AS 14 Purchase Method and Purchase Consideration

Understand Purchase Method and Purchase Consideration

Key rules to remember

Purchase consideration (net assets method)

PC = Agreed value of assets taken over − Liabilities taken over

Include only assets and liabilities actually taken over. Leave out assets the transferee does not take, and liabilities it does not take.

Purchase consideration (net payment method)

PC = Fair value of shares and securities issued + Cash + Other assets paid to the transferor's shareholders

Value shares at fair value if given, else at the issue price stated. Do not add liabilities paid to outsiders.

Intrinsic value per share

Intrinsic value = (Assets − Liabilities) ÷ Number of equity shares

Used only to fix the exchange ratio, not to compute PC. Calculate it for both companies using the values the question states. Check whether preference dues must be deducted first.

Exchange ratio and shares to issue

Shares to issue = Transferor's shares × (Intrinsic value of transferor share ÷ Intrinsic value of transferee share)

Round fractional shares as the question instructs, and settle fractions in cash if stated.

Goodwill or capital reserve

PC − Net assets taken over (at recorded values): positive = Goodwill; negative = Capital Reserve

Net assets here means assets taken over less liabilities taken over, at the values the transferee records.

Statutory reserve entry in transferee's books

Amalgamation Adjustment Account Dr; To Statutory Reserve (same amount)

Passed only when the statutory reserve of the transferor must be preserved.

How to solve Purchase Method and Purchase Consideration questions

1. 1Read the question and confirm the amalgamation is in the nature of purchase, or that the question says to use the purchase method.
2. 2List the assets and liabilities taken over. Cross out items not taken over, such as bank balances or investments the question excludes.
3. 3Calculate PC as the question implies: net assets at agreed values, shares and cash paid, or the lump sum given. If shares are issued on intrinsic values, use those values only to find the number of shares, then value the shares at fair value or issue price.
4. 4Cross-check where the data allow it. If PC is defined as net assets at agreed values, the share and cash payment should add up to it. Otherwise PC is the agreed price and need not equal the net assets you record.
5. 5Compare PC with net assets at the values the transferee will record. Excess is goodwill; shortfall is capital reserve.
6. 6Handle reserves: drop general and revenue reserves and the profit and loss balance of the transferor, but preserve statutory reserves through the Amalgamation Adjustment Account.
7. 7Write the journal entries in the transferee's books: Business Purchase Account, assets, liabilities, goodwill or capital reserve, and the discharge of PC with share capital and securities premium.
8. 8Show all workings in a clear note, and state the final goodwill or capital reserve figure.

Quickest way: Fast route to PC and goodwill

Common mistakes in Purchase Method and Purchase Consideration

• Including all assets and liabilities in the net assets figure, even those not taken over

  Students copy the whole balance sheet without reading which items the transferee agreed to take.

  Fix: Tick each item the question says is taken over. Compute net assets only from ticked items.

• Adding liabilities paid to outsiders (such as debenture holders or creditors) into PC

  Students confuse total payments by the transferee with payments to the transferor's shareholders.

  Fix: PC is only what shareholders receive. Payments to creditors or debenture holders are settlements of liabilities, not PC.

• Using face value of shares instead of the fair value when computing PC

  Students see the face value in the question and ignore the issue price or market value.

  Fix: When a fair value or issue price is given, use it for PC. Credit face value to share capital and the excess to securities premium.

• Carrying the transferor's general reserve and profit and loss balance into the transferee's books

  This is the pooling method treatment and students mix the two methods.

  Fix: In the purchase method, only net assets are acquired. Drop these reserves. Preserve only statutory reserves via the Amalgamation Adjustment Account.

• Naming goodwill as capital reserve, or the reverse

  Students forget which way the difference runs.

  Fix: PC higher than net assets means you paid for something extra, so it is goodwill. PC lower than net assets means a gain, so it is capital reserve.

• Forgetting the statutory reserve entry or reversing its direction

  The entry looks unusual because no cash or asset is involved.

  Fix: Debit Amalgamation Adjustment Account, credit Statutory Reserve, for the amount to be preserved. Mention it clearly when the question states a statutory reserve.

Worked examples