Accounting for Purchase of Business

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A business accountant at work.
A business accountant at work. (Image: LDProd/iStock/Getty Images)

In accounting, a business combination is a transaction that gives your company control of one or more businesses. The term applies to both mergers and to purchasing another company. Your company accounts have to record the new assets and any debts you acquired in the purchase. The accounting also has to track the goodwill gained from the purchase, and any extra money spent besides the purchase price.

Assets and Liabilities

When your company makes the purchase, it buys all the business's liabilities and assets. Your company's financial statements must recognize your new assets. The dollar amount you report for them is the fair-market value at the time you bought the company. You do the same thing with liabilities, reporting them as your own. If you acquire any of the company's assets or liabilities in separate transactions, record them separately in your accounts. They're not part of the business combination.

Contingent and Uncertain

Some assets or liabilities are contingent, depending on the outcome of a lawsuit or a contract. If, say, the business you take over is being sued, the possibility of losing the lawsuit is a contingent liability. You don't always recognize contingent liabilities or assets in the financial statements. Only contingencies that are probably going to happen go on the books, and only if you can estimate the probable value. If unrecorded contingencies come to pass, you recognize the gain or loss then.

Measuring Goodwill

To figure the value of the company, you add the price you paid for it to any previous ownership stake you had, plus the value of any other owners' non-controlling shares. Compare the result to the value of the assets. If, say, you have $650,000 in assets and the company value is $875,000, the goodwill is usually worth $225,000. If the assets and non-controlling interest are worth more than your purchase price, you report the excess as a gain in earnings. For instance, if you buy a $650,000 company for $550,000, that's a $100,000 gain.

Purchase Costs

Purchase costs include more than what you paid for the business combination. They include finder's fees, legal and accounting fees, fees for appraising the business value, and consulting and advice fees. It also includes general administrative costs, such as maintaining an acquisition department or registering bonds to finance the purchase. Because these costs aren't part of what you pay for the company, you report them separately, as expenses. You report most of these costs in the year you incur them.

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