What is Purchase Consideration? Start with an everyday intuition
Imagine you want to buy a small shop from its owner. You don't just pay for the goods on the shelves — you also pay for the shop's name, its customer base, the furniture, the pending bills, and maybe even the goodwill. The total amount you agree to pay the seller for everything — all assets, all liabilities, the whole business — is the purchase consideration.
In simple terms: when one business buys another business (not just its products), the lump sum paid is purchase consideration. It is the price of the entire business as a going concern.
The precise meaning (as per NCERT / Class 12)
Purchase Consideration is the agreed amount payable by the purchasing company to the vendor company (the one being sold) for the acquisition of its business.
It is not the same as the net assets (assets minus liabilities). It is a negotiated figure — often different from the book value of net assets. If the purchase consideration is higher than the net assets, the difference is goodwill. If lower, it is capital reserve.
Why does it matter?
Because the entire accounting entry for the purchase of a business hinges on this one number. You cannot record the acquisition without first determining:
- How much to pay the old firm
- Whether goodwill arises or capital reserve is created
- How to settle the payment (cash, shares, debentures, or a mix)
In board exams, the most common mistake is confusing purchase consideration with net assets. They are not the same.
Methods of calculating Purchase Consideration
NCERT prescribes four methods. You need to know all, but the Net Assets Method is the most frequently tested.
| Method | Basis |
|---|
| Net Assets Method | Purchase consideration = Agreed value of assets taken over – Agreed value of liabilities taken over |
| Net Payment Method | Purchase consideration = Total of all payments made by the purchasing company (cash, shares, debentures) to the vendor |
| Lump Sum Method | A single fixed amount agreed upon, no breakup |
| Intrinsic Value / Share Exchange Method | Based on the number of shares issued and their intrinsic value |
In the Net Assets Method, you use agreed values, not book values. If the vendor's machinery is worth ₹5,00,000 in the books but both parties agree it is worth ₹6,00,000, you take ₹6,00,000.
Accounting Treatment — The Journal Entry
When the purchasing company acquires the business, it records the following:
Step 1: Record the assets and liabilities taken over
The journal entry in the books of the purchasing company is:
Sundry Assets A/c Dr. [Agreed value of assets taken over]
Goodwill A/c (if PC > Net Assets) Dr. [Difference]
To Sundry Liabilities A/c [Agreed value of liabilities taken over]
To Vendor (or Business Purchase) A/c [Purchase Consideration]
To Capital Reserve A/c (if PC < Net Assets) [Difference]
Goodwill and Capital Reserve cannot both appear in the same entry. Only one of them arises — the difference between purchase consideration and net assets.
Step 2: Discharge of purchase consideration
When the purchasing company pays the vendor:
Vendor (or Business Purchase) A/c Dr. [Purchase Consideration]
To Bank A/c (if paid in cash)
To Share Capital A/c (if shares issued)
To Debentures A/c (if debentures issued)
The format / proforma for the Net Assets Method
In your exam, you will often be asked to compute purchase consideration using the Net Assets Method. Here is the standard working note format:
Net Assets Method – Computation of Purchase Consideration
| Particulars | Amount (₹) |
|---|
| Assets taken over (at agreed values) | |
| Goodwill | xx,xxx |
| Land & Building | xx,xxx |
| Plant & Machinery | xx,xxx |
| Stock | xx,xxx |
| Debtors | xx,xxx |
| Cash at Bank | xx,xxx |
| Total Assets (A) | X,XX,XXX |
| Less: Liabilities taken over (at agreed values) | |
| Sundry Creditors | (xx,xxx) |
| Bills Payable | (xx,xxx) |
| Outstanding Expenses | (xx,xxx) |
| Total Liabilities (B) | (X,XX,XXX) |
| Purchase Consideration (A – B) | X,XX,XXX |
If the purchase consideration is more than (A – B), the excess is Goodwill. If it is less, the shortfall is Capital Reserve. The purchase consideration itself is the agreed amount, not the computed net assets.
A concrete example (no invented data, just a standard textbook pattern)
Suppose Firm X buys Firm Y's business. Agreed values:
- Assets: ₹10,00,000
- Liabilities: ₹2,00,000
- Purchase consideration agreed: ₹9,00,000
Net assets = ₹10,00,000 – ₹2,00,000 = ₹8,00,000
Purchase consideration (₹9,00,000) > Net assets (₹8,00,000)
Difference = ₹1,00,000 → Goodwill
Journal entry in Firm X's books:
Sundry Assets A/c Dr. 10,00,000
Goodwill A/c Dr. 1,00,000
To Sundry Liabilities A/c 2,00,000
To Vendor (Business Purchase) A/c 9,00,000
If instead the purchase consideration was ₹7,00,000 (less than net assets of ₹8,00,000), the difference of ₹1,00,000 would be Capital Reserve, and the entry would be:
Sundry Assets A/c Dr. 10,00,000
To Sundry Liabilities A/c 2,00,000
To Vendor (Business Purchase) A/c 7,00,000
To Capital Reserve A/c 1,00,000
One final point for exams
The Vendor account (or Business Purchase account) is always credited with the purchase consideration. It is later debited when the payment is made. This account is not an expense — it is a liability account representing what is owed to the old firm.
When you see a question that says "Calculate purchase consideration," first check which method is specified. If none is given, the Net Assets Method is the default. And remember: use agreed values, not book values.