# Demystifying Financial Consolidation Part V

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 ( Fair)

 Value of Net Asset ( Book) 1080-300 = 780 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

—————————————————————————-

Cr

C.L.                                       200

Bonds                                    100

Cash                                      1600

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1. The BS after fair value revaluation is not balance. Thus the Net Asset (Fair) is not correct.
2. In the Acquirer's company books, you put Cash account in the Liabilities + Equity side. That is not correct.

Pls revise.

Hi Halomoan Zhou,

Point 1. For the scenario, we were only interested in the fair value of assets and liabilities of target company not equity part. Thats the reason I kept Total fair value of Liability side  as blank (No corresponding value of 1700), & while calculating net assets(fair) value we only need fair value of assets and liabilities.  So Net Asset(fair) value is correct.

However you raised an excellent point that why balance sheet is not in sync. It is because Whenever we do revaluation, the difference portion(revalued amount) will go to "revaluation surplus" account on equity side which I have not put in.

http://www.iasplus.com/standard/ias16.htm [IAS 16.39]

Point 2. Cash is not part of liability side, it is always asset. These are accounting entries Cr/Dr not balance sheet. What I have shown is that Cash account will be credited by 1600 since we are paying this amount to acquire target company.

I will edit and put Cr/Dr on top to make it clear.

Thanks for the suggestions.

Hi Archit

I understood, but people has to read this comment to get the idea behind.

Best regards,
Halomoan

Hi Halomoan Zhou,

I will surely update the same info in the blog content also.

Regards,
Archit

Hi Halomoan Zhou,

I will surely update the same info in the blog also.

Regards,
Archit