5

Acquisition of Business (Purchase of Business)

In corporate world, a limited company, in its later life, may acquire or purchase an existing business. The existing business may be in the form of sole proprietorship or of partnership or of a limited company. Such a process of acquiring or purchasing the business of others is termed as “acquisition of business” or “purchase of business”. In this chapter, the accounting treatment for “acquisition of business” or “purchase of business” is discussed in detail.

5.1 FACTORS ASSOCIATED WITH ACQUISITION OF BUSINESS

Some important factors associated with “acquisition of business” are explained as follows:

Purchase: The company which acquires or purchases the business of others is known as purchaser.

Vendor: The organization which sells its business is known as the vendor.

Purchase consideration: Purchase price paid by the acquiring company is called “purchase consideration”. The purchase price or purchase consideration will be discharged in the form of shares or debentures or cash.

5.2 DETERMINATION OF PURCHASE CONSIDERATION

Generally, the purchase price is determined at the time of negotiation and shown in the agreement itself (That means it will be given in the question itself.). If it is not given in the question, the methods of determining the purchase consideration are given in the following:

5.2.1 Method 1—Net assets method

Under this method, the purchase consideration is ascertained by adding up the assets taken over by the purchasing company minus the total amount of liabilities taken over.

 

At this juncture, one has to understand and distinguish between the types of assets taken over by the purchasing company and the types of assets not to be taken over by the purchasing company.

Assets to be taken over by the purchasing company: In the absence of a contract to the contrary, the purchasing company takes over the following assets:

1. Land & Buildings
2. Fixtures & Furniture
3. Machinery & Plant
4. Stock in trade
5. Book debts
6. Cash & Bank Balance

The following assets are not taken over by the purchasing company:

1. All fictitious assets
2. All pre-paid expenses
3. P&L A/c (Debit balance)
4. Miscellaneous expenses such as discount on shares/debentures, underwriting commission, etc.

Similarly, only the external liabilities of the selling concern are undertaken by the purchasing company.

But, the internal liabilities of the selling concern such as share capital, reserve fund and undistributed profits are not to be taken by the purchasing company.

To illustrate, the balance sheet of M/s X & Y is as follows: (B/S of selling concern, i.e., vendor):

Under the net assets method, purchase consideration is computed as follows:

 

Purchase consideration	= Various assets − Various liabilities
	= 10,10,000 − 2,00,000 (creditors)
Net assets	= 8,10,000

 

In the absence of any agreement, purchase consideration will be 8,10,000. Goodwill not included and X & Y loan and share capital are excluded.

Suppose if the company pays 7,50,000 for the business in a lump sum for net assets worth 8,10,000, then the difference is treated as capital reserve.

In case the lump sum amount is not settled, then it will be equal to the net assets, including goodwill.

In case the company agrees to take over all the assets but no liabilities, purchase price will be 11,10,000.

If the company agrees to pay creditors, then the company will have to pay 11,10,000 – 2,00,000 = 9,10,000

Or, if the company agrees to take over partner’s loan, then it will have to pay 9,10,000 – ( 1,50,000 + 2,50,000), i.e. 5,10,000 only.

Important note

Net tangible assets 8,10,000 exceeds the purchase consideration 7,50,000. Hence, the difference ( 8,10,000 – 7,50,000) 60,000 is to be treated as capital reserve and that amount ( 60,000) is to be credited to capital reserve A/c. (Debits exceed credits)

5.2.2 Method II—Net payment method

Under this method, purchase consideration is determined according to the terms and conditions of purchase agreement, i.e., which assets to be taken over and at what value, which liabilities to be taken over.

 

Important note

If the value of the net asset is less than the purchase price agreed to be paid, then the difference is treated as goodwill and that amount has to be debited to goodwill account. (Credits exceed debits)

For determining “capital reserve” or “goodwill”, balance sheet figures of the selling concern (vendor) SHOULD NOT be taken into account. But it should be based ONLY on the figures at which the company records in its books.

5.3 ACCOUNTING ENTRIES

5.3.1 When New Set of Books is Opened

5.3.1.1 Entries in the Books of the Purchasing Company

The following are the entries to record the acquisition of business:

Illustration 5.1

Swetha Ltd. was formed with an authorized capital of 20,00,000 divided into equality shares of 10 each, to acquire the business of L&M whose balance sheet on the date of acquisition was as follows:

The purchase price was agreed upon at 23,00,000 to be paid in 20,00,000 fully paid equity shares at 11 and the balance in cash.

You are required to record the above and prepare the balance sheet of Swetha Ltd. assuming the vendor’s account is finally settled.

Solution

 

Illustration 5.2

Mythali Ltd. was formed to take over the assets and liabilities of Mr. Ajay and to acquire the adjacent premises.

The balance sheet of Mr. Ajay on 31 March 2011 was as follows:

The purchase consideration was agreed at 6,00,000 and was to be paid as follows:

1. 4,800 equity shares of 50 each
2. 3,200, 10% preference shares of 100 each issued at par
3. 40,000 in cash.

