Business Purchase and Merger

A business may acquire another business organization to gain financial benefits (increase profitability), to increase market share and to take advantage of internal economies of scale.  A merger takes place when two or more businesses join together to form a new business. The main purpose of a business combination is to gain greater effectiveness than acting individually. Common examples of business purchase and merger are:

• A sole trader acquiring another sole trader’s business
• A partnership acquiring a sole trader’s business
• A company acquiring a sole trader / partnership or another company
• Merger of two or more sole trader’s business to form a partnership
• Merger of a sole trader’s business with an existing partnership

Whatever be the business combinations, it simply means the end of a business organization and the start of a new one. This will require the closing down of all ledger accounts.

In case of a business purchase:

IAS 38 prescribes the rules for accounting for all intangible assets. An asset is a resource controlled by an entity as a result of past events, from which future economic benefits are expected to flow to the entity. IAS 38 expands this definition for intangible assets by stating that an intangible asset is an identifiable non-monetary asset without physical substance.

Examples of intangible assets

• Patents
• Trademarks
• Customer relationships/ lists
• Licensing agreement
• Goodwill

Purchased Goodwill

When a business is purchased, this may involve purchase of some intangible assets. Some may be specifically identifiable intangibles which can be assigned a value such as trademarks.  Another intangible asset could be goodwill which may arise due to good business reputation, good customers and employee relations, after sale services and particularly favourable location.

Purchased goodwill arises on the purchase of one business by another. It is defined as the excess of the purchase price of the business as a whole over the fair value of its separable net assets.

Goodwill          =          Business Purchase Price (BPP)  – Net Assets at fair value

Note:

• Net assets = Non current assets + current assets – current liabilities
• Fair value means agreed value between buyer and seller

Example

A Company acquired the business of a sole trader Malcolm on 31^st December 2014. The purchase consideration was to be settled in 1 500 000 fully paid ordinary shares of $0.75. The summarised Statement of financial position of Malcolm as at 31^st December 2014 was as follows:

The company valued the non-current assets of Malcolm at $850 000, current assets at $320 000 and current liabilities at $270 000.

Business Purchase Price = 1 500 000 * 0.75 = $ 1 075 000

Net Assets       = 850 000 + 320 000 – 270 000 = $ 900 000

Goodwill           = Business Purchase Price – Net Assets

                           = 1 075 000 – 900 000

                           = $ 175 000

Inherent Goodwill

Internally developed or inherent goodwill has not been paid for and is accounted for when a business recognizes the factors such as brand name, established product market, managerial skills, trained work force, quality products etc. In that case if a business decides to show its goodwill in the statement of financial position then goodwill account is debited and capital accounts of owners or partners are credited with any amount that it wished to show as goodwill. The Accounting Standards however state that only purchased goodwill should be shown in company statement of financial positions as an 'intangible non-current asset'.

Negative Goodwill

Negative goodwill arises where the purchase price agreed for the acquisition of the whole business is less than the agreed value of its separately identifiable net assets at the date of purchase. This represents a goodwill account with a credit balance.

Under IFRS 3 (not part of CIE syllabus) negative goodwill is immediately recognized as income in the comprehensive income statement. Under FRS 10 negative goodwill must be subtracted from non-current assets as a negative amount among the intangible non-current assets in the Statement of financial position.

Worked Example 1 – Company acquiring a Partnership business

Brian and Smart had been in partnership for many years sharing profit and losses in the ratio 2:1. They decided to sell their business to Clopperfield Ltd. The partnership's statement of financial position at 30 April 2012 was as follows:

Statement of financial position of Clopperfield Ltd as at 30 April 2012 was as follows:

Clopperfield Ltd purchased the business on 1 May 2012 for $160 000. The company took over all of the assets (except the bank account) together with the current liabilities. The purchase consideration was:

1. 120 000 ordinary shares of $0.50 nominal value issued at a premium of $0.10.
2. 30 000 6% non-redeemable preference shares of $0.50.
3. 10% debentures redeemable in 2020 issued so that Brian and Smart receive the same interest payments as in the partnership.
4. The balance paid from the bank account.
5. Ordinary and non-redeemable preference shares to be apportioned on basis on profit and loss sharing ratio.

The partnership assets were re-valued as follows:

Step 1 – Calculate Goodwill

Business Purchase Price       =          $ 160 000

Net Assets                             =          Assets – Liabilities

                                              =          (95 000+24 500+12 500+27 500+10 250) – 13 950

                                              =          $ 155 800

Goodwill                               =          BPP – Net Assets

                                              =          $ 160 000 - $ 155 800

                                              =          $ 4 200

Step 2 – Method of Payment of Purchase Price

In the books of Brian and Smart – SELLER

Step 3 – Realisation Account

DR Realisation - Assets by amount in SOFP

CR Realisation  - Liabilities by amount in SOFP

Step 4 – Capital Account of Partners

Step 5 – Bank Account – Debit side must equal credit side

In the books of Clopperfield Ltd -  BUYER

Step 6 – Statement of Financial Position

Worked Example 2 - Two sole trader merging together to form a partnership

Aneesa and Emiliya are two sole traders who decided to form a partnership combining their businesses. At 31 March 2020 their statement of financial position were as follows:

Statement of financial position at 31 March 2020

The new partnership was formed on 1 April 2020 when their assets were valued at:

It was agreed that a provision for doubtful debts of 5% would be created, that the bank accounts would be amalgamated and that goodwill would not be retained in the books. Profits were to be shared between Aneesa and Emiliya in the ratio 2:3 respectively.

Step 1 – Goodwill off (Profit sharing ratio)

Total Goodwill = 9 000 + 5 000 = $ 14 000

Aneesa                        = 2 / 5 * 14 000 = $ 5 600

Emiliya                        = 3 / 5 * 14 000 = $ 8 400

Step 2 – Revaluation Account

Step 3 – Capital Account

Step 4 – Draft Statement of financial position of Partnership