lump sum acquisition of a group of assets

Discussion in 'General Accountancy Discussion' started by visualcpa, Jul 21, 2012.

  1. visualcpa

    visualcpa

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    Jul 21, 2012
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    I have provided an example below of a problem and am not sure why inventory is not to be apportioned in a lump sum acquisition- is this because it is measured at Net Realisable Value, or is it related to the fact inventory is a current asset and thus not depreciated. - Your thoughts would be appreciated?

    Example:

    A food manufacturing company called Mr Noodles has decided to purchase a number of assets from another business. An independent valuation of the assets has been carried out and values them as follows: Sauce Unit - $17,000, Bottle Plant - $23,000, Inventory - $6,000 net realisable value , Warehouse and Land - $60,000. Mr Noodles has paid $94,400 for the assets. Show the general journal entries needed to record the purchase of the assets.

    Solution:

    Cost is not apportioned to inventory

    Cost allocated to Sauce Unit = 17,000/100,000 x 88,400
    = $15,028

    Cost allocated to Bottle Plant = 23,000/100,000 *88,400
    = $20,332

    Cost allocated to Warehouse and Land = 60, 000/100,000 * 88,400
    = $53,040
     
    visualcpa, Jul 21, 2012
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  2. visualcpa

    ArcSine

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    The question is, what makes inventory different in the sense that it doesn't participate in the pro-rata allocation arrangement? All the assets have been independently valued, including inventory; so why is the inventory's valuation number respected in the allocation in full, while the appraisal numbers of the other assets are not?

    The difference is that assets such as buildings, equipment, and real property actually have a range of "true" values, with the value of such an asset in any given situation being a function of who owns the asset, and what economic value such owner can derive from the asset. A building might be worth 10,000 to me but 14,000 to you, if you (via superior management, better customer contacts, more talented workforce, e.g.) can generate better profits from the building than me. An independent appraisal can arrive at some "average" value for this asset based on comparables and other broad market data, but it can't specify a value with respect to any particular owner.

    In this case, Noodles has figured the non-inventory assets to be worth 88,400 in Noodles' hands. We might be tempted to assign the 88,400 to the long-term assets in the same way that Noodles valued 'em to arrive at the 88.4K in the first place. But then we realize that the 88,400 isn't the precise total found at the bottom of some 30-page asset-by-asset valuation listing that Noodles prepared. Instead, it's a number arrived at after a lot of back-and-forth negotiations between the parties. In the end, 88.4K was just a number that Noodles felt was acceptable to pay for the entire collection.

    Thus for apportionment purposes, assigning the total on the basis of pro-rata appraisal values is deemed an acceptable simplification.

    Inventory, though, is generally worth the same to all parties; if you could sell a particular pile of finished goods for 6K, so could I, and so could anyone else. It is what it is. If it's been determined that the inventory in question has a net realizable value of 6K, that's really not an "owner-specific" number; give or take a few dollars, that's what Noodles will likely get from selling the stuff. Hence it's reasonable to assign that number (6K) to the inventory in the acquisition.
     
    ArcSine, Jul 22, 2012
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    visualcpa likes this.
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  3. visualcpa

    visualcpa

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    thanks ArcSine, for your detailed answer, it sheds a new light on the issues and highlights the subtly of accounting principles .

    What happens if inventory is not valued at Net realisable value , and just has a fair value attached to it? - can it still be apportioned on a pro rata basis. ?

    Cheers,

    James
     
    visualcpa, Jul 23, 2012
    #3
  4. visualcpa

    ArcSine

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    I'm glad it helped a bit, James.

    The basic ideas I discussed previously form the foundational, theoretical concepts that one would probably start with when developing a set of accounting standards re the allocation of a buyout price across the assets. Whoever developed the allocation methodology you described in your first post (inventory is allocated a portion of the cost equal to its NRV; all other assets are then allocated the remainder of the buyout price based on their relative assessed values) likely would've considered the theoretical differences between inventory and other assets---the stuff I discussed---and from there, developed the specific allocation rules. Hence my answer was to provide a rationale for the existence of allocation rules wherein inventory was treated differently from other assets.

    But when it comes to specific wrinkles and variations on the theme (such as inventory being priced at FMV rather than NRV), you'll need to look at the specific accounting principles in effect for the situation at hand. Hopefully, whatever set of accounting principles you're working under has already addressed that wrinkle and has provided guidance. If the accounting principles which govern the situation you're working with are silent as to the "FMV vs NRV" issue, you might look to see if there appears to be some one approach that the industry tends to go with; failing that, you might need to let instinct and accounting common sense be your guide.

    However, I'd in general be disinclined to throw inventory into the "pro rata allocation" mix along with the other assets, just because you're handed a FMV number instead of an NRV amount. FMV, NRV, estimated current selling price, estimated selling price less a reasonable provision for selling expenses (and possibly a little reasonable markup); these are all close cousins and variations of each other. Having any one instead of any one other doesn't make a huge difference, and especially it doesn't negate the general logic of treating inventory differently in the allocation scheme.

    In most acquisitions in which inventory is involved, the buyer typically has a pretty good idea what that inventory is worth and what they'll be able to sell if for, post-acquisition. In the buyer's mind, a specific portion of the buyout price (somewhere in that FMV, NRV, etc. neighborhood) is definitely going towards buying the inventory. Hence, the accountant's allocation of the buyout price should probably take this into account, whether you're specifically working with the FMV number, the NRV amount, or some other close variation thereof.
     
    Last edited: Jul 23, 2012
    ArcSine, Jul 23, 2012
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