All the assets and liabilities were valued as per the above balance sheet except the book debts which were subject to a bad debts provision of 10%.

The company raised further capital by issue of 15,000 equity shares of 50 each.

The adjoining premises were purchased for 1,00,000 and additional stock for 50,000 was got from open market.

You are required to record the above transactions in the books of Mythali Ltd. through journal entries and draft its opening balance sheet.

Solution

5.3.1.2 Accounting Entries in the Books of the Vendor

When the partnership firm is dissolved on account of conversion of firm into a limited company or purchased by a limited company, the following entries have to be passed in the books of the vendor:

 

Illustration 5.3

Model: Accounting entries in both the books of purchasing company and vendor.

Doss Ltd. was formed with a nominal capital of 20,00,000 consisting of 1,00,000 equity shares of 20 each and 6,000 preference shares of 100 each to acquire on 1 April 2011, the business of Yoga & Co.

Yoga’s balance sheet as on 31 March 2011 was as follows:

The Company took over all the assets and assumed all the liabilities and the consideration was fixed at 13,00,000.

In computing this figure, Land & Buildings were valued at 7,00,000; Plant & Machinery at 2,00,000; Stock at 1,90,000; and debtors at book value subject to an allowance of 5% to cover bad debts. The transfer of the bank overdraft to the company was agreed by the bank on condition that debentures for 1,50,000 were issued to the bank as collateral security.

The purchase price was settled by issue of 50,000 equity shares of 20 each at par, 2,000 preference shares of 100 each and the balance being paid in cash. Doss Ltd. paid the preliminary expendes of 20,000.

You are required to record journal entries in the books of Doss Ltd. and Yoga & Co.

 

5.3.1.3 Debtors and Creditors Taken Over on Behalf of the Vendors

The purchasing company generally does not take over the debtors and creditors belonging to the vendor. The simple reason is that all book debts may not be realized and payment to creditors may not be accurately ascertained. From the vendor’s viewpoint, it is an arduous task for him to realize the book debts and clear off the creditors once they sell their business concern. To overcome this position, the vendor authorizes the purchasing company for realizing book debts and discharging creditors. The vendor agrees to pay certain quantum of amount for such services to be rendered. If any loss or profit will arise in the process, it will belong to the vendor. Purchasing company opens a vendor’s suspense account for this purpose.

For this process, the following are the journal entries to be passed in the books of the purchasing company:

Illustration 5.4

Model: Collection and payment of vendor’s debtors and creditors

On 1 October 2010, Brilliant Ltd. purchased the business of Mr. Bose, a sole trader, taking over all the assets with the exception of book debts amounting to 2,00,000 and creditors amounting to 1,00,000. The company undertook to collect all the book debts and pay off the creditors and for this service, it has to be paid a commission of on the amount collected and % on amounts paid.

The debtors realized 1,80,000, out of which 80,000 was paid to creditors in full settlement. The company was able to collect 8,000 debt which was previously written off as bad by Mr. Bose. The company was also forced to meet a contingent liability of 5,000 on account of a claim against the vendor for damages. The vendor received 20,000, 6% debentures of 100 each at 90 and the balance in cash in settlement of his account with the company.

Journalise the above transactions in the books of the company.

Solution

Illustration 5.5

Model: Debtors and Creditors taken over

Akash Ltd. was incorporated to take over the business of Ganga on and from 1 January 2011. The following is the balance sheet of Ganga as on 31 December 2010:

The company took over the business with the fixed assets and loan creditors on the following basis:

1. Depreciate land and buildings and plant and machinery by 10%
2. The value of goodwill is estimated at 63,000.

The Company realized 48,000 from sundry debtors, as agent of the vendors in full settlement and discharged all the creditors by paying 36,000.

The loan creditors accepted 6% preference shares of 100 in discharge of the loans. On realization of debts and discharge of liabilities, the total amount due to the vendor was settled by issue of fully paid equity shares of 10 each.

You are required to pass the journal entries in the books of Akash Ltd.

Solution

In this question, purchase consideration is not given. As such, it has to be computed first, as follows:

 

Step 1:	Assets at book value:
Add: All	(i) Goodwill (as in question):	63,000
	(ii) Land & Buildings ( 1,40,000 − 14,000) Dep	1,26,000
	(iii) Plant & Machinery ( 80,000 − 8,000)	72,000
	(iv) Furniture ( 10,000 − 1,000)	9,000
Step 2:	Aggregate of Assets:	2,70,000
Step 3:	Less: Creditors taken over (Loan):	1,20,000
*1Step 4:	Purchase Consideration:	1,50,000

 

Illustration 5.6

Model: Debtors and creditors taken over by the Company

Sun Ltd. acquired the business of Moon Agencies, whose debtors and creditors were taken over by the Company for collection and payment for a commission of 10% on all amount collected and 2% on amount paid. The debtors amounted to 4,50,000 and creditors to 2,20,000. There was a contingent liability of 60,000

The Company collected one-third of debtors in full, 50% of debtors at 4% discount, two-thirds of the balance at 6% discount and the remaining proved bad. A debt of 30,000 written off by the vendor in the past was collected at 80% but court expenses for that amounted to 6,000 of which 2,000 only could be recovered from the debtor.

