expensed as incurred:
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Research and Development CostsResearch and Development CostsResearch and Development CostsResearch and Development Costs
Kent Company incurred the following costs for R&D activities:
Materials used from inventory $50,000Wages and salaries 90,000Allocation of general and administrative
costs 20,000Depreciation on building housing R&D
activities 25,000Machine purchased for R&D project that
has no alternative future uses 30,000
ContinuedContinuedContinuedContinued
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Research and Development CostsResearch and Development CostsResearch and Development CostsResearch and Development Costs
The company includes all these costs in R&D expenses, and records them as follows:
Research and Development Expense 215,000
Cash, Payables, etc. 140,000
Inventory 50,000
Accumulated Depreciation, Building 25,000
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Identifiable Intangible AssetsIdentifiable Intangible AssetsIdentifiable Intangible AssetsIdentifiable Intangible Assets
Cost of Intangibles
Cost of Intangibles Expense
In period cost incurred Identifiable Intangible
Assets That Are Typically AmortizedPatentsCopyrightsFranchisesComputer Software CostsLeasehold Improvements
Amortize over service life
ContinuedContinuedContinuedContinued
R & DR & D
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Identifiable Intangible AssetsIdentifiable Intangible AssetsIdentifiable Intangible AssetsIdentifiable Intangible Assets
Cost of Intangibles
Cost of Intangibles
Identifiable Intangible Assets That Are Typically Reviewed for ImpairmentTrademarks and tradenamesLicenses that may be
renewed indefinitely
Recognize loss when impaired
ContinuedContinuedContinuedContinued
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Identifiable Intangible AssetsIdentifiable Intangible AssetsIdentifiable Intangible AssetsIdentifiable Intangible Assets
Cost of Intangibles
Cost of Intangibles
Unidentifiable Intangible Assets That Are Reviewed for ImpairmentGoodwill
Recognize loss when impaired
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PatentsPatentsPatentsPatents
A patent is an exclusive right granted by the federal
government giving the owner control…
A patent is an exclusive right granted by the federal
government giving the owner control…
…of the manufacture, sale, or other use of an invention for 20 years from the date
of filing.
…of the manufacture, sale, or other use of an invention for 20 years from the date
of filing.
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PatentsPatentsPatentsPatents
A company can capitalize the costs of successfully defending the legal validity of a patent. If the suit is lost, all legal costs are expensed.
A company can capitalize the costs of successfully defending the legal validity of a patent. If the suit is lost, all legal costs are expensed.
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CopyrightsCopyrightsCopyrightsCopyrights
©
A copyright is a grant by the federal government to publish, sell or otherwise control literary or artistic products for
the life of the author plus 70 year.
A copyright is a grant by the federal government to publish, sell or otherwise control literary or artistic products for
the life of the author plus 70 year.
BooksMusic Films
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FranchisesFranchisesFranchisesFranchises
Franchises are agreements entered into by two parties in which, for a fee, one party gives the
other party the right to perform certain functions or sell certain products or services.
Burger KingMcDonald’s
Midas MufflerKFC
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Computer Software CostsComputer Software CostsComputer Software CostsComputer Software Costs
Technological Feasibility
General Release
R & D Expense Capitalize Expense
Technological feasibility is established either on the date the company completes a detail program design or, in its absence,
when it completes a working model of the product.
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(1) the preliminary stage is completed,
(2) management authorizes and commits to funding a company software project, and
(3) interest costs are incurred when developing the software.
Computer Software CostsComputer Software CostsComputer Software CostsComputer Software Costs
Internal-Use SoftwareInternal-Use Software
AICPA Statement of Position No. 98-1 specifies that the capitalization of costs begins when---
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Trademarks and TradenamesTrademarks and TradenamesTrademarks and TradenamesTrademarks and Tradenames
Registration of a trademark or tradename with the U.S. Patent Office establishes a right to exclusive use of a name, symbol, or other device used for product identification for 20 years. The right is renewable
indefinitely as long as it is used continuously.
