Acquisition Of Business & Profit Prior To Incorporation

Acquisition of Business

• A company may be formed either to start a completely new business or to acquire an existing business.

• Important Terms: - Purchase Consideration: The term purchase

consideration refers to the amount payable by the purchasing company to the vendor of the existing business.

Acquisition of Business• There are two important methods for

calculating the purchase consideration:- Net Assets Method: According to this method the purchase consideration is arrived at by adding up the various assets taken up at their market value less the amount of liabilities taken over by the purchasing company. For example if the values of the assets taken over amounts to Rs.1 lakh while the liabilities are Rs.20000, the net assets of the business is Rs.80000.

Acquisition of Business- Net Payment Method: According to this

method, the purchase consideration is arrived at by adding up the various amounts which the purchasing company agrees to pay to the vendor.

For example if the purchasing company agrees to pay Rs.10000 in shares Rs.5000 in debentures and Rs.3000 in cash. The purchase consideration will amount to Rs.18000.

Acquisition of Business• Goodwill: In case of acquisition of business by

a company if the amount of purchase consideration is more than the amount of net tangible assets acquired by the company, the excess amount so paid is considered as goodwill. For e.g. if a company pays a sum of Rs.1 lakh for net tangible assets of Rs.80000, it will be presumed that Rs.20000 has been paid by the purchasing company to the vendor for goodwill.

Acquisition of Business• Capital Reserve: Capital reserve represents

the amount of capital profit made by the business. In case the value of net tangible assets acquired by the business is more than the purchase consideration, the profit so made is a capital profit which will be transferred to capital reserve in the books of purchasing company.

Acquisition of Business

• Preliminary expenses: Preliminary expenses refer to those expenses which are incurred in connection with formation of joint stock company. These comprise the expenses incidental to the creation and flotation of a company. Example- Stamp duty, registration charges, legal expenses etc.

Acquisition of Business• Pre-operative Expenses: Pre-operative

expenses are those expenses which are incurred after formation of a company till the time company comes to a revenue earning capacity.

- Financial prudence requires that instead of charging the entire amount to a profit and loss account this could be carried over to subsequent years under the heading miscellaneous expenditure.

Accounting Entries

• For purchase of business: Business Purchase A/c Dr. To Vendor A/c(with the amount of purchase consideration)• For assets and liabilities taken over: Assets taken over Dr. To liabilities taken over To Business purchase A/c

Accounting Entries

• For payment to vendor: Vendor Dr. To Share Capital A/c To Securities Premium A/c To Debentures A/c To Bank A/c(with the respective accounts)

Accounting Entries• In case the purchasing company does not take

over the debtors and creditors but simply agrees to act as an agent of the vendor for collection from debtors and making payment to the creditors.

• Vendor’s Debtors A/c To Vendor’s suspense A/c(with the book value of debtors to be collected)

• Vendor’s Suspense A/c Dr. To Vendor’s creditors A/c(with the book value of creditors to be paid)Bank A/c (with actual amount collected) Dr.Vendors Suspense A/c (with the loss in collections) To vendor’s debtors A/c• Vendor’s Creditors A/c (with actual amount paid) Dr. To Bank A/c To Vendors Suspense A/c (with the profit made on payment)

• In case the purchasing company does not make payment to the vendor at an agreed time, the vendor is entitled to get interest for the delayed payment. The entry will be:

Interest to vendor A/c Dr. To Bank A/c