20,000 of creditors were paid in full and the balance was paid at 97%. The contingent liability came up for payment at 40,000.

The Company settled its account with the vendor in cash. You are required to pass journal entries in the books of Sun Ltd.

Solution

(i) Amount collected from debtors has to be determined first as follows:

(ii) Amount paid to creditors is to be determined as under:

(iii) Total Commission	= 10% on total collections + 2% on total payments
	= *143,300 + *25,080
	= 48,380

 

Approach 2: When vendor’s debtors and creditors are not taken over by the purchasing company, it may be treated by an alternative method, which is described as follows:

 

Note

Balance in vendor’s debtors A/c will be equal to that of debtor’s suspense A/c.

Similarly, balance in vendor’s creditors A/c will be equal to that of creditor’s suspense A/c.

Illustration 5.7

On 1 April 2011, a company bought certain assets from Milton. The company also undertook to collect his debts amounting to 65,000 and to pay his creditors for 15,000 for a commission of 5% on amounts collected and 1% on amounts paid. The debtors realized only 60,000 out, of which 14,000 was paid to creditors in full settlement. Milton received 20,000 in 12% debentures at 90 and the balance in cash Journalise.

Solution

5.3.2 When the Same Account Books (Set of Books) are Continued

So far, we have discussed the accounting treatment when the purchasing company starts new books of account. Now we are going to discuss the purchasing company’s decision to continue the same books of account as where being maintained by the seller.

The following steps are to be followed when the purchasing company decides to continue with the same set of books.

 

Step 1:	In case the assets and liabilities are to be undertaken by the purchasing company, assets and liabilities are to be revalued. Profit and loss adjustment has to be prepared, and the balance (profit or loss) has to be transferred to capital accounts of partners in their old profit sharing ratio (or shareholder’s account, if the vendor is a company).
Step 2:	In case a certain asset or liability is not taken over by the purchasing company, they have to be transferred to the capital accounts of partners in profit sharing ratio. A separate bank account has to be opened if the vendor is a company, the assets not taken over by the purchasing company will be realized and the liabilities not taken over by the purchasing company will be paid.
Step 3:	Any balance of accumulated or undistributed profits or reserves will have to be transferred to capital accounts in profit sharing ratio.
Step 4:	The capital accounts are closed by debiting the capital accounts of partners (or shareholders’ A/c) and crediting share capital account (for shares issued), debentures A/c (for debentures issued) and bank A/c (for cash paid).

 

Important note

No entries are necessary to close the books of the vendor; to open the books of purchasing company.

 

Step 5:

A revised balance sheet has to be prepared by incorporating the above adjustments. Accounting treatment for debtors and creditors not taken over when same set of books are continued:

1. Debtor’s and creditor’s account must not be closed
2. Separate accounts have to be opened:
   1. Debtors suspense A/c and
   2. Creditors suspense A/c

   Other Important entries:

Illustration 5.8

Model: Continuation of same set of books

A and B carrying on business in partnership, sharing profits and losses in the ratio of 2:1 decide to dissolve the firm and sell the business to a limited company on 31 March 2011, the balance sheet of the firm stood on that date as follows:

XYZ Ltd. was registered with an authorized capital of 50,00,000 in equity shares of 100 each to acquire the above business on the following terms:

1. Goodwill is valued at 3,75,000
2. Furniture and stock valued at 72,500 and 8,75,500, respectively
3. Debtors are subject to provision.

Motor vehicle is no more required by the company and A took over at 1,10,000.

The purchase price was satisfied by the issue of shares of 100 each at par.

You are required to pass journal entries and prepare balance sheet of XYZ Ltd. assuming that the same set of books is continued.

Solution

Illustration 5.9

Model: Debtors and creditors not taken over when same set of books is continued

Jasemine Ltd. purchased the business of Mr. Rattan. Jasemine Ltd. did not take over the debtors and creditors of Mr. Rattan amounting to 1,00,000 and 70,000, respectively, but promised to collect from debtors and pay to creditors.

Jasemine Ltd. collected all debts at a discount of 2,500 and a bad debt of 1000 and paid all creditors at a discount of 1,500. Show the entries assuming the set of books is continued.

Solution

WORKING NOTE:

 

Calculation of amount due to vendor on final settlement:
Amount received from debtors ( 1,00,000 – 2,500 – 1,000):	96,500
Less: Amount paid to creditors ( 70,000 – 1,500):	68,500
Net amount due to vendor:	28,000

 

FOR PROFESSIONAL COURSES

Illustration 5.10

Sowmya Ltd. was formed on 1 April 2010, with an authorized capital of 35,00,000 divided into 25,000 equity shares of 100 each and 10,000 preference shares of 100 each, to acquire the business of Bhama as a going concern. The balance sheet of Bhama as at 31 March 2011 was as follows:

The purchase consideration was to be discharged by Sowmya Ltd. by issue of 7,500 equity shares of 100 each, 2500 preference shares of 100 each and 1,00,000 in cash. Sowmya Ltd. also agreed to discharge the sundry creditors but declined to accept X’s loan. All the assets of the old company were taken over at their balance sheet values except stock which was valued at 2,00,000. A provision of 5% was also created against sundry debtors.

