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Discussion Forum Index --> Accounting Questions --> Bargain inventory
Estiben (talk|edits) said:
| 6 December 2006
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| In my limited experience, I have not encountered the answer to this: I have a client who purchased a business at a bargain price. He was able to acquire a $70,000.00 inventory at an investment of about $40,000.00. If I book the inventory at 40k, won't that skew net sales when I do the YE adjustments? But if I book it at 70k, where do I enter the difference? Thanks for the help.
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Natalie (talk|edits) said:
| December 7, 2006
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| You say he purchased a business. Is the difference perhaps goodwill?
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Estiben (talk|edits) said:
| 7 December 2006
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| Natalie, that would produce a credit balance for goodwill. Doesn't seem right to me. But now that I've had a chance to sleep on it, I have an idea. What if I book the difference to other income? That way the inventory balance is realistic, the ordinary income figures make sense, and the rest is attributable to the "windfall" of the bargain purchase. Right, or no?
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Natalie (talk|edits) said:
| December 8, 2006
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| You are correct on the goodwill. It sounds like the only thing purchased was inventory. Is that correct? If so, then the entries should be as you have them, debit inventory $40,000 and credit cash (or loan, capital, stock, etc.) No, you wouldn't book other income. Your client got a great deal, and if he prices with the market, there should be a great return on investment. Analysis of cost of goods sold and gross profit may be challenging for a while, but the explanation is that inventory was purchased initially at a bargain price. What year-end adjustments are you referring to? Maybe I don't understand your initial concern.
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Estiben (talk|edits) said:
| 8 December 2006
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| No, you got it. I was referring to adjusting the inventory against cost of goods or sales. I am comfortable now that you have answered my questions. Thank you so much!
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Dennis (talk|edits) said:
| 10 December 2006
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| Personally I like financials to reflect reality. If the 70,000 is current replacement cost of inventory I would book the difference to a separate asset account and recognize the $30,000 as non-operating income as realized.
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Natalie (talk|edits) said:
| December 11, 2006
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| Dennis, what rule are you basing your suggestion on? The reality is the owner got a great deal, for whatever reason. Certainly for taxes the basis is the cost of $40,000. As far as GAAP goes, there is no rule, principle or even guideline that would allow a business to book this type of entry that I am aware of. The profession is moving to fair market value on certain things, but I think in this situation it is not appropriate.
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Dennis (talk|edits) said:
| 11 December 2006
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| Old habits, Natalie. I want to be able to tell how client is doing with his new business on a current basis. The good deal on inventory is money he's already made. Its easier to do the adjusting entry for tax once than to adjust monthly.
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Lhhesscpa (talk|edits) said:
| 13 December 2006
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| The standard for valuing assets is fair market value. When someone purchases substantially all the assets of a business there is a requirement for the purchaser & seller to each file IRS Form 8594, Asset Acquisition Statement, showing the allocation of the purchase price to various classes of assets in a proscribed order. I would refer to that form should provide the answer to your question on inventory. --Larry Hess, CPA | Albuquerque, NM [[UserTalk:Lhhesscpa | Talk to Me]]
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Natalie (talk|edits) said:
| December 13, 2006
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| So, one question is -- were substantially all of the assets purchased? I read the form instructions, and it looks like the IRS uses this to help determine the value of intangibles such as goodwill, which doesn't apply in this case.
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Lhhesscpa (talk|edits) said:
| 13 December 2006
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| Right. Intangibles are the last asset class that the purchase price is allocated to. In the case we're discussing inventory would seem to get all of the purchase price with nothing left over for lower classes such as fixed assets or intangibles. Was that your thinking,too Natalie? --Larry Hess, CPA - Albuquerque, NM
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Estiben (talk|edits) said:
| 15 December 2006
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| It was indeed the case that the inventory was worth more than the entire purchase price. But thanks for the refence on allocating purchase price, I am sure it will be useful down the road.
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Lhhesscpa (talk|edits) said:
| 15 December 2006
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| Estiben: You were asking about how to account for the windfall profit. My answer was in reference to tax accounting. GAAP would give you the same result. You book assets at the lower of cost or market. In your case that would be $40,000. When you sell that inventory you would simply have unusually large profits. --Larry Hess, CPA | Albuquerque, NM - Talk to me
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Natalie (talk|edits) said:
| December 16, 2006
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| Well, Larry, this form is something I haven't used before. It seems to me that $40,000 would be reported as the purchase price, which is all for inventory. Maybe I don't understand your comment above in which you state the standard is valuing assets at fair market value.
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Lhhesscpa (talk|edits) said:
| 16 December 2006
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| Natalie: Actually we do agree on the inventory at $40k in the case being discussed. This case aside, buyer & seller would would agree on the purchase/sale price of assets using an objective standard which would be FMV. --Larry Hess, CPA | Albuquerque, NM - Talk to me
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Natalie (talk|edits) said:
| December 17, 2006
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| Thanks for that clarification Larry. I thought I was missing something.
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