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Companies Taking Over Other Business

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Introduction

Limited companies often expand their businesses by taking over another business as a going concern

Business taking over may be in the form of an acquisition or an exchange of shares

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Acquisition

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Acquisition

Sole proprietorship, partnership or Limited company

Liquidation

Realization account

Purchasing company

Business purchase account

Asset+ liabilities

Shares, debentures or cash

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Seller’s book

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AcquisitionSeller’s Book

Transfer of assets to the realization account

Dr. Realization

Cr. Assets (at net book values)

Expenses paid for realization Dr. Realization

Cr. Cash

Sale proceeds from disposing of those assets which are not taken over

Dr. Cash

Cr. Realization

Transfer of liabilities to the realization account

Dr. Liabilities

Cr. Realization

Liabilities settled by the company itself Dr. Liabilities

Cr. Cash

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Acquisition

Seller’s Book

Discounts received on the settlement of creditors by the company itself

Dr. Creditors

Cr. Realization

Purchase consideration agreed upon Dr. Purchasing company

Cr. Realization

Profit on realization

(Reverse the entries for any loss on realization)

For Sole Trader

Dr. Realization

Cr. Capital

For Partnership

Dr. Realization

Cr. Partners’ Capital

For Limited Company

Dr. Realization

Cr. Sundry Shareholders

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Acquisition

Seller’s Book

Transfer of balances from partners’ current accounts to the capital accounts

Dr. Partners’ Current

Cr. Partners’ Capital

(for partnership only)

Transfer of balances from the profit and loss account and reserve accounts to the sundry shareholders account

Dr. Profit and Loss/Reserves

Cr. Sundry Shareholders

(for limited company only)

Receipt of cash, shares or debentures from the purchasing company for the settlement of the purchase consideration

Dr. Cash/Shares/Debentures in purchasing company

Cr. Purchasing company

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AcquisitionSeller’s Book

Distribution of cash, shares or debentures between the partners or shareholders

For Sole Trader

Dr. Capital

Cr. Cash/Shares/Debentures in purchasing company

For partnership

Dr. Partners’ Capital

Cr. Cash/Shares/Debentures in purchasing company

For Limited Company

Dr. Sundry Shareholders

Cr. Cash/Shares/Debentures in purchasing company

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Buyer’s book

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Acquisition

Buyer’s Book

Assets taken over at their revised values Dr. Assets

Cr. Business Purchase

Liabilities taken over Dr. Business Purchase

Cr. Liabilities

Purchase consideration agreed upon Dr. Business Purchase

Cr. Vendor

Profit on the acquisition Dr. Business Purchase

Cr. Capital Reserve

Loss on the acquisition Dr. Goodwill

Cr. Business Purchase

Settlement of the purchase consideration by cash and/or issuing shares and debentures

Dr. Vendor

Cr. Cash/Share Capital/Debentures

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Example 1

Taking over a sole traders

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On 31 Dec 1997 Sino Trading Company Ltd. Acquired the business of K. Chan The purchase consideration was $350000 cash. The company revalued the assets taken over as follows:

Machinery $180000Motor vehicles $70000Stock $40000Debtors $50000

Balance Sheet as at 31 Dec 1997 (before takeover)Sino trading co. K. Chan

Land & Buildings $300000 -Machinery 260000 $185000Furniture & Fittings 70000 -Motor Vehicles 130000 68000Stock 84000 43000Debtors 98000 52000Cash 420000 7000

1362000 355000Share capital/capital 1000000 352000Profit and loss 320000 -Creditors 42000 3000

1362000 355000

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RealizationMachinery 185,000Motor Vehicles 68,000Stock 43,000Debtors 52,000Capital – Profit on Realization 5,000 (bal. fig.)