To provide necessary working capital and to pay to purchase consideration, the remaining equity shares were issued at a premium of 10% and the cash was duly received. The preliminary expenses amounting to 75,000 were paid by the Company immediately after the issue.

Show the opening entries in the books of Sowmya Ltd. and also the opening balance sheet.

 

[I.C.W.A. Modified]

Solution

STAGE 1: In this question, purchase consideration is not given directly. So, it has to be determined as follows:

 

(i) Equity shares to be issued: 7,500 × 100	= 7,50,000
(ii) Preference shares to be issued: 2,500 × 100	= 2,50,000
(iii) Cash to be paid	= 1,00,000
(iv) Purchase consideration (Add: i + ii + iii)	= 11,00,000

 

STAGE 2: Passing of Journal Entries

 

STAGE 3: Cash at bank (closing balance) has to be calculated by preparing cash at bank A/c as follows:

STAGE 4: Preparation of Balance Sheet

 

Illustration 5.11

A company was formed with an authorized capital of 10,00,000 divided into 50,000 equity shares of 10 each and 50,000 preference shares of 100 each to acquire the going concern of Mohan whose balance sheet stood as follows:

The purchase price was agreed upon at 3,50,000 to be paid; 1,00,000 in fully paid equity shares, 1,00,000 in fully paid preference shares, 60,000 in redeemable debentures and the balance in cash. The company did not take over the insurance policy, valued the stock and plant and machinery at 10% less than the book value and the freehold premises at 20% move than the book value. The liabilities will be discharged by the company.

The balance of both kinds of shares was issued to and paid up by the public with the exception of 1,200 equity shares held by Sommath on which he did not pay the last call of 3 per share and which were subsequently forfeited and reissued at a discount of 20%.

Give journal entries to record the above and prepare the balance sheet of the company.

Solution

Illustration 5.12

On 31 March 2011, the following was the balance sheet of a firm:

On 1 April 2011, the firm was converted into a limited company on the following terms:

1. Debtors and creditors of the firm were not to be taken over as well as the cash balances.
2. Assets were revalued as to furniture at 24,000; Plant & Machinery at 3,20,000 and the building at 2,80,000
3. Preliminary expenses amounting to 16,000 were disbursed by the firm to be recovered from the company.
4. As purchase consideration, the partners were to be allotted at par 10,400 equity shares of 100 each. They were also entitled to receive 1,60,000 in cash.

Given journal entries and submit the balance sheet as at 1 April 2011, of limited company, assuming the authorized capital to be 16,00,000 made up wholly of equity shares of 100 each.

 

[I.C.W.A. Modified]

Solution

STAGE 1: As purchase price is not given directly, we have to calculate purchase consideration first.

 

Equity shares: 10,400 × 100	10,40,000
Cash	1,60,000
∴ Purchase price	12,00,000

 

STAGE 2:

STAGE 3: Preparation of Balance Sheet

 

Illustration 5.13

The balance sheet of Guber was as follows:

 

On 15 July 2011, Singh Ltd. was incorporated, taking over all the assets (except debtors) and the liability for loans; interest @ 12% p.a. on the purchase price to be allowed to the vendors from 1 April 2011 to the date of completion. The credit balance of Guber’s capital to be satisfied by the issue of equity shares in Singh Ltd.

The loan holders accept 14% preference shares in discharge of their debts. The company, as agent for vendor, agrees to collect the debts, which realize ultimately 1,260,000 out of which they pay, as agent for the vendor, the creditors at the net figure shown in the balance sheet. Of the balance, they paid an account to Guber the sum of 2,00,000; the amount remaining undrawn by Guber, including interest, to be discharged in the form of 5,00,000 debentures at 96 and cash. The new company is entitled to all intervening profit (i.e., between 1 April 2011 and 15 July 2011).

Show the opening entries of Singh Ltd. and closing entries of Guber in respect of the above, assuming that the date of completing is 31 August 2011. Ignore Income Tax.

 

[C.A. (Final). Modified]

Solution

In this question, journal entries have to be passed in the books of Singh Ltd. and Guber.

First, journal of Singh Ltd. is prepared as follows:

 

Illustration 5.14

The following was the balance sheet of L&M as on 31 December 2010:

On 1 January 2011, the above business was purchased by Gopal Ltd. for 13,00,000 to be paid by the issue of equity shares of 100 each credited at 50 paid upon the following terms:

1. Land & Building and Plant & Machinery to be taken at 5,00,000 and 2,00,000, respectively.
2. The company did not take over the furniture which were disposable at 25,000 and did not take bills payable which were taken over by L at an agreed value of 90,000.
3. A provision for doubtful debts was to be made at 2% on debtors.
4. There was a claim for bills discounted amounted to 10,000 which was taken by the company.
5. The company did not take over a workers claim amounted to 10,000 due to accident.

Show the entries in the books of Gopal Ltd. assuming that same set of books is continued.

