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Thursday, November 4, 2010

Entries of Purchasing of a Business by a Company

The entries in the company’s books necessary to record the purchase of the business are as follows:
  • Assets acquired at acquisition values
    Debit – Assets
    Credit – Vendor’s account
  • Liabilities acquired at acquisition values
    Debit – Vendor’s account
    Credit – Liabilities
  • Purchase consideration
    Debit – Vendors account
    Credit – Share capital, share premium, debentures, and cash
  • Excess of purchase consideration over net assets required
    Debit – Goodwill
    Credit – Vendor’s account
  • Excess of net assets acquired over purchase consideration
    Debit – Vendor’s account
    Credit – Capital reserve

Any debtors taken over should be debited at book values and any provisions for doubtful or bad debts should be credited to a provision for bad debts account.

Some accountants prefer to pass the purchase of business account, which replaces the vendor’s account, being credited with the assets acquired and debited with the liabilities taken over and with the purchase consideration.

Where the purchase consideration is less than the value at which the net assets stood in the books of the vendor, but the values of the assets taken over are correctly stated, the surplus should be treated in the company’s books as a capital reserve. The surplus is not available for distribution to shareholders and cannot be credited to a revenue reserve account.
The absence of a goodwill account indicates that no payment has been made for goodwill; it does not indicate that it is nonexistent.

Where a partnership business is transferred to a limited company some difficulty may be experienced in capitalization the company so as to ensure that the rights of the partners are preserved. If the capitals of the partners are in the same ratio as that in which profits are shared, the problem is simplified, as the allotment to the partners of ordinary shares in that ratio will preserve the relationship as nearly as possible. Often, where the capitals are not held in profit-share ratio, the problem is complicated, particularly when taxation is considered.

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