Sino Trading – purchase consideration 350,000

Creditors – taken over 3,000

353,000 353,000

Sino Trading Company Ltd.Realization 350,000 Cash 350,000

In K. Chan’s Book (Seller)All assets and liabilities taken over should be statedAt book value before the takeover in the realizationaccount

CashBal b/ f 7000 Capital 357000Sino trading co. 350000

357,000 357000Capital

Bal b/f 352000Realization –profit 5000

Cash 357000

357000 357000

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In Sino Trading Company Ltd.’s Book (Buyer’s Book)

Business Purchase

Cash – purchase consideration 350,000

Creditors 3,000 Machinery 180,000Motor Vehicles 70,000Stock 40,000Debtors 50,000

Goodwill (bal. fig.) 13,000

353,000 353000

Assets and liabilities taken over should be Stated at their revised values in the businessPurchases account

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In Sino Trading Company Ltd.’s Book (Buyer’s Book)

Sino Trading Company Ltd.

Balance Sheet as at 1 January 1998 (after acquisition)Fixed AssetsGoodwill 13,000Land and Buildings 300,000Furniture and Fittings 70,000Machinery (260,000 + 180,000) 440,000Motor Vehicles (130,000 + 70,000) 200,000

1,023,000Current AssetsStock (84,000 + 40,000) 124,000Debtors (98,000 + 50,000) 148,000Cash (420,000 – 350,000) 70,000

342,000Less: Current Liabilities

Creditors (42,000 + 3,000) 45,000

Working Capital 297,000

1,320,000Share Capital 1,000,000Profit and Loss 320,000

1,320,000

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Example 2

Settlement by sharesThe facts are the same as those in Example 1, except that the purchase consideration was settled by issuing share capital of $350000 instead of paying cash

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In Sino Trading Company Ltd’s Book (Buyer’s Book)

Sino Trading Company Ltd.

Balance Sheet as at 1 January 1998 (after acquisition)Fixed AssetsGoodwill 13,000Land and Buildings 300,000Furniture and Fittings 70,000Machinery (260,000 + 180,000) 440,000Motor Vehicles (130,000 + 70,000) 200,000

1,023,000Current Assets

Stock (84,000 + 40,000) 124,000Debtors (98,000 + 50,000) 148,000Cash 420,000

692,000Less: Current Liabilities

Creditors (42,000 + 3,000) 45,000

Working Capital 647,0001,670,000

Share Capital (1,000,000 + 350,000) 1,350,000Profit and Loss 320,000

1,670,000

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Example 3

Taking over a limited company

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The following trial balances are extracted from Astin Ltd. And cathay Ltd. On 31 Dec 1997

Astin Ltd. Cathay Ltd.

Dr Cr Dr CrGoodwill $3000 -Premises 250000 80000Plant & Machinery 370000 46000Stock 120000 72000Debtors 65000 28000Bank 53000 14000Share capital-ord. shares of $1@ 560000 200000Share premium 1000 20000Profit and loss 130000 50005% debentures 100000 13000Creditors 70000 2000

861000 861000 240000 240000

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Astin Ltd. Took over Cathay Ltd. ( all the assets and liabilities ) on 31 Dec 1997.

Additional information:

1. The debentures in Cathay Ltd. were to be exchanged for a new issue of 5% debentures in Astin Ltd. Of the same nominal value.

2. The purchase consideration was discharged by the issue of 230000 $1 shares at a premium of 10%.

3. The assets were taken over at their book values except premises, stock and debtors, which were revalued at $10000, $70000 and 24000 respectively.

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RealizationPremises 80,000Plant and Machinery 46,000Stock 72,000Debtors 28,000Bank 14,000

Debentures 13,000Creditors 2,000

Astin Ltd. – purchase consideration (230,000 X 1.1) 253,000

In Cathy Ltd.’s Book (Seller)

Sundry Shareholders (profit on realization) (bal .fig.)28,000

268,000 268000

Sundry ShareholdersShares in Astin Ltd.-purchaseConsideration 253000

Share capital 200000 Profit and loss 5000

Share premium 20000

253000 253000

Realization-profit 28000

All shares capital and reserves should be closed to the sundry shareholders’ account

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Business purchasePremises 100000Plant and Machinery 46,000Stock 70,000Debtors 24,000Bank 14,000

Debentures 13,000 Creditors 2,000Astin Ltd. – purchase consideration (230,000 X 1.1) 253,000

In Cathy Ltd.’s Book (Seller)

Goodwill (bal. Fig.) 14000

268,000 268000

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In Astin Ltd.’s Book (Buyer’s Book)

Astin Ltd.