Solution

Note

When same set of books is continued and entries to be recorded in the books of company, goodwill has to be computed separately as follows:

Determination of goodwill:

Computation of final Claim Ratio:

 

	L	M
Balance b/d (Given)	7,00,000	3,00,000
Bills Payable	90,000	—
Goodwill	70,500	70,500
	8,60,500	3,70,500
Add: Revaluation
Profit:	42,000	42,000
Final Claim :	9,02,500	4,12,500
Ratio: L:M	= 9,02,500	412,500
	= 902:412
	= 451:206

 

When a company acquires or purchases the business of others, it is termed as purchase or acquisition of business. Seller concern may be a sole trader, or a partnership firm or an already functioning limited company.

Accounting treatment

Method I: When new set of books is opened, factors to be considered are (i) Assets taken over by the purchasing company; (ii) Liabilities taken over by the purchasing company and (iii) Purchase consideration.

(a) Net assets method and (b) Net payment method are the methods used to determine purchase consideration.

Goodwill: When the value of net assets is less than the purchase considerations, the difference is debited to goodwill account capital reserve: When the value of net assets is more than the purchase consideration, the difference is credited to capital reserve A/c.

The journal entries for various transactions which have to be passed in the books of purchasing company and in the books of the vendor: Refer text.

Method of dealing with debtors and creditors is dealt with in illustrations. (Ref: Illustrations 5.1 to 5.9)

Method II: When same set of books is continued, the important steps involved in accounting treatment are discussed in detail (Ref: The text and Illustrations 5.9 to 5.14)

Acquisition of Business (Purchase of Business): The process of taking over the business of sole trader or firm or an already existing company by a limited company.

Purchaser: The company which acquires the business of others.

Vendor: The selling business concern in the process of acquisition of business.

Purchase Consideration: The purchase price paid by the limited company to the selling concern.

QUESTION BANK

 

I: State whether the following statements are true or false

1. In the absence of a contract to the contrary, miscellaneous expenses are also taken over by the purchasing company.
2. In the absence of a contract to the contrary, the purchasing company will not take over the liabilities that belong to the shareholders.
3. As purchase consideration must always be given in the question, no need to compute it arises.
4. Purchase consideration must be paid in cash only.
5. When the value of net assets is less than the purchase price, the difference has to be credited to goodwill A/c.
6. Profit at the time of acquisition, if any, has to be credited to capital reserve A/c.
7. When interest is paid on purchase price, interest account is to be debited.
8. Purchasing company is paid commission for realizing book debts and discharging liabilities by the vendor.
9. Any profit or loss that will arise in collecting debts and paying creditors must be borne by the purchaser.
10. When debtors and creditors are taken over on behalf of vendors, the debtors and creditors will be included with the main entries for acquisition of business, in the books of purchasing company.
11. When the same set of books is continued, realization A/c has to be opened.
12. When discount is allowed to vendor’s debtors, it will be debited to vendor’s suspense A/c

Answers:

1. False
2. True
3. False
4. False
5. False
6. True
7. False
8. True
9. False
10. False
11. True
12. True

II: Fill in the blanks with apt word(s)

1. In the process of acquisition of business, newly formed limited companies purchase the business of_____or_____form of business concerns.
2. The seller concern is termed as_____in the acquisition of business.
3. Purchase price paid by the purchasing company to the selling business concern is known as_____.
4. _____assets are not taken over by the purchasing company.
5. All_____lliabilities are taken over by the purchasing company.
6. When the value of net assets is less than the purchase price, the difference is debited to_____A/c.
7. When the value of net assets is more than the purchase price, the difference is credited to_____A/c.
8. When debtors and creditors are taken over on behalf of vendors by the purchasing company, it has to open_____A/c in the books.
9. When the same set of books is continued_____, and_____A/c should not be closed.
10. When the same set of books is continued, a separate account for debtors should be opened under the head_____A/c.
11. The purchasing company_____the vendor’s A/c with the purchase price at the time of acquisition.
12. When shares or debentures are issued at a premium, _____ A/c has to be credited with premium amount.

Answers:

1. sole trader or firm
2. vendor
3. purchase consideration
4. Fictious
5. external
6. goodwill
7. capital reserve
8. vendor’s suspense
9. debtors; creditors
10. debtor’s suspense
11. creditors
12. securities premium

