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
- A sole trader acquiring the existing business of a sole trader
- A partnership acquiring the business of another partnership or a sole trader
- 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
- 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.
- Purchase consideration: The is the price which a purchaser would pay to the vendor in order to acquire his business.
- 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.
- 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
- Explain the following terms:
- Goodwill
- Capital reserve
- Purchase consideration
- Vendor
- 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
- The purchase consideration to be N200,000
- All assets and liabilities were taken over with the exception of bank
- Assets to be re-valued are as follows :
Premises 140,000
Fixtures 40,000
Motor car 57,000
Debtors 13,000
Stock 10,000
- The purchase price was paid on January 10th, 1999.
You are required to prepare:
- Journal entries in respect of the acquisition
- ledger A/C
- 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
- State six characteristics of depreciable assets
- Explain three differences between a trial balance and a balance sheet
- List seven errors that will affect the agreement of the trial balance
- Explain the following : (i) real account (ii) nominal account (iii) personal account
- 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
- Goodwill is a ——- (a) current asset ( b) intangible asset( c) current liability( d)fictitious asset
- Vendor means the seller of the (a) business (b) asset (c) liabilities (d) capital
- Capital reserve is( a) current assets( b) fixed assets (c) liabilities (d) equity
- 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
- 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
- Explain the accounting entries in the purchase of a business by a partnership from a sole trader.
- 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.
Should you have any further question, feel free to ask in the comment section below and trust us to respond as soon as possible.
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