Balance Sheet as at 1 January 1998 (after acquisition)

Fixed AssetsGoodwill (3,000 + 14,000) 17,000Premises (250,000 + 100,000) 350,000Plant and Machinery (370,000 + 46,000) 416,000

783,000Current Assets

Debtors (65,000 +24,000) 89,000Bank (53,000 + 14,000) 67,000

Less: Current Liabilities

Working Capital 274,000

Stock (120,000 + 70,000) 190,000

346,000

Creditors (70,000 + 2,000) 72,000

1,057,000Share CapitalShare Capital (560,000 + 230,000) 790,000Share Premium (1,000 + 23,000) 24,000Profit and Loss 130,000

944,000Long-term Liabilities5% Debentures (100,000 + 13,000) 113,000

1,057,000

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Share Exchanges

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Share exchange

A limited company may take over another limited company by exchanging shares with the shareholders of the selling company.

The selling company will not be liquidated. It becomes the subsidiary of the purchasing company.

No entry is necessary in the books of the selling company,as it is only a change in the identity of the shareholders.

The shareholders of the selling company now become shareholders of the purchasing company

The purchasing company now becomes a holding company, In the books of the holding company, the subsidiary is regarded as an investment,

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Share exchange

Limited company Holding company

Shares

Shares

Subsidiary company

No entry in accounts

Issue of shares or debentures toSubsidiary company’s shareholders

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Share Exchange

Accounting Entries

Dr. Investment With the total cost of investmentCr. Share Capital With the par value of the issue of exchangeCr. Share Premium With the premium on the new issue

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Example 4

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The following balance sheets reflect the situation of Joyce Ltd and Anna Ltd. On 31 Dec 1997

Joyce Ltd. Anna Ltd.

Goodwill - $20000Land & building 1300000 1000000Plant & machinery 750000 450000Office equipment 80000 50000Stock 150000 97000Debtors 180000 110000Bank 65000 34000

2525000 1761000

Share capital- ord. Shares of $1@ 2000000 1000000Profit and loss account 400000 600000General reserve 50000 60000Creditors 75000 101000

2525000 1761000

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Joyce Ltd. took over Anna Ltd. By exchanging with the shareholders of Anna Ltd. Three shares of Joyce Ltd. Were exchanged at a premium of 20% for every two shares of Anna Ltd.

There is no accounting entry required in the books of Anna Ltd. as there is no liquidation of Anna Ltd. The only changes is that the shareholders of Anna Ltd. Become shareholders of Joyce Ltd.

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In Joyce Ltd.’s Book (Buyer’s Book)

Joyce Ltd.

Balance Sheet as at 1 January 1998 (after acquisition)

Fixed Assets Land and Premises 1300,000

2,130,000 Investment in Anna Ltd., at cost 1,800,000Current Assets

Stock 150,000Debtors 180,000Bank 65,000

395,000Less: Current Liabilities

Creditors 75,000Working Capital 320,000

4,250,000

Plant and Machinery 750,000Office Equipment 80,000

Share CapitalOrdinary Shares of $1 each (2000000+150000) 3,500,000

ReservesShare Premium [(1000000*3/2)*20%] 300,000General Reserve 50,000Profit and Loss Account 400,000

4250000

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Pre-incorporation Profit

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Pre-incorporation profit

Limited Co. take over other businesses. It takes p period of time before they can be incorporated.

