Business Purchase - Principles Of Accounting
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A buyer may decide to purchase a business for several reasons. They may include-
1. 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:
/ http://www.principlesofaccounting2.com/ 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)
An individual (a person) purchases a business
b)
A partnership or a sole trader acquires the business of a sole trader
c)
Two or more sole traders join together to form a partnership
d)
A limited company takes over the business of a partnership or a sole trader
Why business purchases are taking places? a)
To avoid competition ( competition will lead the business to “cutthroat” and lose)
b)
To enjoy the profit of the business which is to be purchased
c)
To enlarge the size of the business
d)
To avoid the burdens and toil of organizing a new business
e)
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
Dr
Business Purchase
Cr
(including Goodwill)
1. 2. For the liabilities taken overBusiness Purchase
Dr
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Cr
1. 3. For recording the business purchase price-
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Business Purchase - Principles Of Accounting
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Business Purchase
Dr
Vendor
(with Business Purchase Price)
Cr
1. 4.For the capital brought in the businessBank/ Cash
Dr
Share Capital
Cr
1. 5. For recording the payments to vendorVendor
Dr
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Cr
Key points
Only the revalued amounts are considered for the calculation of business purchase price and the
purchaser’s balance sheet shows only these values. In the purchaser’s 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
Liabilities 30 000Creditors 25 000Bank Loan 15 500Capital 12 300
$ 17 000 10 000
/ http://www.principlesofaccounting2.com/ Furniture Debtors
Stock Cash in Hand
8 700 1 300
Cash at Bank
4 600 97 400
70 400
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
32 000
Debtors
Building
23 000
Stock
Furniture
15 000
Creditors
11 000 9 000 16 000
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
$ 15 000 3 000 69 350
17 000 1 000 2 350 87 350
87 350
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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. Building at book value
less $ 2 000 depreciation
Furniture at book value
less 10% depreciation
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Business Purchase - Principles Of Accounting
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Fittings at
$ 9 000
Debtors at
$ 950
Stock at
$ 18 500
Creditors
$ 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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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 businessAssets
$
Liabilities Capital 1 00 000Creditors 7 000
Fixed Assets Premises Fixtures & Fittings
$ 1 26 300 12 000
4 000
Motor Van
Current Assets 13 000 10 000
Stock Debtors
4 300 1 38 300
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
$ 1 05 000
Stock
$ 11 000
Furniture & Fittings
$ 5 000
T. Terry has to pay an additional amount as Goodwill, which is equal to 2 years purchase of average of past 3 year’s profits which were:
/ http://www.principlesofaccounting2.com/ 1995
$ 10 000
1996
$ 12 000
1997
$ 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)
Calculate the business purchase price
b)
Pass Journal Entries in the books of T. Terry
c)
Prepare his Balance Sheet after the purchase transactions are over
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
$
Liabilities 50 000Capital 10 000Creditors 9 000 4 000
Premises Fixtures Stock Debtors Bank
1 250 74 250
$ 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
$ 55000
Stock
$ 8550
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b) M. Mortan should pay an additional amount equal to the average profit of R. Rocky’s business over the last three years. The profits were: 1994
$ 12500
1995
$ 13000
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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
(II) Show the Journal Entries necessary in M. Mortan’s books to record the business.
purchase of R. Robbins
(III) Assuming no other transactions except the settlement of the business purchase price, calculate M. Mortan’s working capital.
Q 5. Sanal is the owner of a business. His Balance Sheet on 01.01.1998 was as follows.
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$ Assets 1 09 300Land 12 000Buildings 4 200Furniture
Capital Creditors Bank Overdraft
$ 50 000 40 000 7 500 5 000 12 500
Fittings Stock Debtors
10 000 500
Cash in hand 1 25 500
1 25 500
Amal is also a businessman carrying on a similar business concern. His balance sheet on the above date appeared as follows:
Liabilities
Amount 110500Land 25000Building
Capital Creditors
Assets
Amount 70000
Fixtures
30000 7000
Stock Debtors
12000 10000
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Cash in hand Cash at bank 135500
135500
Amal decided to purchase the business of Sanal on the following conditionsa)
Amal will take over all the assets and liabilities except bank overdraft and cash in hand.
b)
Sanal revalued the assets and liabilities as follows:
$ Land
57 000
Furniture
7 000
Buildings
38 000
Fittings
4 000
Stock
13 000
Debtors
Book value less 1 000 as bad debts
Creditors c)
12 200
The purchase price is fixed at 130800.
d) Amal has to pay an additional amount equal to the average of Sanal’s 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)
Calculate the Goodwill
ii)
Prepare the journal entries including the bank transactions
iii)
Prepare the business purchase account
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