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• Deferred charges (a catch-all category in which several individually immaterial items are accumulated)
• Organization costs
Other IntangiblesOther IntangiblesOther IntangiblesOther Intangibles
Legal fees, stock certificate costs, underwriting fees, accounting fees, promotional fees
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GoodwillGoodwillGoodwillGoodwill
Purchased goodwill arises when a company
is acquired. It is the difference between the purchase price of the
acquired company as a whole and the fair
value of the reported identifiable net assets.
Purchased goodwill arises when a company
is acquired. It is the difference between the purchase price of the
acquired company as a whole and the fair
value of the reported identifiable net assets.
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GoodwillGoodwillGoodwillGoodwill
Sara Company purchases all the assets of Trevor Company for $790,000 cash and Trevor Company is dissolved.
Trevor Company’s identifiable assets had a fair value of $920,000 and its liabilities totaled $200,000.
Sara Company purchases all the assets of Trevor Company for $790,000 cash and Trevor Company is dissolved.
Trevor Company’s identifiable assets had a fair value of $920,000 and its liabilities totaled $200,000.
Assets 920,000Goodwill 70,000 Liabilities 200,000 Cash 790,000
Individual assets and liabilities Individual assets and liabilities actually would be debited or credited.actually would be debited or credited.
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Impairment of GoodwillImpairment of GoodwillImpairment of GoodwillImpairment of Goodwill
A company must review its goodwill for
impairment annually at the reporting unit level.
A company must review its goodwill for
impairment annually at the reporting unit level.
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Impairment of GoodwillImpairment of GoodwillImpairment of GoodwillImpairment of Goodwill
A company must also review its goodwill for impairment whenever events or changes in circumstances occur that would more-likely-than-
not reduce the fair value of the goodwill below its carrying value.
A company must also review its goodwill for impairment whenever events or changes in circumstances occur that would more-likely-than-
not reduce the fair value of the goodwill below its carrying value.
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Impairment of GoodwillImpairment of GoodwillImpairment of GoodwillImpairment of Goodwill
The Kent Company acquired the Devon Company as a subsidiary several years ago. The Devon Company has a
book value of $3.6 million, including goodwill of $400,000. Kent Company estimates that its fair value is $3 million. If
Kent Company allocates $2.7 million of the fair market value to Devon Company’s identifiable assets and liabilities,
this means that $300,000 is implied for goodwill. Thus, there has been an impairment loss of $100,000.
Impairment Loss on Goodwill 100,000
Goodwill100,000
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Disclosure of IntangiblesDisclosure of IntangiblesDisclosure of IntangiblesDisclosure of Intangibles
FASB Statement No. 142 requires a company to disclose certain information about its intangible assets, in either the financial statement or it notes, including:
FASB Statement No. 142 requires a company to disclose certain information about its intangible assets, in either the financial statement or it notes, including:
1. In the period it acquires intangible assets:a. The cost of any intangible asset acquired, separated
into categories.b. For assets subject to amortization, the residual
value and the weighted-average amortization expense for the next five years.
c. The cost of any R&D acquired and written off, and where it is included in the income statement.
ContinuedContinuedContinuedContinued
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Disclosure of IntangiblesDisclosure of IntangiblesDisclosure of IntangiblesDisclosure of Intangibles
FASB Statement No. 142 requires a company to disclose certain information about its intangible assets, in either the financial statement or it notes, including:
FASB Statement No. 142 requires a company to disclose certain information about its intangible assets, in either the financial statement or it notes, including:
2. In each period for which it presents a balance sheet:a. For intangible assets that are amortized, the total
cost, the accumulated amortization, the amortization expense, and the estimated amortization expense for the next five years.
b. For intangible assets that are not amortized, the total cost and the cost of each major intangible asset class.
ContinuedContinuedContinuedContinued
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Disclosure of IntangiblesDisclosure of IntangiblesDisclosure of IntangiblesDisclosure of Intangibles
FASB Statement No. 142 requires a company to disclose certain information about its intangible assets, in either the financial statement or it notes, including:
FASB Statement No. 142 requires a company to disclose certain information about its intangible assets, in either the financial statement or it notes, including:
2. In each period for which it presents a balance sheet:c. For goodwill, the amount of goodwill acquired, the
amount of any impairment losses recognized, and the amount of goodwill included in the disposal of a reporting unit.
d. For any intangible asset impairment, the facts and circumstances leading to the impairment, the amount of the loss, and the method used.
