Acquisition by a Limited Company (Cambridge International A-Level Accounting)

Spec point — how to calculate the value of goodwill on the acquisition of a business by another entity how to prepare journal entries and make entries in the relevant ledger accounts to record the: – acquisition of a sole trader’s business or partnership by a limited company

Acquisition by a limited company

What is the purchase consideration?

• The purchase consideration is the total agreed price paid by an acquiring entity to purchase a business

• The purchase consideration uses the agreed values for assets, liabilities and goodwill

• The acquiring entity might offer:

  • cash
  • shares in the acquiring entity
  • debentures

• Sometimes, debentures are issued to the current partners so that the interest is the same as the interest they currently receive on their capital or loan

  • To calculate the value of the debenture:

    • Multiply the capital or loan by the interest allowed
    • Divide this by the interest of the debenture

How is the purchased goodwill calculated?

• You might be given the value of the purchased goodwill in the question

• Goodwill might be calculated before the acquisition by

  • multiplying the profit for the year by a given factor
  • multiplying the average profit over specified years by a given factor

• Goodwill might be calculated after the acquisition by

  • subtracting the net assets from the purchase consideration

• Purchased goodwill remains as an intangible non-current asset in the new entity's books

  • This is different to inherent goodwill, which is written off

How do I make journal entries when a limited company acquires a sole trader or partnership?

The books of the sole trader or partnership

• STEP 1 Record any day-to-day transactions such as paying suppliers

  • Anything that would be debited or credited to the statement of profit or loss is instead entered in a realisation account

    • Remember, debit entries would decrease the profit and credit entries would increase the profit
    • For example, if the business receives a discount from a supplier, then this is credited to the realisation account instead of being credited to the statement of profit or loss

• STEP 2 Transfer the non-cash assets to the realisation account using the book value

  • Debit the realisation account
  • Credit each asset account

• STEP 3 Transfer the liabilities to the realisation account using the book value

  • Debit each liability account
  • Credit the realisation account

• STEP 4 Record the purchase consideration from the acquiring company

  • Debit the relevant account

    • Bank if cash is received
    • Shares in acquiring company if shares are received
    • Debentures if debentures are received

  • Credit the realisation account

• STEP 5 Record any assets that are taken by the current owners using the agreed value

  • Debit the capital account
  • Credit the realisation account

• STEP 6 Record the realisation expenses that apply to the current owner(s)

  • Debit the realisation account
  • Credit the bank account

• STEP 7 Close the realisation account by finding the profit or loss on realisation

  • If it is a profit:

    • Debit the realisation account
    • Credit the capital account(s)

  • If it is a loss

    • Debit the capital account(s)
    • Credit the realisation account

• STEP 8 Close the capital account(s)

  • Transfer the balances from the current accounts if it is a partnership

  • Deal with the amount owed to the current owner(s)

    • Debit the capital account(s)
    • Credit the bank, shares or debenture account

Exam Hint Even if the exam question does not ask you to prepare a realisation, it is helpful to sketch the account as it helps you see all the transactions.

The books of the limited company

• STEP 1 Make debit entries for the acquired assets using the agreed value

  • Non-current assets
  • Inventory
  • Trade receivables
  • Goodwill (if an agreed value was given)

• STEP 2 Make credit entries for the acquired liabilities using the agreed value

  • Trade payables

• STEP 3 Make credit entries for the purchase consideration

  • Bank if cash was paid
  • Ordinary share capital if shares were issued
  • Share premium if shares were issued at a premium
  • Debentures if they were issued

• STEP 4 Calculate the value of the purchased goodwill if it was not agreed during the acquisition

  • Find the difference between the total debit entries and the total credit entries

Exam Hint The book value (carry value) of each asset and liability is entered into the books of the sole trader or the partnership. However, the agreed values are entered into the books of the acquiring limited company.

Worked Example Daniel had been a sole trader for many years. He decided to retire and agreed to sell his business to PT Limited on 31 December 2025.

Daniel's statement of financial position at 31 December 2025 was as follows:

	$
Non-current assets	120 000
Current assets
Inventory	18 000
Trade receivables	24 000
Cash at bank	5 000
Total assets	167 000
Capital	150 000
Current liabilities
Trade payables	17 000
Total capital and liabilities	167 000

The following information is also available:

1. The profit for the year ended 31 December 2025 was $45 000.

2. The value of goodwill was agreed at two times the most recent profit.

3. PT Limited took over all the assets and liabilities of the business except for the cash at bank.

4. The assets taken over were revalued as follows:

• Non-current assets: $140 000
• Inventory: $16 000
• Trade receivables: $22 000

1. The trade payables were taken over at their book value.
2. The purchase consideration was settled by

• the issue of 100 000 ordinary shares of $1 each in PT Limited at a premium of $0.50 per share
• the balance being paid in cash

(a) Calculate the value of goodwill on the acquisition of the business.

(b) Calculate the total purchase consideration.

(c) Prepare the realisation account in Daniel's books for the year ended 31 December 2025.

(d) Prepare the journal entry in PT Limited’s books to record the acquisition of Daniel's business. A narrative is not required.

Answer:

(a)

Multiply the most recent profit by 2

$45 000 × 2 = **$90 000 **

(b)

Calculate the net assets using the agreed values and then add the value of the goodwill

	$
Non-current assets	140 000
Inventory	16 000
Trade receivables	22 000
Trade payables	(17 000)
Net assets taken over	161 000
Add: Goodwill	90 000
Final answer: Purchase consideration	Final answer:** 251 000

(c)

Use the book values from the statement of financial position

Daniel

Realisation account

	$		$
Non-current assets	120 000	Trade payables	17 000
Inventory	18 000	PT Limited (Purchase consideration)	251 000
Trade receivables	24 000
Capital (profit on realisation)	106 000
	268 000		268 000

(d)

Calculate the amount that PT Limited paid in cash for the acquisition

		$
Purchase consideration		251 000
Ordinary share capital	100 000 × $1	(100 000)
Share premium	100 000 × $0.50	(50 000)
Bank		101 000

Make the journal entries using the agreed revalued amounts

PT Limited

Journal

	$	$
Non-current assets	140 000
Inventory	16 000
Trade receivables	22 000
Goodwill	90 000
Trade payables		17 000
Ordinary share capital		100 000
Share premium		50 000
Bank		101 000
	268 000	268 000