PURCHASE OF BUSINESS

FINANCIAL ACCOUNTING SSS3 SECOND TERM              

WEEK 1

PURCHASE OF BUSINESS

Contents

• TERMINOLOGIES IN THE PURCHASE OF BUSINESS
• ACCOUNTING ENTRIES ILLUSTRATION

INTRODUCTION

Purchase of business is the activity of buying or acquiring a business as a going concern. This means acquiring an existing business with the intention of continuing its operations. this acquisition can be in any of the following ways

1. A sole trader acquiring the existing business of a sole trader
2. A partnership acquiring the business of another partnership or a sole trader
3. A company may be buying another or a partnership business.

In any of the acquisitions above, the assets and liabilities taken over by the purchasing businesses will be recorded in the same way.

TERMINOLOGIES IN THE PURCHASE OF A BUSINESS

1. Vendor. This is the person or partnership or company that sold the business to another. The vendor may be paid cash, cheque  or in shares of the new company
2. Purchase consideration. This is the price which a purchaser would pay to the vendor in order to acquire his business
3. Goodwill. This is the excess of the purchase consideration over the net value of assets taken over. Net assets mean total assets fewer liabilities. it is also called the net worth of the business.
4. Capital reserve. Where the purchase consideration is lesser than the net worth of the business, the difference is referred to as capital reserve.

ACCOUNTING ENTRIES:

1.       Agreed  purchase price

          Dr Business Purchase A/C

          Cr. Vendors A/C

2.       Take over the value of assets

          Dr Assets Account 

          Cr. Business Purchase A/C

3.       Agreed value of liabilities taken over

          Dr Business Purchase A/C

          Cr. Liabilities A/C

4.       Excess of purchase consideration over net asset

          Dr Goodwill

          Cr. Business Purchase A/C

5.       Excess of an asset over purchase consideration.

          Dr Business Purchase A/C

          Cr. Capital Reserve A/C

6.       Settlement of the vendor’s  A/C with cash

          Dr Vendor’s A/C

          Cr. Cash A/C

7.       Settlement of Vendor’s A/C with shares

          Dr Vendor’s A/C

          Cr, Share Capital A/C

EVALUATION

1.       Explain the following terms:

          a.       Goodwill

          b.       Capital reserve

          c.       Purchase consideration

          d.       Vendor

2.       List six factors which can create goodwill for any firm or organization.

Evaluation

Explain the following: i. vendor ii. Purchase consideration

GENERAL EVALUATION/REVISION QUESTIONS

1. State six characteristics of depreciable assets
2. Explain three differences between a trial balance and a balance sheet
3. List seven errors that will affect the agreement of the trial balance
4. Explain the following : (i) real account (ii) nominal account (iii) personal account
5. List eight items that cause disagreement between Cash Book and bank statement balance

Reading assignment

Essential Fin. Accounting by O.A Longe page 299-307.

Weekend  Assignment

1. Goodwill is a ------- (a) current asset ( b) intangible asset( c) current liability( d)fictitious asset
2. Vendor means the seller of the (a) business (b) asset (c) liabilities (d) capital
3. Capital reserve is( a) current assets( b) fixed assets (c) liabilities (d) equity
4. The double entry for payment of cheque to the vendor is (a) Dr. vendor A/C, Cr. bank  (b) Cr. Vendor, Dr. bank (c) Cr.cheque Dr. vendor (d) Dr Vendor Cr. Cash
5. The double entry for the agreed purchase price is (a) Dr.purchase of business A/C, Cr. Vendor   (b) Dr. asset Cr. liabilities  (c) Dr Cash Cr. Vendor (d) Dr Asset Cr. Cash

THEORY

1. Explain the accounting entries in the purchase of a business by a partnership from a sole trader.
2. Explain i. Capital reserve ii. Goodwill on purchase of a business