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:

BUSINESS PURCHASE

MERGER

SELLER

BUYER

To close down all accounts and dissolve the business

To fuse all assets and liabilities to existing ones

Assets are revalued and liabilities reassessed by all parties

Requirement:

Requirement:

Requirement:

a) Realisation Account

a) Calculation of Goodwill

a) Revaluation

b) Capital Account

b) Mode of payment

b) Capital Account

c) Bank Account

c) Statement of financial position

c) Statement of financial position


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 31st 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 31st December 2014 was as follows:


$ 000

$ 000

Non Current assets


700

Current Assets

350


Less current liabilities

(280)

70

Capital


770


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:



$

$

Non-current assets



Property


85 000

Fixtures and fittings


27 500

Plant and machinery


14 750



127 250

Current assets



Inventories

28 800


Trade receivables

10 950


Bank

5 450

45 200

Total assets


172 450

Capital accounts



Brian


76 000

Smart


57 500



133 500

Non-current liabilities



Loan from Brian at 8% per annum

15 000


Loan from Smart at 6% per annum

10 000

25 000



158 500

Current liabilities



Trade payables


13 950



172 450


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



$

$

Non-current assets



Property


145 000

Fixtures and fittings


57 750

Plant and machinery


18 750



221 500

Current assets



Inventories

39 450


Trade receivables

12 380


Bank

69 675

121 505

Total assets


343 005

Equity



300 000 Ordinary shares of $0.50


150 000

Share premium


75 000

Retained earnings


99 330



324 330

Current liabilities



Trade payables


18 675



343 005

 

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:



$

Property

95 000

Fixtures and fittings

24 500

Plant and machinery

12 500

Inventories

27 500

Trade receivables

10 250


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



$


Business Purchase Price

160 000





Ordinary Shares



Nominal = 120 000 shares * $ 0.50

60 000

Brian = 2/3*72 000 = $ 48 000

Premium = 120 000 shares * $ 0.10

12 000

Smart = 1/3*72 000 = $ 24 000




Preference Shares (30 000 shares * $ 0.50)

15 000

Brian = 2/3* 15 000 = $10 000



Smart = 1/3 * 15 000 = $ 5 000




Debentures



Brian (8%*15000*10)

12 000


Smart (6%*10 000*10)

6 000





Bank (160 000 – 72 000 – 15 000 – 18 000)

55 000



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


DR                                                                Reaslisation Account                                                               CR


$


$

Total non current assets

127 250

Business Purchase Price

160 000

Inventory

28 800

Trade Payables

13 950

Trade receivables

10 950



Profit on realisation




Brian (2/3)

4 633



Smart (1/3)

2 317




173 950


173 950


Step 4 – Capital Account of Partners


DR                                                                      Capital Account                                                                    CR


Brian

Smart


Brian

Smart


$

$


$

$

Ordinary Shares

48 000

24 000

Balance b/f

76 000

57 500

Preference Shares

10 000

5 000

Loan

15 000

10 000

Debentures

12 000

6 000

Profit on Realisation

4 633

2 317

Bank

25 633

34 817





95 633

69 817


95 633

69 817


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


DR                                                                       Bank Account                                                                     CR


$


$

Balance b/f

5 450

Capital - Brian

25 633

Clopperfield Ltd

55 000

Capital - Smart

34 817


60 450


60 450


In the books of Clopperfield Ltd -  BUYER


Step 6 – Statement of Financial Position


Statement of financial position of Clopperfield Ltd as at 1st May 2012

$

$

Tangible Non-current assets



Property (145 000 + 95 000)


240 000

Fixtures and fittings (57 750 + 24 500)


82 250

Plant and machinery (18 750 + 12 500)


31 250

Intangible Non-current assets



Goodwill


4 200



357 700

Current assets



Inventories (39 450 + 27 500)

66 950


Trade receivables (12 380 + 10 250)

22 630


Bank (69 675 – 55 000)

14 675

104 255

Total assets


461 955

Equity



420 000 Ordinary shares of $0.50 (150 000 + 60 000)


210 000

Share premium (75 000 + 12 000)


87 000

30 000 6% Non Redeemable preference shares of $0.50


15 000

Retained earnings


99 330

Shareholder’s Fund


411 330

Non-current liabilities



10% Debentures (12 000 + 6 000)


18 000

Capital Employed


429 330

Current liabilities



Trade payables (18 675 + 13 950)


32 625

Equity and Liabilities


461 955


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


Aneesa

Emiliya


$

$

$

$

Non current assets





Premises




86 000

Equipment


12 000


19 000

Fixtures


6 000


3 000

Motor vehicles


8 200





26 200


108 000

Current Assets





Inventory

15 000


5 700


Trade receivables

17 000


18 000


Cash and cash equivalents

9 050

41 050


23 700



67 250


131 700

Capital


56 250


108 850

Current Liabilities





Trade payables


11 000


12 000

Cash and cash equivalents




10 850



67 250


131 700

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



Aneesa

Emiliya


$

$

Premises

120 000

Equipment

16 000

20 000

Fixtures

6 500

2 800

Motor vehicle

12 100


Inventory

14 800

5 100

Goodwill

9 000

5 000


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


DR                                                         Revaluation Account - Aneesa                                                       CR


$


$

Trade receivables

850

Equipment

4 000

Inventory

200

Fixtures

500

Profit on revaluation

16 350

Motor Vehicles

3 900



Goodwill

9 000


17 400


17 400



DR                                                        Revaluation Account - Emiliya                                                      CR


$


$

Fixtures

200

Premises

34 000

Inventory

600

Equipment

1 000

Trade receivables

900

Goodwill

5 000

Profit on revaluation

38 300




39 000


39 000


Step 3 – Capital Account


DR                                                                      Capital Account                                                                       CR


Aneesa

Emiliya


Aneesa

Emiliya


$

$


$

$

Goodwill w/o

5 600

8 400

Balance b/f

56 250

108 850

Balance c/d

67 000

138 750

Profit on revaluation

16 350

38 300


72 600

147 150


72 600

147 150




Balance b/d

67 000

138 750


Step 4 – Draft Statement of financial position of Partnership


Statement of financial position as at 1st April 2020


$

$

Non current assets



Premises


120 000

Equipment (16 000 + 20 000)


36 000

Fixtures (6 500 + 2 800)


9 300

Motor vehicles


12 100



177 400

Current Assets



Inventory (14 800 + 5 100)

19 900


Trade receivables [ (17 000-850) + (18 000 – 900)]

33 250

53 150

Total Assets


230 550

Capital - Aneesa


67 000

Capital - Emiliya


138 750



205 750

Current Liabilities



Trade payables (11 000 + 12 000)

23 000


Cash and cash equivalents (9 050 – 10 850)

1 800

24 800

Equity and Liabilities


230 550