Business acquisition and merger

Accounting A2 · Financial accounting. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Businesses join together to grow quickly, share skills and capital, cut costs and reduce competition. Sole traders may merge into a partnership, a sole trader may join an existing partnership, or a limited company may buy a sole trader or a partnership.

The buyer records the assets and liabilities it takes over at their agreed (fair) values, not at the seller’s carrying amounts. The price paid is the purchase consideration. It can be cash, shares, debentures or a mixture. If it is more than the net assets taken over, the difference is goodwill.

The seller closes its books through a realisation account, which shows the profit or loss on the sale of the business.

Rules to remember

Net assets taken over = assets taken over − liabilities taken over, all at agreed values.
Goodwill = purchase consideration − fair value of the net assets taken over.
Shares issued as consideration are valued at the issue price: nominal value goes to share capital and the excess goes to share premium.
Seller’s books: debit the realisation account with the assets at carrying amount; credit it with the liabilities taken over and the purchase consideration. The balance goes to the owners’ capital accounts.
Sole traders forming a partnership: each owner’s opening capital = the agreed value of the net assets (and goodwill) brought in.
If goodwill is not kept in the new partnership’s books, it is written off against the partners’ capital accounts in the new profit-sharing ratio.
Assets not taken over, often the bank balance, stay with the seller and are left out of the calculation.

Common mistake

Students value the shares issued at nominal value when they were issued at a premium, which understates the purchase consideration and the goodwill. Use the issue price.

Worked example

A company buys a sole trader’s business. The agreed values are: non-current assets $140 000, inventory $22 000, trade receivables $18 000 and trade payables $15 000. The company pays $30 000 in cash and issues 100 000 ordinary shares of $1 each at $1.50. What is the goodwill?

Net assets taken over = $140 000 + $22 000 + $18 000 − $15 000 = $165 000.
Shares = 100 000 × $1.50 = $150 000 (share capital $100 000, share premium $50 000).
Purchase consideration = $150 000 + $30 000 cash = $180 000.
Goodwill = $180 000 − $165 000 = $15 000.

Answer: Goodwill of $15 000 is recorded as an intangible non-current asset.

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8. Business Purchase & Merger (PDF)

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