MCom I Semester Corporate Accounting Amalgamation Reconstruction Study Material Notes

MCom I Semester Corporate Accounting Amalgamation Reconstruction Study Material Notes: Accounting for amalgamations Types of amalgamation Purchase Consideration Difference Between amalgamation in the Nature of Merger and Amalgamation He Nature of PurchaseMethods of determining purchase considerations Calculation of Purchase considerationsAccounting treatment :

CTET Paper Level 2 Set IX Model Paper in English

Amalgamation and Reconstruction

The modern age is the age of large-sized business units and industrial competition. Companies engaged in the same trade agree to combine with the object of eliminating or at least decreasing competition, pooling financial, technical and commercial resources, securing the economies of large scale production and controlling price and markets by securing the monopolistic situation. Apart from pooling arrangements, combination proceeds either by means of holding companies or through mergers. Accounts of holding companies have been dealt with in a separate chapter elsewhere. This chapter deals with merger and reconstruction only.

Merger may take the form of amalgamation or absorption.

Amalgamation : When two or more existing companies go into liquidation and a new company is formed to take over their business, this type of combination is termed as ‘amalgamation’. Thus, in amalgamation (1) existing companies are liquidated and (2) a new company is formed to takeover the business of the existing companies. In this form of merger, the liquidators of old companies become the vendors and the new company becomes the purchaser.

Absorption : When an existing company acquires one or more existing companies, it is known as absorption. Under it, (1) no new company is required to be formed, (2) the absorbed company or companies go into liquidation and (3) the absorbing company continues its legal entity. In this form of merger, the liquidators of absorbed companies become the vendors and the absorbing company becomes the purchaser.

Accounting for Amalgamations

The Institute of Chartered Accountants of India has issued in October 1994 Accounting Standard 14 (AS – 14) on “Accounting for Amalgamations”. It is in force since accounting periods commencing on or after 1-4-1995 and is mandatory in nature. This standard specified the procedure of accounting for amalgamations and the treatment of any resultant goodwill or reserves.

A S 214 has modified the prevailing concepts of amalgamation and absorption as described above. This standard recognizes that amalgamation may take the shape of merging of one company with another or merging of two or more companies to form a new company. Traditionally, the former situation was called as

absorption and the latter as ‘amalgamation’. However, after the issue of AS – 14, this distinction is of no significance and the concept of absorption has been incorporated in the term amalgamation. In this standard, the term ‘transferor company’ is used for ‘absorbed’ or ‘amalgamating’, i.e. vendor company and the word) ‘transferee’ company has been used for absorbing or amalgamated, i.e. purchasing company. Thus, the h transferor company means the company which is amalgamated into another company and the transferee company means the company into which a transferor company is amalgamated

At is to be noted that AS – 14 does not deal with cases of acquisitions which arise when there is a purchase by one company (referred to as the acquiring company) of the whole or part of the shares or the whole or part of the assets of another company (referred to as the acquired company) in consideration for payment in cash or by issue of shares or other securities in the acquiring company or partly in one form and partly in the other) Here, it is to be noted that in case of acquisitions, the acquired company is not dissolved and its separate entity continues to exist whereas in case of amalgamation the amalgamating company is dissolved without liquidation and is merged into the amalgamated company.

Types of Amalgamation

AS-14 divides amalgamation for accounting purposes into two categories: (1) Amalgamation in the nature of merger and (ii) Amalgamation in the nature of purchase.

(1) Amalgamation in the nature of merger

It is an amalgamation which satisfies all the following five conditions as laid down under paragraph 3(e) of AS-14: 0 All the assets and liabilities of the transferor company become, after amalgamation, the assets and liabilities of the transferee company.

(ii) Shareholders holding not less than 90% of the face value of the equity shares of the transferor company (other than the equity shares already held therein, immediately before the amalgamation, by the transferee company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue of the amalgamation.

(iii) The consideration for the amalgamation receivable by these equity shareholders of the transferor company who agree to become equity shareholders of the transferee company is discharged by the transferee company wholly by the issue of equity shares in the transferee company except that cash may be paid in respect of any fractional shares.

(iv) The business of the transferor company is intended to be carried on, after the amalgamation, by the transferee company.

