Acquisition of Business

Acquisition of Business

When a company takes over the running business of a Sole Trader or Partnership it is known as “Acquisition of Business”

In case of an Acquisition of Business, there are two approaches of maintaining the books of Accounts.

A.    When New Set of Books of Accounts are Opened, &

B.     When the Same Set of Books are Continued.

Meaning of some common terms for the Purpose of this Chapter.

Ø  Purchasing Company: The company which is acquiring the Business is called as the Purchasing Company.

Ø  Vendor: The business which is purchased by the Purchasing Company is called as the Vendor.

Ø  Purchase Consideration: (PC) The price paid by the purchasing company to the vendor for the acquisition of the business is called as Purchase Consideration.

Ø  PC can be paid in Cash, Equity Share, Preference Shares, Debentures, Etc.

I.         Accounting Treatment when New Set of Books are Opened:

In the Books of Purchasing Company the following entries are to be Passed.

i.           For the Purchase of Business

       Business Purchase A/c           Dr.

              To Vendors A/c

       (The entry is passed with the amount of Purchase Consideration)

ii.         For Assets & Liabilities Taken over.

        Various Assets A/c   Dr.

              To Liabilities A/c

              To Business Purchase A/c

        (All the Assets and Liabilities Taken over are to be recorded at their agreed values, Business Purchase is to be recorded as per entry i, passed above.)

        Note: If the Total of Credit side is more than the Debit side, then the difference on the Debit Side will be represented as “Goodwill A/c”

        If the Total of Debit side is more than Credit side, then the difference on the Credit side will be represented as “Capital Reserve A/c”

iii.       For Payment of Purchase Consideration.

Vendor’s A/c             Dr.

       To Cash/Bank A/c

       To Share Capital A/c

       To Securities Premium A/c   (If Any)

       To Debentures A/c.

Note: If Debtors and Creditors of the vendor is not taken over by the purchasing company, rather they have just agreed to collect the amount from debtors and pay the amount to the creditors, in such a case the Purchasing Company maintains a separate account called Vendor’s Suspense A/c.

Any profit in this process belongs to the vendor and the purchasing company would pay that amount to the vendor.

Sometimes the purchasing company would charge a certain amount for the services provided to the vendor company as regards their debtors and creditors.

Calculation Purchase Consideration

There are three methods of calculating the Purchase Consideration:

1.      Lump Sum Method

2.      Net Assets Method

3.      Net Payments Method

1    1.       Lump sum Method:

Under this method the amount of Purchase Consideration is given in the question itself and it needs no calculation.

2    2.      Net Assets Method:

This method is also known as Net Worth Method.

Under this method the value of Purchase Consideration is calculated on the basis of the Net value of the Assets taken over, i.e. the value of Assets Taken over Less the Value of Liabilities Taken over.

Assets Taken over at Agreed Value                                XXX

Less: Liabilities Taken over at Agreed Value                 XXX

Purchase Consideration                                                  XXX

Notes:

a.   The term Assets taken over includes only the assets taken over by the purchasing      company including the Cash & Bank Balance. Any assets not taken over should be ignored. Normally the Fictitious assets are never taken over.

b.   The goodwill if taken over by the purchasing company will have to be valued as per the method stated in the question.

c.   The term liabilities includes only the outside liabilities and not the liabilities due to shareholders in form of Share Capital, Reserves & Surplus, Etc.

3     3.      Net Payment Method:

Under this method all the payments made to the owner of the vendor business in form of Shares, Debentures, Cash, etc. are added to calculate the value of Purchase Consideration.

Note: Any Payment made to Debentureholders should not be considered as a part of Purchase Consideration as debentureholders are not the owners of the Business.

II.         Accounting Treatment when Same Set of Books are Continued:

If the purchasing company wishes to continue the same set of books and not open a new set, then in such a case the following treatment is to be given -

a.       A Revaluation A/c is prepared to show the increase or decrease in the value of the Assets and Liabilities.

b.      Any Profit or loss in the Revaluation A/c is transferred to the capital Account of the Sole Trader or Partners (in their Profit Sharing Ratio).

c.       Any Assets or Liabilities not taken over by the purchasing company will be transferred to the capital account at their book values. In case of Partnership they will be transferred in their Profit Sharing Ratio.

d.      If there are any reserves or undistributed losses they will also be transferred to the capital account at their book values. In case of Partnership they will be transferred in their Profit Sharing Ratio.

e.       After all the adjustments are made the capital account is closed by transfer of Cash/ Shares/ Debentures, etc. received from purchasing company in form of Purchase Consideration.

Journal Entries:

1         For Increase in the value of Assets:

          Asset A/c                                Dr.

                 To Revaluation A/c

2         For Decrease in the value of Assets:

         Revaluation A/c                      Dr.

                To Asset A/c

3        For increase in the value of Liabilities:

         Revaluation A/c                      Dr.

                To Liabilities A/c

4       For Decrease in the value of Liailities:

         Liabilities A/c                          Dr.

               To Revaluation A/c

5       For transfer of reserves:

        Reserves A/c                           Dr.

              To Capital A/c

Note: In case of undistributed losses the entry will be reversed.

6      For Assets not taken over by purchasing company:

        Capital A/c                              Dr.

               To Assets A/c

7      For Liabilities not taken over by purchasing company:

        Liabilities A/c                          Dr.

              To Capital A/c

8      For Profit on Revaluation:

        Revaluation A/c                      Dr.

              To Capital A/c

  Note: In case of Loss on Revaluation the above entry would be reversed.

9     For payment of Purchase Consideration:
       Capital A/c                              Dr.

             To Cash A/c

             To Equity Shares A/c

             To Debentures A/c.

Important Note: In all the entries above the term capital would represent partner’s capital in case of partnership business. The amount will be divided among partners in their Profit Sharing Ratio.