III: Multiple choice questions—Choose the correct answer

1. On acquisition of business, which of the following item is not taken over by the purchasing company (in the absence of contract):
   1. profit and loss A/c (debit balance)
   2. cash balance
   3. bank balance
   4. none of these
2. On purchase of business, which of the following is taken over by the purchasing company (in the absence of agreement):
   1. share capital
   2. external liabilities
   3. reserve fund
   4. undistributed profits
3. The accounting treatment with respect to acquisition of business will be by using
   1. when new set of books is opened
   2. when the same set of books is continued
   3. a & b
   4. none of these
4. Purchase consideration can be paid by the company in
   1. shares
   2. debentures
   3. cash
   4. all of the above
5. Goodwill A/c will be debited with the difference amount
   1. when the value of net assets is less than purchase price
   2. when the value of net assets is greater than purchase price
   3. a & b
   4. none of the above
6. If the interest is due on the purchase price, the account to be debited is
   1. vendor’s account
   2. bank A/c
   3. interest A/c
   4. vendor’s suspense A/c
7. Any profit or loss arising on account of realizing book debts and discharging creditors will be borne by
   1. the purchasing company
   2. the vendor
   3. a & b
   4. none of these
8. The excess of net assets over purchase consideration is
   1. goodwill
   2. net loss
   3. capital reserve
   4. balance in suspense A/c
9. When debtors and creditors are taken over on behalf of vendors, the account to be opened by the purchasing company in its books is
   1. debtor’s suspense A/c
   2. creditor’s suspense A/c
   3. a & b
   4. vendor’s suspense A/c
10. When the same set of books is continued, amounts realized from the proceeds of assets taken over by partners will be distributed in the ration of
    1. profit sharing
    2. capitals
    3. 1:1 (equal)
    4. final claim

Answers:

 

1. (a)	2. (b)	3. (c)	4. (d)
5. (a)	6. (c)	7. (b)	8. (c)
9. (d)	10. (d)

 

1. Explain the term “acquisition of business”.
2. Name the two approaches for accounting treatment relating to purchase of business.
3. Name the assets not taken over in the absence of an agreement.
4. In the absence of a contract to the contrary, name the liabilities which are not taken over by the purchaser.
5. How “goodwill” will be computed?
6. How “capital reserve” will be determined?
7. What do you mean by “vendor’s suspense A/c”?
8. Name the two accounts that should be opened for debtors and creditors (not taken over) when the same set of books in continued.

1. Explain the meaning of “acquisition of business”. What do you mean by conversion? What are the reasons for such conversion?
2. Explain in detail the important factors which are to be taken into account, when new set of books is opened?
3. Enumerate the journal entries that are to be passed by the purchasing company in its books on acquisition of business, when new books are opened?
4. What are the journal entries that are to be passed in the books of vendor in the process of acquisition of business when new books are opened?
5. Explain the accounting treatment for “debtors and creditors not taken over by the purchasing company,” when new books of account are opened?
6. Explain the important steps to be taken when the same set of books will be continued after acquisition process.
7. What are the necessary journal entries to be passed when the same set of books is continued?
8. Explain the accounting treatment for debtors and creditors not taken over by the purchasing company when the same set of books is continued.

 

 

1. X Ltd. was registered with a capital of 50,00,000 consisting of 25,000 equity shares of 100 each and 25,000 14% preference shares of 100 each. It purchased the going concern of M/S Tom & Dick for 12,50,000 on the basis of the following balance sheet:

 

The purchase price was to be paid: 2,50,000 in fully paid equity shares; 2,50,000 in fully paid preference shares, 2,50,000 in fully paid debentures and the balance in cash. The remainder of the shares were offered to the public payable 20 per share on application, 30 on allotment and 40 on first call and were taken up and paid for. The vendors were duly paid the purchase consideration.

Record the above transactions by means of journal entries and draw up the company’s balance sheet.

[Ans: Goodwill: 1,50,000; Final call not yet made;

Balance sheet total: 52,95,000]

2. Ajay & Co. Ltd. was incorporated to acquire the business of Vivek whose balance sheet was as follows:

The purchase consideration was agreed at 6,00,000 which was to be paid as:

1. 16,800 equity shares of 20 each
2. 2,04,000 in preference shares of 100 each and
3. the balance in cash

The company raised further capital by issue of 45,000 equity shares of 20 each payable 10 on application and 10 on allotment. After receipt of all the money for shares issued, the company purchased buildings worth 4,80,000. Pass journal entries in the books of the company and prepare the balance sheet.

[Ans: Goodwill: 1,20,000; Balance sheet total: 14,64,000]

3. A company was formed with an authorized capital of 30,00,000 divided into 1,50,000 equity shares of 100 each, 15,000 9% preference shares of 100 each to purchase the going concern of M/s Raju & Co. the balance sheet of which stood as follows:

The purchase price was agreed up on at 10,50,000, payable as to 3,00,000 in fully paid up equity shares, 3,00,000 in fully paid preference shares, 1,80,000 in redeemable debenture and the balance in cash.

The remaining shares were issued to and paid for by the public with the exception of 30 per share on 360 equity shares which were forfeited and reissued at a discount of 20%.

Give journal entries to record these transactions in the books of the company and prepare the initial balance sheet.

[Ans: Goodwill: 2,57,400;

Balance sheet total: 32,57,400]

4. The balance sheet of A, B and C stood as under when they sold off their concern to newly started joint stock company:

The joint stock company was started with a capital of 20,00,000 divided into 10,000 shares of 200 each. It also issues debentures for 10,00,000 at a discount of 5%. The entire concern of A, B and C was taken up by the company on agreeing to pay them 9,60,000 by the issue of 2,400 shares fully paid and 4,80,000 in cash.

