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Friday, April 23, 2010

Goodwill and Pre-acquisition Profits

Assuming instead that S Ltd has earned profits of 8000$ in the period before acquisition, its balance sheet just before the purchase would like as follows.

Net tangible assets 40000$
Share capital 40000$
Reserves 8000$

If H Ltd now purchases all the shares in S Ltd it will acquire net tangible assets worth 48000$ (share capital + reserves) at a cost of 60000$. Clearly in this case S Ltd’s intangible assets (goodwill) are being valued at 12000$ by the parent company must be incorporated in the cancellation process so as to arrive at a figure for goodwill arising on consolidation. In other words, not only S Ltd’s shares capital, but also its pre-acquisition reserves, must be cancelled against the asset “investment in S Ltd” in the accounts of parent company. The unconcealed balance of 12000$ appears in the consolidated balance sheet.

The consequence of this is that any pre acquisition reserves of a subsidiary company are not aggregated with the parent company’s reserves in the consolidated balance sheet. The figure of consolidated reserves comprises the reserves of the parent company plus the post-acquisition reserves only of subsidiary companies. The post-acquisition reserves are simply reserves not less reserves at acquisition.


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