Meaning of purchase consideration, Methods of calculating Purchase consideration, Net Payment method, Net Asset method

Purchase Consideration refers to the consideration payable by the purchasing company to the vendor company for taking over the assets and liabilities of Vendor Company.

If one company purchases another business as a going concern (that is, the business will continue to operate for eternity), it can pay for it using one or more of the following methods:

• Cash: The entire amount is paid in cash. This is a rare scenario as the following two methods are more common.
• Shares: The limited liability company offers some of its shares to the owners of the business that is being purchased.
• Debentures: The limited liability company may offer some of its debentures to the owners of the business.

The following two things must be kept in mind when the price of the business is being determined:

• The assets bought are stated at different values in the books of the limited company and the books of the selling business. This is because they are revalued to reflect their current worth in the market. This value is known as the fair value of the assets.

The price paid by the limited company for the business is known as the purchase consideration. In many cases, the purchase consideration is not the same as the net assets bought and the difference must be recorded in the books of account.

If the purchase consideration is greater than net assets, the difference is known as positive goodwill. However, if the purchase consideration is lower than the net assets, the difference is known as negative goodwill. The accounting treatment for each of these types of goodwill is different.

Accounting Standard–14 defines the term purchase consideration as the “aggregate of the shares and other securities issued and the payment made in the form of ach or other assets by the transferee company to the shareholders of the transferor company”. Although, purchase consideration refers to total payment made by purchasing company to the shareholders of Vendor Company, its calculation could be in different methods, as explained below:

1. Lump sum method
2. Net Assets method
3. Net Payment Method

Lump sum Method:

Under this method purchase consideration will be paid in lump sum as per the valuation of purchasing companies’ valuation. E.g., if it is stated that A Ltd. takes over the business of B Ltd. for Rs.15, 00,000 here the sum of the Rs.15, 00,000 is the Purchase Consideration.

Net Assets Method:

(1) The value of goodwill will be ascertained.

(2) Fixed assets of the company, disclosed or undisclosed in Balance Sheet, are taken at their realisable values.

(3) Floating assets are to be taken at market value.

(4) Remember to exclude fictitious assets, such as Preliminary Expenses, Accumulated Losses etc.

(5) Provision for depreciation, bad debts provision etc. must be considered.

(6) Find out the external liabilities of the company payable to outsiders including contingent liabilities.

Under this method P.C. shall be computed as follows:

Net Payment Method:

Under this method P.C. should be calculated by aggregating total payments made by the purchasing company. E.g.: A Ltd. had taken over B Ltd. and for that it agreed to pay Rs.5, 00,000 in cash 4, 00,000 Equity Shares of Rs.10 each fully paid at an agreed value of Rs.15 per share then the P.C. will be ascertained as follows: