Purchase of a Business

Back to: FINANCIAL ACCOUNTING SS3

 

Welcome to class! 

In today’s class, we will be talking about the purchase of a business. Enjoy the class!

Purchase of a Business

Purchase of business is the activity of buying or acquiring a business as a going concern. This means acquiring an existing business with the intention of continuing its operations. This acquisition can be in any of the following ways

1. A sole trader acquiring the existing business of a sole trader
2. A partnership acquiring the business of another partnership or a sole trader
3. A company may be buying another or a partnership business.

In any of the acquisitions above, the assets and liabilities taken over by the purchasing businesses will be recorded in the same way.

Terminologies in the purchase of a business

1. Vendor: This is the person or partnership or company that sold the business to another. The vendor may be paid cash, cheque or in shares of the new company.
2. Purchase consideration: The is the price which a purchaser would pay to the vendor in order to acquire his business.
3. Goodwill: This is the excess of the purchase consideration over the net value of assets taken over. Net assets mean total assets less liabilities. It is also called the net worth of the business.
4. Capital reserve. Where the purchase consideration is lesser than the net worth of the business, the difference is referred to as capital reserve.

Accounting entries

 1. Agreed purchase price:

Dr. Business Purchase A/C

Cr. Vendors A/C

2. Take over the value of assets:

Dr. Assets Account

Cr. Business Purchase A/C

3. Agreed value of liabilities taken over:

Dr. Business Purchase A/C

Cr. Liabilities A/C

4. Excess of purchase consideration over net asset:

Dr. Goodwill

Cr. Business Purchase A/C

5. Excess of an asset over purchase consideration:

Dr. Business Purchase A/C

Cr. Capital Reserve A/C

6. Settlement of the vendor’s A/C with cash:

Dr. Vendor’s A/C

Cr. Cash A/C

7. Settlement of Vendor’s A/C with shares:

Dr. Vendor’s A/C

Cr. Share Capital A/C

 

Journal entries:

JOURNAL

	Dr	Cr
	N	N
Assets: fixtures	X
Motor vans	X
Debtors	X
Stock	X
Goodwill	X
Liabilities: creditors		x
Purchase consideration		x
Assets and liabilities taken over
Purchase of business account	X
Vendor account		x
Agreed purchase price of the business
Vendor’s account	X
Bank account or share capital account		x
Cash or share paid in full settlement		x

Evaluation

1. Explain the following terms:
2. Goodwill
3. Capital reserve
4. Purchase consideration
5. Vendor
6. List six factors which can create goodwill for any firm or organization.

Illustration

Lanka had taken over the business of Olaiya on 31/1/99 on the basis of the last balance sheet as follows:

Balance sheet

N                                               N

Capital             180,000      Premises                      100,000

Creditors            60.000     Fixtures                         45,000

Accruals              10,000      Motor car                      55,000

Debtors                                                                   15,000

Stock                                                                         5,000

Bank                                                                        30,000

250,000                                              250,000

Additional information

1. The purchase consideration to be N200,000
2. All assets and liabilities were taken over with the exception of bank
3. Assets to be re-valued are as follows :

Premises                                                               140,000

Fixtures                                                                    40,000

Motor car                                                                 57,000

Debtors                                                                    13,000

Stock                                                                        10,000

4. The purchase price was paid on January 10^th, 1999.

You are required to prepare:

1. Journal entries in respect of the acquisition
2. ledger A/C
3. balance sheet

Solution

• Journal:

                                                            DR                             CR

                                                                N                               N

Premises                                          140,000

Fixtures                                              40,000

Motor van                                         57,000

Debtors                                             13,000

Goodwill                                           10,000

Creditors                                                                            60,000

Accruals                                                                              10,000

Purchase of Business.                                                        200,000

Assets and liabilities taken over

Purchase of business A/C               200,000

Vendor A/C                                                                       200,000

Purchase price per agreement

Vendor A/C                                     200,000

Bank A/C                                                                        200,000

Cash or share paid in full settlement

• Ledger accounts:

Business Purchase Account

                                         N                                                             N

Liabilities taken over                       Asset taken over

Creditors                      60,000       Premises                              140,000

Accruals                      10,000        Fixtures                                  40,000

Purchase price           200,000       Motor van                              57,000

Debtor                                                                                         13,000

Stock                                                                                            10,000

Goodwill                                                                                       10,000

270,000                                                           270,000

 

Bank Account            

Vendor          200,000

Vendor Account

Bank              200,000                      Purchase Consideration                 200,000

Goodwill Account

Purchase of business  10,000

• Balance Sheet:

                                  N                                                                N

Capital A/C            200,000                goodwill                           10,000

Premises                                                                                     140,000

Fixtures                                                                                         40,000

Creditors                60,000                Motor van                           57,000

Accruals                 10,000                debtors                                13,000

Stock                                                                                             10,000

270,000                                               270,000

General evaluation

1. State six characteristics of depreciable assets
2. Explain three differences between a trial balance and a balance sheet
3. List seven errors that will affect the agreement of the trial balance
4. Explain the following : (i) real account (ii) nominal account (iii) personal account
5. List eight items that cause disagreement between Cash Book and bank statement balance

Reading assignment

Essential Fin. Accounting by O.A Longe page 299-307.

Weekend  assignment

1. Goodwill is a ——- (a) current asset ( b) intangible asset( c) current liability( d)fictitious asset
2. Vendor means the seller of the (a) business (b) asset (c) liabilities (d) capital
3. Capital reserve is( a) current assets( b) fixed assets (c) liabilities (d) equity
4. The double entry for payment of cheque to the vendor is (a) Dr. vendor A/C, Cr. bank (b) Cr. Vendor, Dr. bank (c) Cr. cheque Dr. vendor (d) Dr. Vendor Cr. Cash
5. The double entry for the agreed purchase price is (a) Dr. purchase of business A/C, Cr. Vendor (b) Dr. asset Cr. liabilities  (c) Dr. Cash Cr. Vendor (d) Dr. Asset Cr. Cash

Theory

1. Explain the accounting entries in the purchase of a business by a partnership from a sole trader.
2. Explain i. Capital reserve Goodwill on purchase of a business

 

In our next class, we will be talking about Accounting Ratios and Interpretation of Financial Statements.  We hope you enjoyed the class.

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