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Conceptual IssuesConceptual IssuesConceptual IssuesConceptual Issues
Expensing internally generated goodwill is justified on the basis that measuring the cost of internally generated goodwill with a reasonable degree of
reliability is very difficult.
Expensing internally generated goodwill is justified on the basis that measuring the cost of internally generated goodwill with a reasonable degree of
reliability is very difficult.
Capitalization of internally generated goodwill would require amortization. It would be very
difficult to identify the revenues generated and therefore to decide over which periods, and by
which method, to match the amortization expenses against the benefits.
Capitalization of internally generated goodwill would require amortization. It would be very
difficult to identify the revenues generated and therefore to decide over which periods, and by
which method, to match the amortization expenses against the benefits.
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Click here to skip Appendix material.
Appendix: Estimating the
Value of Goodwill
Appendix: Estimating the
Value of Goodwill
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Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (AppendixValue of Goodwill (Appendix)Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (AppendixValue of Goodwill (Appendix)
1. Estimate the average future earnings from the identifiable net assets.
2. Estimate the rate of return that should be earned by the company on its identifiable net assets.
3. Estimate the current fair value of the identifiable net assets.
4. Compute the estimated excess annual earnings.
ContinuedContinuedContinuedContinued
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Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)
5. Estimate the expected life of the excess annual earnings.
6. Compute the present value of the estimated excess annual earnings.
7. Compute the total value of the company being considered for purchase.
8. Apply sensitivity analysis.
Two additional steps may follow the calculation of the value of goodwill:
Two additional steps may follow the calculation of the value of goodwill:
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Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)
STEP 1: Estimate the average future earnings.
1. Eliminate unusual gains or loss, extraordinary items, the results of discontinued operations, and the effects of changes in accounting principles.
2. Adjust for differences in accounting principles.
Select a number of years to determine the trend of the firm’s earnings.
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Average annual revenue $628,000 Average annual cost of goods sold $266,000Average operating expense 180,000Expected annual increase in wages not to
be recovered by increased revenues 40,000Increase in annual depreciation on the
current fair value of the assets 12,000Annual amortization of new intangibles 10,000Expected expenses (508,000
)Expected average annual earnings before taxes $120,000 Estimated income taxes (30%) (36,000
)
Greenfield Company
Expected average annual earnings $84,000
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Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)
STEP 2: Estimate the rate of return.
Based on the risk of the investment, Greenfield assumed a 10% return
after income taxes.
Based on the risk of the investment, Greenfield assumed a 10% return
after income taxes.
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Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)
STEP 3: Estimate the current fair value of the identifiable net assets.
Book value of identifiable net asset $570,000 Revaluation of LIFO inventory to fair value 90,000 Increase in allowance for uncollectible accounts (10,000)Revaluation of property, plant and equipment to fair value 120,000 Fair value of trademark 150,000 Revaluation of bonds payable (lower interest rate) (60,000)Unfunded projected benefit obligations of pension (140,000)Current fair value of identifiable net assets $720,000
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Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)
STEP 4: Compute the estimated excess annual earnings.
Average expected annual earnings $84,000 10% return on fair value of identi- fiable net assets (72,000 )Estimated excess annual earnings $12,000
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Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)
STEP 5: Estimate the expected life of excess annual earnings.
Greenfield Company estimates that the excess annual earnings
will last for ten years.
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Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)
STEP 6: Compute the present value of the estimated excess annual earnings.
Estimated excess annual earnings $12,000Present value factor for an annuity of 10 periods at 10% x 6.144567Present value of estimated excess annual earnings (goodwill) $73,735
Estimated excess annual earnings $12,000Present value factor for an annuity of 10 periods at 10% x 6.144567Present value of estimated excess annual earnings (goodwill) $73,735
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Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)Steps Used In Estimating the Steps Used In Estimating the Value of Goodwill (Appendix)Value of Goodwill (Appendix)
STEP 7: Compute the total value of the company.
Fair value of the assets $720,000Goodwill 73,735Total value of the company $793,735
Fair value of the assets $720,000Goodwill 73,735Total value of the company $793,735
STEP 8: Apply sensitivity analysis.