All the debentures and the remaining shares are issued to the public which are all taken up and paid for with the exception of 1,000 shares held by X on which he has not paid the final call of 80 per share which were forfeited and reissued as fully paid at a discount of 40 per share. The company paid 10,000 for preliminary expenses.

Pass the necessary journal entries in the books of the company and prepare its balance sheet.

[Ans: Goodwill: 60,000; Capital reserve: 80,000;

Balance sheet total: 31,60,000]

5. On 1 April 2011, a company has bought certain assets from Raghu. The company also undertook to collect his debts amounting to 7,80,000 and to pay his creditors of 1,80,000 for a commission of 3% on the amount collected and 1% on the amount paid. The debtors realized 7,20,000 only and the creditors were paid 1,68,000 in full settlement. Raghu received 3,00,000 8% debentures at 90% and the balance in cash.

Journalise the transactions in the books of the company

[Ans: Commission due from vendor: 23,280; Cash paid to vendor: 2,58,720]

6. On 1 January 2011, Vincent Ltd. acquired the business of Sagar taking all the assets with the exception of book debts which it undertook to collect on behalf of Sagar and out of the proceeds pay the liabilities owning at the date of transfer. At that date, the book debts amounted to 2,70,000 and creditors 1,85,000. The company agreed to do the job for vendors on 3% commission on amounts collected and 1% on amount paid.

The company could not collect 14,000 from the existing debtors and allowed 1,500 as cash discount to the remaining debtors. The company could collect the time-barred debt (which was written off as bad by the vendors) of 10,000. The company paid 1,75,000 to creditors in satisfaction of total amount due. However, the company was forced to meet a contingent liability on bills discounted by the vendors of 15,000. Give journal entries (including that of cash) in the books of Vincent Ltd.

[Ans: Commission: 9,835;

Final payment to vendors: 64,665]

7. A and B are in partnership in computer components manufacturers. The balance sheet of A and B as on 31 December 2010 was as follows:

They decided to sell their business as from the above date to Chips Ltd. The Company acquires the stock, plant, Land & Buildings and goodwill for which the vendors receive 15,00,000 in fully paid up equity shares of 100 each. The Company agrees to pay creditors and collect the book debts on behalf o the vendors for a commission of 3% on cash collected and 2% on amounts paid.

By March 2011, the creditors have all been paid and the amount so paid is 2,76,300. Also, the book debts have all been collected or accounted for and have realized 5,21,300. Accordingly on 31 March, the vendors were paid the balance which the company holds to credit. Pass the journal entries in the books of the company and show the vendor’s suspense account.

[Ans: Commission: 21,165; Final payments to vendors: 2,23,835]

8. M/s Anju & Manju carrying on business in partnership decided to dissolve the firm and sell off the business to a limited company, a newly floated one, on 31 December 2010, when the firm’s position was as follows:

The arrangement with the limited company was as follows:

1. Furniture and stock were purchased at balance sheet values less 10%.
2. Goodwill of the firm was valued at 1,21,440.
3. The firm’s debtors, cash and creditors were not to be taken over by the company, but the company agreed to collect the book debts and discharge the liabilities of the vendor as agent, for which service the company was to be paid 3% on all collections from the vendor’s debtors and 2% cash paid to vendor’s creditors.
4. The purchase price was to be paid to the company in fully paid ordinary shares of 50 each at a premium of 10 per share

The company received 5,76,000 from vendor’s debtors in full satisfaction during the first 2 months after purchase of business. The creditors were paid off, 3,000 being allowed by them as discount. The company paid the balance due to the vendors on 1 March 2011. (Ignore the question of in term distribution of cash.)

Write up journal entries and balance sheet in the company’s books.

[Ans: Purchase consideration: 3,23,400;

Commission: 22,320;

Purchase price paid: 5388 shares;

Balance sheet total: 3,45,600]

9. AB & Co. is converted into a limited company but the same books of accounts are desired to be continued. The balance sheet with reference to which the conversion has taken place is given as follows:

Goodwill is valued at 12,50,000. Car is taken up by A at an agreed value of 1,50,000. Stock and machinery are valued at 27,50,000 and 17,50,000, respectively.

The partners are issued required number of shares of 100 each at par.

Pass journal entries and draft the Balance Sheet of the Limited Company.

[Ans: Amount payable to A is 38,00,000 and B is 29,50,000;

Balance sheet total: 77,50,000]

10. Sharma and Varma were carrying on business in partnership sharing profits and losses in the ratio 3:2. They sell their business to a limited company on 31 March 2011 and on that date their balance sheet stood as follows:

A limited company having an authorized capital of 30,00,000 in equity shares of 100 each purchased the above business under the following terms:

1. Goodwill was valued at 2,40,000.
2. Depreciation on plant & machinery was @ 10% and appreciation of land & buildings was by 20%.
3. A provision of doubtful debts @ 5% on debtors was allowed.
4. Investment was taken over by Varma at an agreed value of 96,000.
5. Total purchase consideration was to be satisfied by the issue of fully paid equity shares of 100 each.

Show the journal entries and the revised balance sheet assuming that the same set of books is continued.

