Page 7 - DCOM205_ACCOUNTING_FOR_COMPANIES_II

Accounting for Companies – II

notes Following are some important terms used in acquisition of business:
1. Purchase Consideration: The amount payable by the purchaser company to the vendors
for acquisition of business is called Purchase Consideration or Purchase Price. This is
determined by agreement between the purchase and the seller. Generally, purchase
consideration is asked in the examination problem. If it is not given in the question, it can
be determined by any one of the following methods:
(a) Net Assets Method: If in the examination problem there is neither information
regarding the purchase price non-payment, purchase consideration can be computed
by N.A. method as below:
Purchase Price = Total agreed value of assets less value of liabilities assumed by the purchaser.

(b) Net Payment Method: In this method, purchase price is computed by adding up
the various payments made by the purchaser to vendor. This payment can be in the
following manner:
(i) Payment in cash,
(ii) Payment by issue of equity shares or preference shares or both,
(iii) Payment by issue of debentures.
2. Goodwill or Capital Reserve: If in the examination problem the amount of goodwill is
not given, value of goodwill is calculated by the comparison of purchase price paid and
net assets or net worth. Net assets are calculated by taking the difference of assets taken
over and liabilities taken over. Here, only revised value of assets and liabilities taken are
considered. If, in the problem, revised value of assets and liabilities are not given, book
value of the assets and liabilities should be treated as revised value.
Goodwill = Purchase Price – Net Assets
Capital Reserve = Net Assets – Purchase Price.
If the purchase consideration is more than the net assets, excess should be treated as
goodwill. On the other hand, if net assets are more than the purchase price, excess of net
assets should be treated as capital reserve (capital profit).

3. Assets taken over by the purchasing company: If the question is silent regarding the assets
taken by the purchasing company, all assets including the cash balance of the vendor are
assumed to be taken by purchaser, but fictitious assets and miscellaneous expenses are not
taken.
4. Liabilities taken over by the purchasing company: If the question is silent regarding the
liabilities taken by the purchasing company, all liabilities excluding the internal liabilities
(as share capital, reserve funds and undistributed profits) of vendor are assumed to be
taken by purchaser.
5. Interest payable to vendors on purchase consideration: If the payment of purchase price
is delayed by the purchaser, the vendor can demand for interest on purchase, price for
delayed period from the date of purchase of business to the date of payment.
6. Expenses of realisation of vendor: The payment of realisation expenses is made either by
vendor or by purchasing company. When these expenses are paid by purchasing company,
sufficient amount is given to vendor by purchasing company to meet the cost of realisation
in addition to purchase price. The amount paid for realisation expenses is in the nature
of capital expenditure; therefore it is debited to either goodwill account or preliminary
expenses account.

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