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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

Premium on Bonds                  10

Cash                                      1600


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5 Comments

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  1. Halomoan Zhou
    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.

    (0) 
    1. Archit Agrawal Post author
      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.  

      (0) 

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