Acquisition by a Limited Company (Cambridge (CIE) A Level Accounting): Revision Note

Acquisition by a limited company

What is the purchase consideration?

• The purchase consideration is the total agreed price paid by an acquiring entity to purchase a business

• The purchase consideration uses the agreed values for assets, liabilities and goodwill

• The acquiring entity might offer:

  • cash

  • shares in the acquiring entity

  • debentures

• Sometimes, debentures are issued to the current partners so that the interest is the same as the interest they currently receive on their capital or loan

  • To calculate the value of the debenture:

    • Multiply the capital or loan by the interest allowed

    • Divide this by the interest of the debenture

How is the purchased goodwill calculated?

• You might be given the value of the purchased goodwill in the question

• Goodwill might be calculated before the acquisition by

  • multiplying the profit for the year by a given factor

  • multiplying the average profit over specified years by a given factor

• Goodwill might be calculated after the acquisition by

  • subtracting the net assets from the purchase consideration

• Purchased goodwill remains as an intangible non-current asset in the new entity's books

  • This is different to inherent goodwill, which is written off

How do I make journal entries when a limited company acquires a sole trader or partnership?

The books of the sole trader or partnership

• STEP 1
  Record any day-to-day transactions such as paying suppliers

  • Anything that would be debited or credited to the statement of profit or loss is instead entered in a realisation account

    • For example, if the business receives a discount from a supplier, then this is credited to the realisation account

• STEP 2
  Transfer the non-cash assets to the realisation account using the book value

  • Debit the realisation account

  • Credit each asset account

• STEP 3
  Transfer the liabilities to the realisation account using the book value

  • Debit each liability account

  • Credit the realisation account

• STEP 4
  Record the purchase consideration from the acquiring company

  • Debit the relevant account

    • Bank if cash is received

    • Shares in acquiring company if shares are received

    • Debentures if debentures are received

  • Credit the realisation account

• STEP 5
  Record any assets that are taken by the current owners using the agreed value

  • Debit the capital account

  • Credit the realisation account

• STEP 6
  Record the realisation expenses that apply to the current owner(s)

  • Debit the realisation account

  • Credit the bank account

• STEP 7
  Close the realisation account by finding the profit or loss on realisation

  • If it is a profit:

    • Debit the realisation account

    • Credit the capital account(s)

  • If it is a loss

    • Debit the capital account(s)

    • Credit the realisation account

• STEP 8
  Close the capital account(s)

  • Transfer the balances from the current accounts if it is a partnership

  • Deal with the amount owed to the current owner(s)

    • Debit the capital account(s)

    • Credit the bank, shares or debenture account

The books of the limited company

• STEP 1
  Make debit entries for the acquired assets using the agreed value

  • Non-current assets

  • Inventory

  • Trade receivables

  • Goodwill (if an agreed value was given)

• STEP 2
  Make credit entries for the acquired liabilities using the agreed value

  • Trade payables

• STEP 3
  Make credit entries for the purchase consideration

  • Bank if cash was paid

  • Ordinary share capital if shares were issued

  • Share premium if shares were issued at a premium

  • Debentures if they were issued

• STEP 4
  Calculate the value of the purchased goodwill if it was not agreed during the acquisition

  • Find the difference between the total debit entries and the total credit entries