Business Purchase

7/28/2019 Business Purchase

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Business Purchase

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document entitled BusinessPurchaseStudent note

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Inherent vs Purchased Goodwill

So far in the course we have revalued goodwillbased on what a partnership believes itsgoodwill is worth.

This is known as inherent goodwill as it willonly arise if and when the business is actuallysold.

Inherent goodwill can not be shown on thebalance sheet of a limited company (accordingto FRS 10)



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Inherent vs Purchased Goodwill

When a business is purchased as a goingconcern, there will usually be some goodwillpaid for this is purchased goodwill.

Purchased goodwill is the difference betweenthe fair value of the net assets of the businessand the value of the business as a goingconcern

Purchased goodwill can be reported in thebalance sheet of a limited company



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Business purchase step 1

Debit all of the assets to be taken over by thenew business

Use the agreed value (not necessarily the

book value from the balance sheet) and donot take over provision for depreciation.

In most cases the bank/cash account balances

are not taken over Include a line in the journal for goodwill

although you may not know the amount yet.



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Assets are debited at their agreed

values. There will always be

goodwill on the purchase of an

existing business leave room for it

but calculate it at the end



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Credit the liabilities that are being taken over

in the purchase.

Use the amounts shown in the balance sheet.



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Credit the consideration (payment made to

current owners) for the purchase.

In most questions this will be in the form of

cash and/or shares (at a premium) and/or

debentures

Be careful of the dates consideration may be

made on different days



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The consideration is a

mix of share capital and

cash.

Credit capital for the par

value of the shares issued

and share premium for thebalance.

Dont forget the cash!



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Now you can calculate the amount of goodwill

being purchased (i.e. goodwill is the amount

required to balance the journal entry).



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The credit side of the

journal entry adds to

$297470

The debit side adds to

$225 870.

Therefore the goodwill

paid for on purchase is

$71 600.

71 600



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Loan from a partner

Very often a business purchase question will

include be for a company acquiring a partnership

It is common in these questions for there to be a

loan from a partner on the books.

In this instance it is usual for a debenture to be

issued to the partner for the loan. It is usually

worded so that the partner continues to receivethe same amount of interest after the takeover as

before.

e.g. Nelumdeniya is a partner

in a firm that is beingpurchased. The partnership

books show a loan from

Nelumdeniya for $100 000

earning 9% ($9000 in interest

per year).

The company will issue

Nelumdeniya with a 6%debenture for the loan. How

much will the debenture need

to be, for Nelumdeniya to

receive the same amount of

interest as before?

Old interest rate is 9%. New

interest rate is 6%.Nelumdeniya will need a

debenture of (9/6 X 100 000)

$150 000 to ensure he receivesthe same amount of interest as

before.



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Negative Goodwill

There may be occasions where a business is soldfor an amount less than the fair value of its netassets.

This may be because the owner would prefer aquick sale to a protracted winding up of thebusiness

In this instance the goodwill is credited on the

books of the new business It is still shown under the intangible assets but is

a negative number.

e.g. Hayward is running a

business that shows net assets

of $100 000 on his balance

sheet. He accepts an offer of

$80 000 from Worason Ltd topurchases the business.

The entry in the books ofWorasen Ltd to record the sale

would be:

Assets 100 000

Goodwill 20 000

Bank 80 000

The change on Worasen Ltdsbalance sheet would be:


Business Purchase

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