business purchase to be used in conjunction with pdf document entitled “business purchase –...

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Business Purchase

To be used in conjunction with PDF document entitled “Business

Purchase – Student note”


Inherent vs Purchased Goodwill

• So far in the course we have revalued goodwill based on what a partnership believes its goodwill is worth.

• This is known as inherent goodwill as it will only arise if and when the business is actually sold.

• Inherent goodwill can not be shown on the balance sheet of a limited company (according to FRS 10)


Inherent vs Purchased Goodwill

• When a business is purchased as a going concern, there will usually be some goodwill paid for – this is purchased goodwill.

• Purchased goodwill is the difference between the fair value of the net assets of the business and the value of the business as a going concern

• Purchased goodwill can be reported in the balance sheet of a limited company


Business purchase step 1

• Debit all of the assets to be taken over by the new business

• Use the agreed value (not necessarily the book value from the balance sheet) and do not 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.


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



• Credit the liabilities that are being taken over in the purchase.

• Use the amounts shown in the balance sheet.



• 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


The consideration is a mix of share capital and

cash.

Credit capital for the par value of the shares issued

and share premium for the balance.

Don’t forget the cash!



• Now you can calculate the amount of goodwill being purchased (i.e. goodwill is the amount required to balance the journal entry).


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


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 receive the same amount of interest after the takeover as before.

e.g. Nelumdeniya is a partner in a firm that is being

purchased. 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 receives the same amount of interest as

before.


Negative Goodwill

• There may be occasions where a business is sold for an amount less than the fair value of its net assets.

• This may be because the owner would prefer a quick sale to a protracted winding up of the business

• 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 to

purchases the business.

The entry in the books of Worasen Ltd to record the sale

would be:Assets 100 000 Goodwill 20 000 Bank 80 000

The change on Worasen Ltd’s balance sheet would be:

business purchase to be used in conjunction with pdf document entitled “business purchase –...

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