Question

a. Identify and explain the reasons why total purchase price paid in acquiring a subsidiary company is rarely equal to its total net assets/equity as reported in its audited financial statements. (32 marks)

You may include the following in your discussion:

• • Financial statement line items of assets/liabilities that would/would not usually give rise to the difference and the reasons thereon.
• • Any other reasons.

b. Illustrate the accounting concepts that deal with the difference in the purchase price and total net assets/equity of the subsidiary acquired in the preparation and presentation of consolidated financial statements. (8 marks)

Answer 1

Hello,

Hope you are doing well.

The question related to the part that how in actual scenario the acquisition takes place.

a. Financial statement line items of assets/liabilities that would/would not usually give rise to the difference and the reasons thereon.

The following are some of the reasons (Giving rise to differences):

• Actual Value of fixed assets: There is wide variance usually noticed among the fixed asset values as the amount that is stated in the Balance sheet would not be equal to the realisible amount. So to say for eg. the Land is valued at the amount when acquired however it might have appreciated over the period of time.
• Equity Value: The value of equity shares would be different as compared to the the stock market value of the shares hence there is a difference in the amount of equity and the total purchase price of the equity as it may also be based upon the market value of the shares
• Valuation difference: Another major difference lies in the fact that the acquirer company may follow different policy with respect to valuations of certain assets and liabilities which may cause the variance in the purchase price paid corresponding to the audited numbers of such assets and liabilities (For eg. Inventory)

The following are some of the reasons (Not Giving rise to differences):

• Liquid assets: Usually the liquid assets (such as cash at back) are having the same market value as the balance sheet value hence these line items donot cause any variance in the purchase price and the balance sheet value.
• Liabilities paid off: The liabilties which are p[aid off before acquisition donot cause any differences as the values wont exist in the acquirer Balance sheet.
• Miscellaneous Expense: This Balance sheet line item is not included in the computed net assets and hence the value of which wont make any impact in the differences caused.  

Any other reasons:

• Market reputation: This significant aspect of the organisation cannot be depicted through a balance sheet, and hence the market reputation of the firm may cause the purchase price to vary. Hence a company with a better reputation might give rise to goodwill.
• Underlying agreement: Any lawful agreement binding upon both the parties would also define the purchase price in the event of invocation of such agreement wherein the price stated in the agreement becomes the final acquisition price
• Judicial Dispute: Any juducial dispute in a court of law might order the acquisition price which might not be corresponding to the Net assets.

Accounting Treatment:

In the books of the acquirer company the difference between the purchase price paid and the net assets is booked, this nature of this difference defines the appropriate treatment of the same.

1. Purchase price paid > Net Assets

In most of the scenarios this is the case where in the Purchase price is greater than that of the Net asset which gives rise to Goodwill which is classified under the Intangible Assets.

2. Purchase price paid < Net Assets

In case the purchase price is less than that of the Net assets the difference is then classified under the Equity Portion under the head as Capital Reserve.