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Purchase Consideration – Types & Methods explained

There is a specific formula for calculating the final purchase consideration amount which is needed to pay by the buyer at the time of amalgamation.

Purchase consideration explained –

The Purchase consideration is the final amount on which a deal is locked between two companies or two people at which they agreed to sell or buy their business respectively. The amalgamation is the addition or combination of two firms. And in sales, the purchase amount will be disclosed before amalgamation. The Net Asset is the highly used type of Purchase consideration method.

In some cases, when a brand or company is growing so rapidly and the value of their assets is pretty much low but the analytical data is indicating a record-breaking performance. Now, people who are willing to buy that company, have to deal in the Lump-Sum purchase consideration method.

Amalgamation

Amalgamation is the cost which you are paying to the person from which you are buying the complete company.

Purchase consideration

There is a specific formula for calculating the final purchase consideration amount which is needed to pay by the buyer at the time of amalgamation. And we can understand this by an example:

Suppose if you’re buying my company and we both agreed on 1000$ value. Along with that, you’re buying 10K shares for 10$ each share then the value of shares will be combined with the company value to become consideration value. Now the final price will be like 1000$ (Agreed amount) + 10000$ (Total shares value) = 11000$.

Note: You can assume any currency here to simplify.

 

Types of Purchase consideration

The final purchase consideration value can be calculated by four top methods and that’s are:

  1. Net Assets method
  2. Net Payment method
  3. Lump-Sum method
  4. Intrinsic Value method

Later in this article on Purchase consideration methods, we will understand the concept of all four major methods and their working algorithms.

READ: Commercial financing roles & description

Net Assets Method:

The Net Assets method is used when the company calculates the value of shares based on the assets of the company. And to calculate Amalgamation value by Net Assets method is Net Assets available for equity shareholders divided by the number of equity shares.

To get net assets value you need to subtract the value of the assets from third-party liabilities from total assets value including preference share capital and other liabilities. Then the output value is net assets which are divided by the number of equity shareholders.

Net Payment Method:

In the Net Payment method, all focus is on Share Holders’ profit and the amount they are getting after the Amalgamation of the company. Also, ignore value and assets given to debenture holders.

Here the company which is taking over any other company has to pay the Amalgamation value to the equity and liability shareholders. For example, the new company agreed to provide their company shares to the existing shareholder of the old company with some more profit like along with hard cash, etc., or premium shares.

Related Questions And Answers:

Qn 1: What is Purchase Consideration as per AS-14?

Ans: In AS-14 value, only payments for Shareholders are considered which is made by the transferee company to the shareholders of the transferor company. Also, debenture holder cost and liquid expenses are not considered as the value in AS-14 purchase consideration.


Qn 2: What are the methods of calculating purchase consideration?

Ans: There are four types of Purchase consideration or methods by which you can calculate the amalgamation value of any company?

  • Net assets method
  • Net payment method
  • Lump-Sum method
  • Intrinsic value or share exchange method
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Harish Yadav

Finance and market analyst and chief writer on howtofinance. Passionate to read books and articles on marketing and accounting. Also edits other articles and publish them here.

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