(v) No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity of accounting policies.

In this type of amalgamation, there is genuine pooling not merely of the assets and liabilities of the combining companies but also of shareholders’ interest and of the businesses of these companies. The equity shareholders of the combining entities continue to have a proportionate share in the combined entity. Moreover, the resultant figures of assets, liabilities, capital and reserves more or less represent the sum of the relevant figures of the amalgamating companies.

(2) Amalgamation in the nature of the purchase

Amalgamation may be considered in the nature of purchase when any one or more of the five conditions specified for amalgamations in the nature of merger is not satisfied.

Purchase Consideration

The price payable by the transferee company to the transferor company for the amalgamation of business is called the purchase consideration. In fact, it is the amount payable by the transferee company for the net assets of the transferor company taken over. Para 3 (g) of AS-14 defines the term consideration for amalgamation as the aggregate of the shares and other securities issued and the payment made in the form of cash or other assets by the transferee company to the shareholders (equity and preference both) of the transferor company.’ It is very important to note that purchase consideration does not include the amounts of outside liabilities (e.g. creditors, debentures etc.) which will always be presumed to have been taken over and discharged by the transferee company. However, if it is expressly given in the question that any such liability is not being taken over by the transferee company, it will be paid by the transferor company. Moreover, the consideration for amalgamation should include any non-cash element at fair value. For example, in case of securities, the value fixed by the statutory authorities may be taken to be the fair value. In case of other assets, market value of the asset given up may be treated as the fair value and in case market value of the asset given up can not be reliably assessed, such asset may be valued at its net book value.

Difference between Amalgamation in the Nature of Merger and Amalgamation in the Nature of Purchase

1 Shareholders’ Interest : In the case of merger, there is genuine pooling not merely of assets and liabilities of amalgamating companies but also of the shareholders’ interest. At least 90% of the equity shareholders of transferor company become shareholders of the transfer shareholders of transferor company (or companies) continue to company become shareholders of the transferee company. As such, the Steror company (or companies) continue to have a substantial or proportionate share in the equity and management of the transferee company. In the case of amalgamation in the nature of purchase, all the assets and hand necessarily be transferred to the transferee company. Moreover, 90% of the equity shareholder transferor company need not necessarily continue to remain the shareholders of the transferee company As such, the shareholders of transferor company normally do not have controlling interest transferee company.

2. Accounting Method : In the case of merger, pooling of interest method of accounting is applicable in the books of transferee company whereas in the case of amalgamation in the nature of purchase, purchase method of accounting is applicable.

3. Value of Assets and Liabilities : In the case of merger, assets, liabilities and reserves of the transferor company are recorded by the transferee company at their existing carrying values but in the case of purchase, assets and liabilities of the transferor company are recorded by the transferee company at their revised fair values.

4. Identity of Reserves : In the case of merger, identity of reserves is maintained and they are merged into the reserves of transferee company in the same form as they appear in the balance sheet of transferor company. On the contrary, reserves of transferor company, other than statutory reserves, are not included in the financial statements of the transferee company.

5. Continuation of Business of the Transferor : In the case of merger, it is intended to continue the business of transferor company but in case of purchase, continuation of business of the transferor company is not a must.

6. Purchase Consideration : In the case of merger, purchase consideration is discharged by the transferee company almost wholly by the issue of its equity shares but in case of purchase, the purchase consideration may be discharged in any way, i.e., in cash, shares or debentures or a combination of any of these three.

Methods of Determining Purchase Consideration

Purchase consideration may be determined by any of the following methods:

(1) Lump Sum Payment Method : The amount of purchase consideration may be expressly given in the problem as a lump sum. In such a case, no calculation is required.

(2) Net Assets Method : If neither the lump sum amount nor the details of various forms of payment receivable by the transferor company from the transferee company are given in the problem then the purchase consideration will be calculated by net assets method. In this method, the amount of purchase consideration is ascertained by adding the fair or agreed value of assets taken over by the transferee company and deducting there from the fair or agreed value of outside liabilities to be assumed by it. If any asset or liability of the transferor company is revalued then the revalued value of such item will be taken as its fair value otherwise book value of the item should be considered as its fair value.

While determining the amount of purchase consideration under this method, the following points merit attention :

(a) Purchase consideration is calculated on the basis of those assets and liabilities which are being taken over by the transferee company. Hence, if any asset or liability is not being taken over by the transferee company, the same should not be included while computing purchase consideration.

(b) The term “all assets” will always include cash in hand and cash at bank, unless otherwise stated but it shall never include any fictitious assets or expenses not written off (e.g. preliminary expenses, underwriting commission, discount on issue of shares or debentures, advertisement suspense account, debit balance of profit and loss account etc.). If there is any goodwill, prepaid expenses, patent, trademark etc., the same will be included in the assets unless otherwise stated.

(c) The term “liabilities will mean all liabilities to third parties (eng. Trade Creditors, Bills Payable overdraft, Outstanding Expenses, Debentures, Loans, Provision for Taxation. Employee Deposit, Unclaimed Dividends etc.) but it shall not include any past accumulated profits (such as General Reserve, Reserve Fund, Sinking Fund. Dividend Equalization Fund, Capital Securities Premium Account, Capital Redemption Reserve Account, Credit balance of Prontando Account Forfeited Shares Account Development Rebate Reserve, Contingency Ry compensation, Accident or Insurance Fund etc) where funds in the nature of my Leasehold Redemption Fund, Rehabilitation Fund Staff Provident Fund, Pension Fund, superannuation Fund, Workmen’s Savings Bank Account. Workmen’s Profit Sharing Fund, Employees Welfare Fund, Sundry Shareholders Dividend Account, Workmen’s Compensation,

Accident or insurance Fund upto the amount of actual claim etc.) shall be included in liabilities.

(d) The term “Trade Liabilities” will mean trade creditors and bills payable only and shall not include outstanding expenses, provision for taxation, bank overdraft, debentures etc.

(e) The term “business” will always mean both the assets and liabilities to outside parties.

(3) Net Payment Method : Under this method, the purchase consideration is ascertained by adding up the cash paid and the agreed values of shares and debentures allotted by the transferee company to the shareholders (equity and preference both) of the transferor company in discharge of their claims but the payment made to debentureholders and other outside liabilities should not be considered as part of the purchase consideration as these liabilities will be presumed to be taken over and paid by the transferee Company. Similarly, cost of winding up of transferor company paid by the transferee company shall also be! ignored for the purpose of purchase consideration.

Notes: (i) Shares and debentures of the transferee company can be issued as fully paid-up or partly paid up. Further, these shares and debentures can be issued at par, at premium or at discount as per the terms! of the agreement

(ii) The assets and liabilities taken over by the transferee company are not ties taken over by the transferee company are not considered in calculating the purchase consideration. If the value of net assets transferred to the transferee com to purchase consideration then necessary entry is passed in the books of the transferee company for adjusting the difference.

(iii) Shares issued by the transferee company to the transferor company as par

any to the transferor company as part of purchase consideration should be valued at their paid-up value unless agreed otherwise. That is to say market value of shares issued should be ignored unless it is agreed to issue shares at market value

(IV) Owing to exchange ratio, sometimes it is not possible to find the whole number of shares. Any fraction of shares so arrived at is always satisfied in cash. The value of fractional share is calculated on the basis of the market price of the shares unless an express agreement is made for its valuation on the

basis of paid-up value of share.

Illustration 2. X Co. Ltd, agrees to take over the business of Y Ltd., the consideration being the assumption of trade liabilities Rs. 50,000; the payment of the costs of the liquidation Rs. 5,000; the redemption of B Debentures of Rs. 2,00,000 at a premium of 10%: the discharge of ‘A’ Debentures Rs. 4,00,000 at a premium of 8% by the issue of 10% Debentures in the X Co. Ltd, and the payment of Rs. 10 per share in cash and the exchange of 2 fully paid Rs. 10 shares in the X Co. Ltd. at the market price of Rs. 15 per share for every share in the Y Co. Ltd. The share capital of the vendor company consists of 20,000 shares of Rs. 25 each fully paid. Calculate purchase consideration as per AS – 14.

Solution :

Payment to shareholders :

Cash                                                      20,000 x 10

Shares of purchasing company          20,000 x 2 @ Rs. 15

Purchase Consideration

8,00,000

Note : As per AS – 14, consideration for amalgamation means the aggregate of the shares and other securities issued and payment made in the form of cash or other assets by the transferee company to the transferor company. Hence, payment made to debenture holders and payment of the costs of liquidation should not be considered as part of purchase consideration. (4) Share Exchange Method : In this method, the purchase consideration is ascertained on the basis of the ratio in which the shares of the transferee company are to be exchanged for the shares of the transferor company. It is to be remembered that here also purchase consideration will mean payment to shareholders only. The exchange ratio is generally based on intrinsic value or net assets value of each company’s shares. For example, suppose that A Ltd. is taking over B Ltd. and the intrinsic value of shares of the two companies is respectively Rs. 20 and Rs. 8. In this case, the number of shares to be allotted to B Ltd. as purchase consideration will be determined as follows:

Total number of shares of B Ltd. *

It is significant to remember that in the calculation of purchase consideration the shares so issued will be shown at their paid-up value unless it is agreed to issue shares at market value.

Amalgamation Reconstruction Study Material

Illustration 3. The following is the Balance Sheet of X Ltd. as on 31st March 2006:

Opening entries in the books of transferee (purchasing) company

It is relevant to state that AS-14 regulates the accounting treatment of amalgamation only in the books of the transferee company. The accounting procedure in the books of transferee company will differ upon the type of amalgamation (i.e. amalgamation in the nature of merger or purchase). There are two methods of accounting for amalgamation in the books of transferee company, viz. :

1The pooling of interest method,

2. The purchase method.

Amalgamation Reconstruction Study Material

The Pooling of Interest Method     

This method of accounting is applicable for amaleamation in the nature of merger w business of the amalgamating companies are intended to be carried on by the amalgamaton Hence, minimum changes are made in aporeontine the individual financial statements of the amalgamaung companies. Following are the main features of this method:

(1) The assets, liabilities and reserves (whether capital or revenue or arising on revaluation of the transferor company are recorded by the transferee company at their existing carrying amounts and the same form as at the date of amalgamation.

If the transferor and transferee companies have conflicting accounting policies, a uniform set of accounting policies should be adopted to ensure uniformity. The effect on the financial statements of any changes in accounting policies if material should be reported in the year of change in accordance with

AS-5. (ii) The balance of the Profit and Loss Account of the transferor company should be aggregated with the corresponding balance of the transferee company or transferred to General Reserve, if any.

(iii) The identity of the reserves is maintained and they are shown in the balance sheet of the transferee company in the same form as they had appeared in the financial statements of the transferor company For example, general reserve of the transferor company will become the general reserve of the transferee company and the capital reserve of the transferor company will become capital reserve of the transferee company. As a result of this treatment, reserves which were available for distribution as dividend before amalgamation would be available for distribution as dividend after the amalgamation also.

(iv) The difference between the amount recorded as share capital issued plus any additional consideration in the form of cash or other assets (i.e. the purchase consideration) and the amount of share capital of the transferor company should be adjusted in reserves.

Clarification : According to an opinion of Expert Committee of I.C.A.I., the difference between the issued share capital of the transferee company and share capital of transferor company (or companies) should be treated as Capital Reserve. But this will not be available for distribution to shareholders as dividend and/or bonus shares. It clearly means that if purchase consideration exceeds the share capital of transferor company, it is a capital loss and so adjustment must be made, first of all in the capital reserves and if capital reserves are insufficient then in the revenue reserves of transferor and transferee companies. However, if these two are insufficient then the unadjusted difference may be adjusted against Profit and Loss account but in no case statutory reserves should be applied for this purpose. If there is still some unadjusted balance, the net difference will be adjusted by debiting general reserve account of the transferee company. However, if the transferee company is a newly incorporated company or in case of an old company, it has no general reserve then the difference will be adjusted by debiting it to the profit and loss account.

The calculation procedure will be as follows: Purchase Consideration

Paid-up Share Capitals of the transferor company (companies)

Difference (being loss)

Adjustment against capital reserves, revenue reserves and accumulated

profits of the transferor and transferee companies

Net Difference

(V) The liquidation or realization expenses of the transferor company borne by transferee company will be debited to general reserve account or profit and loss account of the transferee company.