Business Purchase - Principles Of Accounting

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A buyer may decide to purchase a business for several reasons. They may include1. An attractive purchase price 2. An opportunity to expand business activities 3. An opportunity to acquire profit making businessUsually the purchaser does not takeover all the assets and liabilities of the vendor (i.e.) the vendor will retain the cash and be left to pay off some or all of the liabilities. Business Purchase price: This is the price to be given by the purchaser to the vendor. The purchaser and the vendor will calculate this price together (usually on the basis of the assets and liabilities taken over by the purchaser) or on the basis of the average profit of the business during the past years. Calculation of Goodwill or Capital Reserves(negative goodwill): Sometimes the purchaser will have to pay for Goodwill or receive Capital Reserve. Goodwill or capital reserve is the difference between net assets and business purchase price. Goodwill / Capital reserve = Business Purchase Price Net Assets (Positive figure is goodwill and negative figure is capital reserve) Factors / reasons for Good will:

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A person has to pay for goodwill when taking over a business or when admitted as a partner because of Profitability Reputation Locality Public relation Existing business means, the business is being operated and a balance sheet is there for the business at any time. The types of business purchase can be mentioned as follows: a) b) c) d) An individual (a person) purchases a business A partnership or a sole trader acquires the business of a sole trader Two or more sole traders join together to form a partnership A limited company takes over the business of a partnership or a sole trader

Why business purchases are taking places? a) b) c) d) e) To avoid competition ( competition will lead the business to cutthroat and lose) To enjoy the profit of the business which is to be purchased To enlarge the size of the business To avoid the burdens and toil of organizing a new business To enjoy the Good will of the business

Double Entries necessary in the books of the Purchaser.

1. For the assets taken overVarious Assets taken over Business Purchase Dr Cr (including Goodwill)

1. 2. For the liabilities taken overBusiness Purchase Various Liabilities taken over Dr Cr

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1. 3. For recording the business purchase price-

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Business Purchase Vendor

Dr Cr

(with Business Purchase Price)

1. 4.For the capital brought in the businessBank/ Cash Share Capital Dr Cr

1. 5. For recording the payments to vendorVendor Bank / cash Dr Cr

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Key points Only the revalued amounts are considered for the calculation of business purchase price and the purchasers balance sheet shows only these values. In the purchasers books goodwill is always debited as a fixed asset and capital reserve (negative goodwill) is always credited as capital profit.

Q 1.Following is the Balance Sheet of M. Moof as at 31.12.1998.

Assets Land Building

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Furniture Debtors 70 400 Stock Cash in Hand 8 700 1 300 Cash at Bank 4 600 97 400 97 400 G. Grant decided to purchase the business of M. Moof on 01.01.1999. He will take over the assets and liabilities on the following valuationsLand Building Furniture 32 000 23 000 15 000 Debtors Stock Creditors 11 000 9 000 16 000

Liabilities 30 000Creditors 25 000Bank Loan 15 500Capital 12 300

$ 17 000 10 000

He will not take over the cash in hand, cash at bank and bank loan. The purchase price is fixed at $ 80,000.

You are required to calculate the amount of Goodwill and pass journal entries in the books of G. Grant assuming that G. Grant settled the amount payable to M. Moof by cheque. Q 2. M. Martin is a sole trader. His Balance Sheet as on 01.01.1998 was as follows.

Assets Buildings Furniture Fittings Stock Debtors Cash in hand

$ Liabilities 37 000Creditors 20 000Bank Overdraft 10 000Capital 17 000 1 000 2 350 87 350

$ 15 000 3 000 69 350

87 350

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Building at book value Furniture at book value less $ 2 000 depreciation less 10% depreciation

R. Robin decided to purchase the business of M. Martin on 01.01.1998 and he decided to take over all the assets and liabilities except cash in hand and bank overdraft on the following valuations.