A company cannot earn profits before it legally comes into existence through incorporation.

The profits generated after the takeover and before the incorporation are knows as pre-incorporation profits

Pre-incorporation profits are capital in nature. They must be transferred to a capital reserve account which is not available for dividend distribution.

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Pre-incorporation Profits

Accounting entries

Dr. Profit and Loss With the pre-incorporation profits earnedCr. Capital Reserve/Goodwill

Dr. Goodwill With the pre-incorporation lossCr. Profit and Loss

After incorporation, the company legally comes into existence. The profits generated after incorporation are known post-incorporation profits

The profits which can be transferred to the profit and loss appropriation account and is also available for the distribution of dividends.

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Allocation of profits between different parties

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Allocation of Profits between Different Parties

Case 1

A partnership was taken over by a limited company on 1 April. The company was incorporated on 1 June.

1/1

Date of takeover

1/4 1/6 31/12

Apportionment of profits:1/1 to 31/3 Partnership1/4 to 31/5 Pre-incorporation Profits1/6 to 31/12 Limited company(Post-incorporation profits)

Date of incorporation Financial year end

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Allocation of Profits between Different Parties

Case 2

A partnership was taken over by a limited company on 1 January. The company was incorporated on 1 April.

1/1 1/4 31/12

Apportionment of profits:1/1 to 31/3 Pre-incorporation Profits1/4 to 31/12 Limited company (Post-incorporation profits)

Date of takeover Date of incorporation Financial year end

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Allocation of Profits between Different Parties

Case 3

A partnership was taken over by a limited company on 1 April. The company was incorporated on the same date.

1/1 1/4 31/12

Apportionment of profits:1/1 to 31/3 Partnership1/4 to 31/12 Limited company (Post-incorporation profits)

Date of takeover of incorporation Financial year end

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Apportionment of revenues and expenses Theoretically, a separate set of records should be

dept for each period. However, a business may not have stock-take or may

not close the accounts when there is a change in ownership of the business

Therefore the income and expenditures must be apportioned over different periods in order to compute the pre-incorporation profits and the post-incorporation profits

The income and expenditures of the business should each be apportioned on a different basis

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Basis of Apportionment Examples

Sales Variable expenses and Revenues- They would increase proportionally to the increase in turnover- e.g. gross profit, selling and distribution expenses, carriage outwards, cost of goods sold, bad debts, discounts allowed, etc.

Time Fixed expenses and revenues- They would increase proportionally to time- e.g. rent and rates, interest, administrative exp., office salaries, depreciation, etc.

Actual - There is no need to apportion these expenses and revenues as they are incurred in a particular period.

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Apportionment of Revenues and Expenses

Basis of Apportionment Examples

Actual - Partnership e.g. Interest on drawings, interest on capital, partners’ salaries, etc.- Pre-incorporation period e.g. interest on purchase consideration- Post-incorporation period e.g. preliminary expenses, interest on purchase consideration, debenture interest, directors’ remuneration, etc.

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Example 5

Refer to textbook P.191-192

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Example 5

SalesCost of SalesGross ProfitLess: ExpensesRentSales Comm.Preliminary Exp.DebentureInt. on PurchaseConsiderationDirectors’ FeesDisc. AllowedDepreciationOffice SalariesNet Profit

Apportionmentbasis

Turnover (3:8:4)Turnover (3:8:4)

Time (3:6:3)Turnover (3:8:4)ActualActual

Time (6:1)ActualTurnover (3:8:4)Time (3:6:3)Time (3:6:3)

Partnership(Jan to Mar.)

360,00090,000

270,000

30,0008,400

5,40012,00024,000

190,200

Pre-incrop.(Apr. to Sept)

960,000240,000720,000

60,00022,400

30,000

14,40024,00048,000

521,200

Post-incorp.(Oct. to Dec.)

480,000120,000360,000

30,00011,20010,00015,000

5,00018,0007,20012,00024,000

227,600