IntroductionIntroductionAt times companies whether a new one or existing one takes over a running business. Sometimes, partner of the firm may convert their business joint stock to avail themselves the advantage of limited liabilities when the business in facet is developing or a private company may be converted into a public company.

Thus a, in the following circumstances, the question of purchasing a business arises:

• When a newly started company takes over some running business instead on starting a new business.

• A partnership may be converted into a joint stock company.

• A private company may be converted into a public company

• An existing company may take over the business of another company to avoid competition

Purchase considerationThe important question in case of

purchase of business is to determine the purchase consideration. For this purpose bother the parties should come to an agreement in respect of values of an assets ands then purchase consideration is determined.

Generally the purchase consideration is calculated by either of the following two methods

1. Consideration method2. Net assets method

Consideration method• Sometimes the consideration payable

against purchase price in the form of shares, debentures or cash is given and the purchase price can easily be ascertained by totaling the consideration agreed upon. Goodwill or capital reserve is calculated by comparing the purchase price with thaw value of net assets.

• While finding out purchase price by consideration method, all type of consideration given by the purchasing company for whatever purpose must be include in purchase price.

• The shares issued by the purchasing company re valued at their paid-up-value

• Goodwill or capital reserve has to be found out by ascertain the differences between purchase price and net assets

Net assets method• The value of total assets taken over less

the liabilities taken over will give the net assets of business purchased. The net assets so arrived will be at the purchase consideration. The value of the goodwill of the business agreed upon is generally stated and the same is included in the total assets

It must be noted that• Purchase price= Assets taken over-

liabilities taken over

• Only assets are taken over by the new company and the liabilities are not taken over.

• The values arriving at the net assets , must be new values agreed upon. If new values of a particular assets is not specified, the book value should be the agreed upon

• The fictitious assets like preliminary expenses and debit balance of profit and loss accounts should be added in the total assets

• Thaw accumulated profit like reserve fund ;credit balance of profit and loss accounts etc are not the liabilities and should not be deducted from the total assets.

• The partner’s wife loan (out of her streedhan) is an outside liability just like other creditors.

• The workers profit sharing find saving fund provident fund gratuity fund, pension fund etc are liabilities to the workers and so they must be deducted from assets taken over.

• After determining by net assets method the statement of payment of purchase consideration must be prepared as follows:

1. No. of equity shares x issued price …...2. Dentures issued ……3. Balance in cash ……

purchase consideration

……

Goodwill• When a running business is acquired, the

important question arises is to fix up the purchase price or the purchase consideration. The parties settles the prices on the basis of the values of the assets taken over the profitability of the business the values of tangible assets like land, building , machinery , stock etc can be easily ascertained. But the problem of determining the value of goodwill of the exiting business is a bit difficult to solve. Generally goodwill is valued at three to five times of super profit of the business.

• In the problem of purchase of business, if the value of goodwill is not stated , is found out by deducting the values of net assets taken over from the purchase price

• Goodwill= purchase consideration – net assets.

Capital reserve• A running business is not profitable,

may be purchased at the value which is less than its net assets . In case if the purchasing company makes profit which is equal to difference between net assets and purchase price. The profit is transfer to capital reserve account, which can be utilized in writing off the fictitious assets like preliminary expenses, discount on issue of debentures or shares etc.

Entries in books of purchasing company

1. For recording the purchase of business :

2. For up bringing into assets and liabilities taken over :

Business purchase A/c Dr.

(purchase consideration)

to vendor’s A/c

Various assets (taken over) Dr.

(at the value agreed upon)

To various liabilities (at the value agreed upon)

To business purchase (purchase consideration)

• Instead of two entries shown one entry can be passed :

Various assets(takenover)A/c Dr.

(at the value agreed upon)

To various liabilities A/c (at the value agreed upon)

To vendor’s A/c (purchase consideration)

• On payment of purchase consideration :

Vendor’s A/c Dr.

(purchase consideration)

To share capital A/c (if shares are issued)

To security premium A/c (if shares are issued at premium)

To debentures A/c (If debentures are issued)

To cash/bank A/c (if cash is paid)

Made by :•Rukshar Bhokal•Preeti Lohan•Dipti Lohan•Hema Vora•Chandni Sompura•Rutu Chandariya•Ridhi Vadodariya