The amount of purchase consideration can be computed under any of the following four methods:- 1. Lump Sum Method 2. Net Worth or Net Assets Method 3. Net Payment Method 4. Intrinsic Value Method (Shares Exchange Method).
Method # 1. Lump Sum Method:
The purchasing company may agree to pay a lump-sum to the vendor company on account of the purchase of its business. In fact, this method is not based on any scientific thoughts and techniques. This method is an unscientific and non-mathematical method of ascertaining purchase consideration.
A purchasing company agreed to take over a business of selling company for Rs. 5, 00,000. In such a case, the purchase consideration is Rs. 5,00,000. No calculations are needed.
Method # 2. Net Worth or Net Assets Method:
Under this method, purchase consideration is calculated by adding up the values of various assets taken over by the purchasing company and then deducting there from the values of various liabilities taken over by the purchasing company. The values of assets and liabilities for the purpose of calculation of purchase consideration are those which are agreed upon between the purchasing company and the vendor company and not the values at which the various assets and liabilities appear in the Balance Sheet of the vendor company.
(Agreed value of Assets taken over) – (Agreed value of liabilities taken over) = Net Assets
The following relevant points are to be noted while ascertaining the purchase price under this method:
(i) If the transferee company agrees to take over all the assets of the transferor company, it would mean inclusive of cash and Bank balances.
(ii) The term all assets, however, does not include fictitious assets, like Debit balance of Profit and Loss Account, Preliminary Expenses Account, Discount and other expenses on issue of shares and Debentures, Advertising Expenses Account etc.
(iii) Any specific asset, not taken over by transferee company, should be ignored while computing the purchase price,
(iv) If there is any goodwill, pre-paid expenses etc. the same are to be included in the assets taken over unless otherwise stated,
(v) The term liabilities will always signify all liabilities to third parties. Trade liabilities are those incurred for the purchase of goods such as Trade Creditors or Bills Payable,
(vi) Other liabilities like Bank Overdrafts, Tax payable, Outstanding expenses etc. are not a part of trade liabilities.
(vii) Liabilities do not include accumulated or undistributed profits like, General Reserve, Securities Premium, Workmen Accident Fund, Insurance Fund, Capital Reserve, Dividend Equilisation Fund etc.
Illustration 1 (Net Assets Method):
Calculate purchase consideration from the following given Balance Sheet:
Illustration 2 (Net Asset Method):
The A Company and B Company whose business are of similar nature, decided to amalgamate and a new Company called AB Company Ltd. is formed to take over their assets and liabilities.
The following are their Balance Sheets:
Assuming that the assets and liabilities are worth at their book values, what amount each Company will get? Pass necessary journal entries in the books of the companies. Also prepare the Balance Sheet of AB Company Ltd.
Method # 3. Net Payment Method:
The agreement between selling company and purchasing company may specify the amount payable to the share-holders of the selling company in the form of cash or shares or debentures in purchasing company. AS – 14 states that consideration for amalgamation means the aggregate of shares and other securities issued and the payment made in the form of cash or other assets by transferee company to the share-holders of transferor company. Thus, under net payment method purchase consideration is the total of shares, debentures and cash which are to be paid for claims of Equity and Preference share-holders of the transferor company.
The following points are to be noted while ascertaining the purchase price under net payment method:
(i) The assets and liabilities taken over by the transferee company and the values at which they are taken over are not relevant to compute the purchase consideration.
(ii) All payments agreed upon should be added, whether it is for equity share holders or preference share-holders.
(iii) If any liability is taken over by purchasing company to be discharged later on, such amount should not be deducted or added while computing purchase consideration.
(iv) When liabilities are not take over by the transferee company, they are neither added or deducted while computing consideration.
(v) Any payment made by transferee company to some other party on behalf of transferor company are to be ignored.
Illustration 3 (Net Payment Method):
Following in the Balance Sheet of Abi Ltd.:
Calculate purchase consideration under Net Payments Method on the following basis:
1. The vendee company agrees to discharge the 7% debentures at a premium of 10% by issuing 9% debentures of vendee company.
2. Preference shares are discharged at a premium of 10% by issuing 15% Preference Shares of Rs. 100 each in vendee company.
3. For every 2 Equity shares in Abi Ltd. 3 Equity shares of Rs. 10 each in vendee company will be issued, in addition to cash payment of Rs. 3 per Equity share in Abi Ltd.
1. Under net payment method, purchase consideration is the total of shares and cash which are to be paid for the claims of Equity and Preference share-holders of transferor company.
2. The claims of debenture-holders met by purchasing company.
Method # 4. Intrinsic Value Method (Shares Exchange Method):
Under this method, net value of assets is calculated according to net assets method and it is divided by the value of one share of transferee company which gives the total number of shares to be received by the share-holders of transfer or company from the transferee company. When the number of shares to be received by the transferor company is known then it is divided by the existing shares of the transferor company and thus the ratio of shares can be found out.
Suppose, in exchange of 50 shares of transfer or company, 100 shares of transferee company is available, then every one share in the transferor company, two shares in the transferee company is available. Therefore, the ratio is 1: 2. This method is also known as Share Proportion Method.
Intrinsic Value = Assets available for equity shareholders/Number of equity shares
Sometimes owing to certain ratio in which shares are to be given, it is not possible to find the whole number of shares. Any fraction of shares so arrived at, in the absence of any agreement, is always settled in cash at market value.
The purchasing company agrees to issue four shares of Rs. 10 each for every three shares of Rs. 10 each of the vendor company. The total numbers of shares of the vendor company are 10,000. The market price of each share of the purchasing company is Rs. 15. Find out purchase price.
The total number of shares to be issued by the purchasing company to the vendor company = 10,000 x 4/3 = 13,333 1/3
The purchase price = 13,333x Rs 15 each = Rs 1, 99,995
In cash Rs 15 x 1/3 Rs 5
Total = 2,00,000
In the absence of instruction, it is presumed that cash for a fraction of a share will be paid on market price basis.