In the last blog, we have already discussed the theoretical concepts related to purchase method. In this blog, we will see one scenario which will make concepts clear.
Given is the balance sheet (Book Value) of the target company. Since this is the book value balance sheet, we can’t use it for purchase method. We should get the fair value of assets and liabilities.
First table is for the book value of assets and liabilities.
Scenario 1 Purchase Method:
Balance Sheet (Book Value)
Assets | Book Value | Liabilities & Equity | Book Value |
A.R | 240 | C.L | 200 |
Inventory | 40 | Bonds Payable | 100 |
Land | 500 | Common Equity | 70 |
Goodwill ( Existing) | 100 | Paid in Capital in excess of par | 630 |
Building | 200 | Retained Earning | 80 |
TOTAL | 1080 | TOTAL | 1080 |
As we have already discussed, we won’t consider the goodwill on the Balance sheet of Target Company while valuing it. So in the below Balance sheet we have not considered Goodwill (Existing) Entry.
There are some intangible items which might not be present in the Book value balance sheet, but we need to consider them when valuing Target Company like Brand Value. We can see in the below balance sheet that we have considered fair value of Brand = 100.
Liabilities are also revalued if there is change in the interest rates in the market. But in most of the cases, the adjustment won’t be big.
Balance Sheet (Fair Value)
Assets | Book Value | Fair Value | Liabilities & Equity | Book Value | Fair Value |
A.R | 240 | 240 | C.L | 200 | 200 |
Inventory | 40 | 60 | Bonds Payable | 100 | 110 |
Land | 500 | 1000 | Common Equity | 70 | |
Goodwill ( Existing) | 100 | - | Paid in Capital in excess of par | 630 | |
Building | 200 | 300 | Retained Earning | 80 | |
Brand Value | - | 100 | | | |
TOTAL | 1080 | 1700 | TOTAL | 1080 | |
Value of Net Asset ( Book) | 1080-300 = 780 |
Value of Net Asset ( Fair)
1700 – 310 = 1390 |
Goodwill Calculation:
Consideration Paid: 1600
Company Valued at net asset: 1390
Goodwill = 210
In the above example, we have made the assumption that the acquirer company has acquired 100 percent stake in the target company, so there is no NCI entry. If the stake acquired would have been between 50 and 100, we would have been required to account for NCI stake.
Accounting Entries in the Acquirer’s company Books
Dr
A.R 240
Inventory 60
Land 1000
Brand Value 100
Building 300
Goodwill 210
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Cr
C.L. 200
Bonds 100
Premium on Bonds 10
Cash 1600
