Acquisition by a Limited Company

When a limited company acquires an existing business (a sole trader or partnership), it agrees to pay a purchase consideration — the total value given to the seller for the business.

In exchange, the company takes over the net assets of the business — its assets less its liabilities — usually at agreed (fair) values, which may differ from the book values. For example, premises might be revalued up, or a provision created for doubtful debts.

$\text{Net assets acquired} = \text{Agreed value of assets} - \text{Agreed value of liabilities taken over}$

So two key figures drive the accounting: the purchase consideration (what is paid) and the fair value of the net assets (what is received). The difference between them is goodwill.

Goodwill on acquisition is the amount by which the purchase consideration exceeds the fair value of the net assets acquired:

$\text{Goodwill} = \text{Purchase consideration} - \text{Fair value of net assets acquired}$

• A positive figure is purchased goodwill — the company paid more than the net assets are worth, for things like the business's reputation, customers and location. This goodwill is recorded as an intangible non-current asset (it is purchased, so unlike internally-generated goodwill it is recognised).
• A negative figure (consideration below net assets) is sometimes called a bargain purchase / negative goodwill.

Example. Consideration $250,000; fair value of net assets $210,000 → goodwill = $40,000 (an intangible asset). Purchased goodwill is recognised because there is an objective cost for it (the price paid).

The company settles the purchase consideration using a combination of:

• ordinary shares — issued to the seller (at an agreed value);
• debentures / loan stock — long-term debt issued to the seller;
• cash — paid from the bank.

When shares are issued above their nominal value, the excess is share premium:

$\text{Share premium} = (\text{Issue price} - \text{nominal value}) \times \text{number of shares}$

Example. Consideration $250,000 settled by 150,000 $1 shares issued at $1.40 (= $210,000) and $40,000 cash. Of the $210,000: share capital = 150,000 × $1 = $150,000; share premium = 150,000 × $0.40 = $60,000. Total consideration = 210,000 + 40,000 = $250,000. ✓

The total of all forms of consideration must equal the purchase consideration — a key check.

In the acquiring company's books, the acquisition is recorded by bringing in the net assets at fair value and the goodwill, against the consideration given:

• Debit each asset acquired (at fair value) and Goodwill (if positive);
• Credit each liability taken over (at fair value);
• Credit the consideration: share capital + share premium (for shares), debentures, and bank (for cash).

The entries must balance: total debits (assets + goodwill) = total credits (liabilities + consideration). A business purchase account is sometimes used as a working: the assets/liabilities and goodwill on one side, the consideration on the other, with goodwill as the balancing figure.

So the full picture is: identify the net assets at fair value, compute goodwill as the balancing item against the consideration, then record the shares, debentures and cash that make up the consideration — checking the whole entry balances.