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Fittings at Debtors at Stock at Creditors

$ 9 000 $ 950 $ 18 500 $ 15 500

The business purchase price was fixed at $ 70 000. He brought into the business sufficient amount of money to settle the business purchase price. You are asked to calculate the Goodwill or Capital Reserve. Prepare Journal Entries in the books of R. Robin assuming that he settled the account by cash on 01.01.1998

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Assets

Q 3.The following Balance Sheet is taken from the books of l. Lawrence on 01.01.1998 on which date he decided to sell his business-

Fixed Assets
Premises Fixtures & Fittings Motor Van

Liabilities Capital 1 00 000Creditors 7 000 4 000 13 000 10 000 4 300 1 38 300

$ 1 26 300 12 000

Current Assets
Stock Debtors Bank

1 38 300

T. Terry decided to purchase the above business and take over all the assets and liabilities except bank balance on the revaluations of the following assets. Premises Stock Furniture & Fittings $ 1 05 000 $ 11 000 $ 5 000

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1995 1996 1997 $ 10 000 $ 12 000 $ 14 000 On 01.01.1998 T. Terry deposited $ 1 55 000 into the business bank account as Capital and settled the business purchase price by cheque. You are required to: a) b) c) Calculate the business purchase price Pass Journal Entries in the books of T. Terry Prepare his Balance Sheet after the purchase transactions are over

T. Terry has to pay an additional amount as Goodwill, which is equal to 2 years purchase of average of past 3 years profits which were:

Q 4. M. Mortan decided to purchase the business of R. Rocky on 01.01.1997. He deposited into the business bank account an amount of $ 80,000, out of which $ 30,000 he borrowed from a bank. The Balance Sheet of R. Rocky on 01.01.1997 was as shown below. Assets Premises Fixtures Stock Debtors Bank $ 50 000Capital 10 000Creditors 9 000 4 000 1 250 74 250 Liabilities $ 60 050 14 200

74 250

It was agreed that:a) M. Mortan should take over all the assets, except the balance at bank, and all liabilities but that the following assets should be revalued: Premises Stock $ 55000 $ 8550

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1994 1995 $ 12500 $ 13000

b) M. Mortan should pay an additional amount equal to the average profit of R. Rockys business over the last three years. The profits were:

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1996

$ 15000

The sale was completed on 01.01.1997 and the payment was made by cheque. (I) Calculate the amount paid for the business by M. Mortan purchase of R. Robbins

(II) Show the Journal Entries necessary in M. Mortans books to record the business.

(III) Assuming no other transactions except the settlement of the business purchase price, calculate M. Mortans working capital.

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Liabilities Capital Creditors Bank Overdraft $ Assets 1 09 300Land 12 000Buildings 4 200Furniture Fittings Stock Debtors Cash in hand 1 25 500 $ 50 000 40 000 7 500 5 000 12 500 10 000 500 1 25 500

Q 5. Sanal is the owner of a business. His Balance Sheet on 01.01.1998 was as follows.

Amal is also a businessman carrying on a similar business concern. His balance sheet on the above date appeared as follows:

Liabilities Capital Creditors

Amount 110500Land 25000Building Fixtures Stock Debtors

Assets

Amount 70000 30000 7000 12000 10000 2500 4000

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Cash in hand Cash at bank 135500 135500 Amal decided to purchase the business of Sanal on the following conditionsa) b) $ Land Furniture Buildings Fittings Stock Debtors Creditors c) 57 000 7 000 38 000 4 000 13 000 Book value less 1 000 as bad debts 12 200 Amal will take over all the assets and liabilities except bank overdraft and cash in hand. Sanal revalued the assets and liabilities as follows:

The purchase price is fixed at 130800.

d) Amal has to pay an additional amount equal to the average of Sanals Business over the past 3 years profit. The profits were:1995 $ 20 000, 1996 $ 15 000, 1997 $ 10 000.

Amal took a loan from the bank $ 75 000 and the balance amount of business purchase price he arranged from his private property and deposited the amount in the business bank account.. On 01.01.1998 he settled the Business Purchase Price. Required toi) ii) Calculate the Goodwill Prepare the journal entries including the bank transactions

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iii) Prepare the business purchase account Prepare Amals revised balance sheet after the purchase transactions have been completed. Incoming search terms:

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accounting entries for acquisition of a business journal entry goodwill account and capital reserve journal entry for purchase of business how is a business purchase accounting entries business purchase accounts acquisition of business accounting entries acquisition of a company journal entry accounting for the purchase of a business accounting for purchase of new business accounting for purchase of a business

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