Limited liability companies often purchase other businesses for a number of reasons. For example, Facebook purchased Instagram so that it has greater influence in the field of social media. Because new assets are added to the limited liability company, there is a specific accounting treatment for business purchases. In this article, we will explore one concept in particular: purchase consideration.
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.