1. 1 Companies Taking Over Other Business

2. 2 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

3. 3 Acquisition

4. 4 Sole proprietorship, partnership or Limited company Liquidation Realization account Purchasing company Business purchase account Asset+ liabilities Shares, debentures or cash

5. 5 Seller ’ s book

6. 6 Acquisition Seller’s Book Transfer of assets to the realization account Dr. Realization Cr. Assets (at net book values) Expenses paid for realizationDr. 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 itselfDr. Liabilities Cr. Cash

7. 7 Acquisition Seller’s Book Discounts received on the settlement of creditors by the company itself Dr. Creditors Cr. Realization Purchase consideration agreed uponDr. 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

8. 8 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

9. 9 Acquisition Seller’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

10. 10 Buyer ’ s book

11. 11 Acquisition Buyer’s Book Assets taken over at their revised valuesDr. Assets Cr. Business Purchase Liabilities taken overDr. Business Purchase Cr. Liabilities Purchase consideration agreed uponDr. Business Purchase Cr. Vendor Profit on the acquisitionDr. Business Purchase Cr. Capital Reserve Loss on the acquisitionDr. Goodwill Cr. Business Purchase Settlement of the purchase consideration by cash and/or issuing shares and debentures Dr. Vendor Cr. Cash/Share Capital/Debentures

12. 12 Example 1 Taking over a sole traders

13. 13 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$180000 Motor vehicles$70000 Stock$40000 Debtors$50000 Balance Sheet as at 31 Dec 1997 (before takeover) Sino trading co.K. Chan Land & Buildings$300000 - Machinery 260000$185000 Furniture & Fittings 70000 - Motor Vehicles 130000 68000 Stock 84000 43000 Debtors 98000 52000 Cash 420000 7000 1362000 355000 Share capital/capital 1000000 352000 Profit and loss 320000 - Creditors 42000 3000 1362000 355000

14. 14 Realization Machinery 185,000 Motor Vehicles 68,000 Stock 43,000 Debtors 52,000 Capital – Profit on Realization 5,000 (bal. fig.) Sino Trading – purchase consideration 350,000 Creditors – taken over 3,000 353,000 Sino Trading Company Ltd. Realization 350,000Cash 350,000 In K. Chan’s Book (Seller) All assets and liabilities taken over should be stated At book value before the takeover in the realization account Cash Bal b/ f 7000Capital 357000 Sino trading co. 350000 357,000 357000 Capital Bal b/f 352000 Realization –profit 5000 Cash 357000 357000

15. 15 In Sino Trading Company Ltd.’s Book (Buyer’s Book) Business Purchase Cash – purchase consideration 350,000 Creditors 3,000 Machinery 180,000 Motor Vehicles 70,000 Stock 40,000 Debtors 50,000 Goodwill (bal. fig.) 13,000 353,000 353000 Assets and liabilities taken over should be Stated at their revised values in the business Purchases account

16. 16 In Sino Trading Company Ltd.’s Book (Buyer’s Book) Sino Trading Company Ltd. Balance Sheet as at 1 January 1998 (after acquisition ) Fixed Assets Goodwill 13,000 Land and Buildings 300,000 Furniture and Fittings 70,000 Machinery (260,000 + 180,000) 440,000 Motor Vehicles (130,000 + 70,000) 200,000 1,023,000 Current Assets Stock (84,000 + 40,000)124,000 Debtors (98,000 + 50,000) 148,000 Cash (420,000 – 350,000) 70,000 342,000 Less: Current Liabilities Creditors (42,000 + 3,000) 45,000 Working Capital 297,000 1,320,000 Share Capital 1,000,000 Profit and Loss 320,000 1,320,000

17. 17 Example 2 Settlement by shares The 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

18. 18 In Sino Trading Company Ltd’s Book (Buyer’s Book) Sino Trading Company Ltd. Balance Sheet as at 1 January 1998 (after acquisition) Fixed Assets Goodwill 13,000 Land and Buildings 300,000 Furniture and Fittings 70,000 Machinery (260,000 + 180,000) 440,000 Motor Vehicles (130,000 + 70,000) 200,000 1,023,000 Current Assets Stock (84,000 + 40,000)124,000 Debtors (98,000 + 50,000) 148,000 Cash 420,000 692,000 Less: Current Liabilities Creditors (42,000 + 3,000) 45,000 Working Capital 647,000 1,670,000 Share Capital (1,000,000 + 350,000) 1,350,000 Profit and Loss 320,000 1,670,000

19. 19 Example 3 Taking over a limited company

20. 20 The following trial balances are extracted from Astin Ltd. And cathay Ltd. On 31 Dec 1997 Astin Ltd.Cathay Ltd. DrCrDrCr Goodwill $3000- Premises 25000080000 Plant & Machinery 37000046000 Stock 12000072000 Debtors 6500028000 Bank 5300014000 Share capital-ord. shares of $1@ 560000200000 Share premium 100020000 Profit and loss 1300005000 5% debentures10000013000 Creditors 700002000 861000 861000 240000 240000

21. 21 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.