[Ans: Revaluation loss: 21,000;

Purchase consideration: 10,83,000;

Balance sheet total: 13,23,000]

 

 

11. On 1 January 2010, Patel sells his business to Rao Ltd. The company took over the assets and liabilities for a purchase consideration of 4,25,000 being paid equally in cash and shares of 50 each fully paid up. Patel received 75,000 on account in 2010 from the company but no other entries have been made.

The balance sheet of Patel’s business on the date of sale was as follows:

Fixed assets and stock were to be revalued at 1,25,000 and 1,40,000, respectively.

In addition to matters arising out of the above, there were the following balances in the books of Rao Ltd. as on 31 December 2010:

Stock on hand on 31 December 2010 2,00,000.

Show the needed journal entries in the books of the company to give effect to the above arrangement and prepare the adjusted trial balance P&L A/c of the year ended 31 December 2010 and the balance sheet as at that date of Rao Ltd.

 

[C.A. (Inter). Modified]

[Ans: Goodwill: 40,000; Shares issued for consideration: 2,12,500;

Adjusted trial balance total: 10,49,000;

Gross profit: 1,64,000; Net loss: 16,000;

Balance sheet total: 7,20,000]

[Vendor shown as creditor: 1,37,500]

12. M and N are proprietors of a competing business. In order to protect their business, they float a company called M&N Ltd. with an authorized capital of 30,00,000 divided into 1,80,000 equity shares of 10 each and 12,000 12% preference shares of 100 each.

On the date of the transfer, M’s assets amount to 7,96,050 excluding goodwill. His liabilities at the same time amount to 97,800. On the same date, N’s assets amount to 5,85,000 excluding goodwill and his liabilities to 45,000. It is agreed that the company will take over the assets and liabilities of both M and N and will issue to each 45,000 equity shares fully paid up and pay the balance in cash. It is also agreed that fully paid up preference shares will be issued to them on account of goodwill which is to be valued on the basis of two years’ purchases of the last three year’s profits which are as follows:

 

	M	N
First year	48,000	24,000
Second year	36,000	33,000
Third year	33,000	42,000

 

In addition to the above, the public subscribe and pay in full for 60,000 equity shares and the remaining preference shares. The company also pays 45,000 as preliminary expenses.

You are required to show the vendor’s accounts in the company’s ledger and prepare the balance sheet of the company after these transactions are completed.

[Ans: Total of balance sheet: 28,42,800]

13. The following is the balance sheet of M/s P & Q as on 31 March 2011:

Profits were shared as two-thirds to P and one- thirds to Q. On 1 April 2011, PQ Ltd. purchased the business of M/s P & Q for a payment of 12,00,000 to be made in the form of equity shares of 100 each credited as 80 paid. The company did not take over the investments and Mrs. P’s loan. The company also decided to revalue land and buildings as 5,40,000, plant and machinery at 2,80,000; and to create a provision of doubtful debts at 5% on debtors. There was a claim by a worker for 12,000 for injuries in an accident. The company decided to admit the claim. Out of the investments, 24,000 worth are worthless. Mrs. P. agrees to receive the remaining investments and 2,800 shares of PQ Ltd. in settlement of her loan.

The company decides to retain the books of account of the firm. Journalise.

[Ans: Goodwill: 1,22,000; Revaluation profit: 78,000]

14. The balance sheet of X, Y & Z stood as follows when they sold off the concern to a newly started joint stock company.

The joint stock company was started with a capital of 12,00,000 divided into 12,000 shares of 100 each. It also issued debentures for 6,00,000 at a discount of 5%.

The entire concern of X, Y & Z was taken by the company on agreeing to pay them 2,88,000 by the allotment of 2,880 shares fully paid and 2,88,000 in cash.

All the debentures and the remaining shares are issued to the public which were all taken up and paid for with the exception of 1,200 shares held by Mr. C on which he did not pay the final call of 40 per share which were forfeited and reissued as fully paid as 20 per share. The company paid 6,000 as preliminary expenses.

Pass the necessary entries in the books of the company and prepare the balance sheet.

[Ans: Balance sheet total: 18,96,000]

15. X Ltd. was incorporated for taking over the business of Y from 1 April 2011. The following was the balance sheet of Y as on 31 March 2011:

The company took over the business with fixed assets and loans on the following terms:

1. The fixed assets should be depreciated at 10%.
2. The value of goodwill is estimated at Rs. 1,60,000.

The company realized 1,60,000 from sundry debtors as the agent of the vendor in full settlement and discharged all the creditors by paying 1,36,000 for a commission of 3% on the amount collected and 2% on the amount paid.

The loan creditors accepted 10% preference shares of 100 each in discharge of the loans.

After realization of the debts and discharge of the liabilities, the total amount due to the vendor was settled by payment of 10,880 in cash and the balance in the shape of fully paid equity shares of 10 each.

Show purchase consideration and pass journal entries in the books of the company. Also give the balance sheet of the company after taking over the business of Y.

 

[C.S. (Inter). Modified]

[Ans: Purchase consideration: 2,94,400;

Total of balance sheet: 5,46,520]