22. 22 Realization Premises 80,000 Plant and Machinery 46,000 Stock 72,000 Debtors 28,000 Bank 14,000 Debentures 13,000 Creditors 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 Shareholders Shares in Astin Ltd.-purchase Consideration 253000 Share capital 200000 Profit and loss 5000 Share premium 20000 253000 Realization-profit 28000 All shares capital and reserves should be closed to the sundry shareholders’ account

23. 23 Business purchase Premises 100000 Plant and Machinery 46,000 Stock 70,000 Debtors 24,000 Bank 14,000 Debentures 13,000 Creditors 2,000 Astin Ltd. – purchase consideration (230,000 X 1.1) 253,000 In Cathy Ltd.’s Book (Seller) Goodwill (bal. Fig.) 14000 268,000 268000

24. 24 In Astin Ltd.’s Book (Buyer’s Book) Astin Ltd. Balance Sheet as at 1 January 1998 (after acquisition) Fixed Assets Goodwill (3,000 + 14,000) 17,000 Premises (250,000 + 100,000) 350,000 Plant and Machinery (370,000 + 46,000) 416,000 783,000Current Assets Debtors (65,000 +24,000) 89,000 Bank (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 1,057,000 Share Capital Share Capital (560,000 + 230,000) 790,000 Share Premium (1,000 + 23,000) 24,000 Profit and Loss 130,000 944,000 Long-term Liabilities 5% Debentures (100,000 + 13,000) 113,000 1,057,000

25. 25 Share Exchanges

26. 26 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,

27. 27 Share exchange Limited companyHolding company Shares Subsidiary company No entry in accounts Issue of shares or debentures to Subsidiary company’s shareholders

28. 28 Share Exchange Accounting Entries Dr. InvestmentWith the total cost of investment Cr. Share CapitalWith the par value of the issue of exchange Cr. Share PremiumWith the premium on the new issue

29. 29 Example 4

30. 30 The following balance sheets reflect the situation of Joyce Ltd and Anna Ltd. On 31 Dec 1997 Joyce Ltd.Anna Ltd. Goodwill - $20000 Land & building 13000001000000 Plant & machinery 750000 450000 Office equipment 80000 50000 Stock 150000 97000 Debtors 180000 110000 Bank 65000 34000 2525000 1761000 Share capital- ord. Shares of $1@ 2000000 1000000 Profit and loss account 400000 600000 General reserve 50000 60000 Creditors 75000 101000 2525000 1761000

31. 31 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.

32. 32 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 1,800,000 Current Assets Stock 150,000 Debtors 180,000 Bank 65,000 395,000 Less: Current Liabilities Creditors 75,000 Working Capital 320,000 4,250,000 Plant and Machinery 750,000 Office Equipment 80,000 Share Capital Ordinary Shares of $1 each (2000000+150000) 3,500,000 Reserves Share Premium [(1000000*3/2)*20%] 300,000 General Reserve 50,000 Profit and Loss Account 400,000 4250000

33. 33 Pre-incorporation Profit

34. 34 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.

35. 35 Pre-incorporation Profits Accounting entries Dr. Profit and LossWith the pre-incorporation profits earned Cr. Capital Reserve/Goodwill Dr. GoodwillWith the pre-incorporation loss Cr. 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.

36. 36 Allocation of profits between different parties

37. 37 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 1/41/6 31/12 Apportionment of profits: 1/1 to 31/3Partnership 1/4 to 31/5Pre-incorporation Profits 1/6 to 31/12Limited company(Post-incorporation profits) Date of incorporation Financial year end

38. 38 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 31/3Pre-incorporation Profits 1/4 to 31/12Limited company (Post-incorporation profits) Date of takeover Date of incorporation Financial year end

39. 39 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 31/3Partnership 1/4 to 31/12Limited company (Post-incorporation profits) Date of takeover of incorporation Financial year end

40. 40 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

41. 41 Basis of ApportionmentExamples SalesVariable 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. TimeFixed 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.

42. 42 Apportionment of Revenues and Expenses Basis of ApportionmentExamples 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.

43. 43 Example 5 Refer to textbook P.191-192

44. 44 Example 5