Amalgamation of Companies

1. Introduction
2. Meaning of Amalgamation
3. Types of Amalgamation
4. Purchase Consideration
5. Method of Accounting for Amalgamation
6. Journal Entries to Close The Books of Vendor Company
7. Entries in the Books of Purchasing Company

1. INTRODUCTION

1. INTRODUCTION

In today’s modern world, we are witnessing, the rise of different business ideas every other day. This has attributed to the immense increase in the competition. Some of the shrewd businesses survive through this cut throat competition, whereas some of them are wiped out due to the dynamics of this very competition.

Like the strategies to set up businesses, there has been wide increase in realizing the need to stay in the business through the different difficult market situations. Hence, the business world has also seen the growing importance of business-saving strategies.

There can be different strategies to ensure the business continues to exist, or existing companies find ways to increase market share by eliminating the competitors or to come out of financial crisis by restructuring the present capital structure and the like.

Such strategies are termed using different words like “corporate marriages”, “strategic alliances”, “business partnering”, etc. The same has been defined in the Accounting Standard 14 (AS 14).

In this chapter we shall understand the terms, meanings, methods, accounting treatments related to amalgamation in detail.

2. MEANING OF AMALGAMATION

Amalgamation refers to the process of merger of two or more companies into a single entity or where one company takes over the other by outright purchase. Therefore, the term ‘amalgamation’ contemplates two kinds of activities:

1. two or more companies join to form a new company (Popularly known as Amalgamation) or
2. absorption and blending of one by the other (Popularly known as Absorption).

As discussed, this arrangement is sought by companies to receive various advantages such as economies of large-scale production, avoiding competition, increasing efficiency, expansion, increase in market share, etc.

In amalgamation we have generally two companies called as – 1) vendor or Transferor Company and 2) Vendee or Transferee Company. Let us understand the concepts through the following examples-

Example 1- Company A and Company B amalgamate to form Company C. Company A and Co B are called transferor companies and Company C is called as the transferee company- this strategy is called as AMALGAMATION.

Example 2- Company A is taken over by Company B (purchased). Here, Company A is called as Transferor Company and Company B is Transferee Company. This strategy is called as ABSORPTION.

Example 3- Company A has been suffering from losses for past 5 years, a new Company B is floated to take over the existing Company A. Here, Company A is the transferor company and Company B is Transferee Company. This strategy is termed as EXTERNAL RECONSTRUCTION.

The concept of the examples given above can be understood from the following table of differences-

In every type of amalgamation, the assets and liabilities of the transferor company are amalgamated or transferred to the transferee company. The accounting treatment in the books of both the transferor and transferee is given in further sections.

3. TYPES OF AMALGAMATION

The Institute of Chartered Accountants of India has introduced Accounting Standard -14 (AS 14) on ‘Accounting for Amalgamations’. The standard recognizes two types of amalgamation – 

Amalgamation in the nature of merger is an amalgamation where there is a genuine pooling not only of assets and liabilities of the transferor and transferee companies but also of the shareholders’ interests and of the businesses of the companies. The accounting treatment of such amalgamations should ensure that the resultant figures of assets, liabilities, capital and reserves more or less represent the sum of the respective figures of the transferor and transferee companies.

Amalgamation in the nature of merger is an amalgamation, as per para 3(e) of AS-14, which satisfies all the following conditions:

1. All the assets and liabilities of the transferor company become, after amalgamation, the assets and liabilities of the transferee company.
2. 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.
3. The consideration for the amalgamation receivable by those 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.
4. The business of the transferor company is intended to be carried on, after the amalgamation, by the transferee company.
5. 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. For example, if transferor company is following weighted average method for inventory valuation, the book value of the inventory of the transferor company will be revised by applying the FIFO method (if the transferee company follows FIFO method for inventory valuation).

If any one or more of the above conditions are not satisfied in an amalgamation, such amalgamation is called amalgamation in the nature of purchase.

Difference between amalgamation in the nature of merger and amalgamation in the nature of purchase 

4. PURCHASE CONSIDERATION

For purpose of accounting for amalgamations, we are essentially guided by AS 14 ‘Accounting for Amalgamations’. Para 3(g) of AS 14 defines the term purchase consideration 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 of the transferor company”.

In simple words, it is the price payable by the transferee company to the transferor company for taking over the business of the transferor company.

The important point to be noted here is the amount paid towards the equity shareholders and preference shareholders is only considered as part of the purchase consideration as per the definition under AS-14. Hence, it should be noted that purchase consideration does not include the sum which the transferee company will directly pay to the debenture-holders or creditors of the transferor company. If a certain liability of the transferor company has not been taken over by the transferee company it will be discharged by the transferor company.

The purchase consideration can be computed in the following methods-

1. Lumpsum method- Under this method, the transferee company agrees to pay a lumpsum/fixed amount to shareholders of the transferor company.
2. Net payment method- Under this method the transferee company makes individual payments to the equity shareholders and preference shareholders either by way of cash, issue of shares and debentures.
3. Net assets method- Under this method, the purchase consideration is arrived based on the value of the Assets less the outside liabilities (excluding share capital and reserves) taken over by the transferee company. As per AS 14, the value of the assets and liabilities shall be at the value as agreed between the two parties. If there is no value agreed, then assets and liabilities taken at the book value.
   The purchase consideration essentially depends upon the fair value of its elements. For example, when the consideration includes securities, the value fixed by the statutory authority may be taken as the fair value. In case of other assets, the fair value may be determined by reference to the market value of the assets given up or in the absence of market value, net book value of the assets (i.e. cost less accumulated depreciation) are considered.
4. Intrinsic value or share exchange method – Under this method, the purchase consideration is calculated at the intrinsic value of shares of the transferor or transferee company. The ratio of shares to be issued is computed and multiplied with intrinsic value. Total share capital of the transferor company shall be divided by the total number of shares.

Sometimes adjustments may have to be made in the purchase consideration in the light of one or more future events. When the additional payment is probable and can be reasonably estimated it is to be included in the calculation of purchase consideration.

Any of the methods or a combination of the above methods can be used by the companies to calculate the purchase consideration.

Purchase consideration either recorded at Issue price or at Par value.

The above methods have been explained in the following illustrations.

5. METHODS OF ACCOUNTING FOR  AMALGAMATIONS

There are two main methods of accounting for amalgamation viz,

IMAGE

The first method is used in case of amalgamation in the nature of merger where the conditions as per para 3(e) of AS-14, required are fulfilled and the second method is used in case of amalgamation in the nature of purchase.

Pooling of Interest Method

Under pooling of interests method, the assets, liabilities and reserves of the Transferor Company will be taken over by Transferee Company at existing carrying amounts unless any adjustment is required due to different accounting policies followed by these companies.

As a result the difference between the amount recorded as share capital issued (plus any additional consideration in the form of cash or other assets) and the amount of share capital of Transferor Company should be adjusted in the reserves of the financial statements of Transferee company (recorded as deduction from the reserves where the capital issued is more than the capital of the transferor company).

In simple terms, where in case of pooling method- the amount to be adjusted against the reserves- can be computed in the following 3 steps-

Step I- Equity Share capital + Preference share capital issued+ any other additional consideration in form of cash and other assets by the Transferee Company.

Step II- Existing Equity share capital + Existing Preference share capital in the books of Transferor Company.

Step III- Step I- Step II= amount to be adjusted from the reserves of Transferee company.

Purchase Method

Assets and Liabilities: the assets and liabilities of the transferor company should be incorporated at their existing carrying amounts or the purchase consideration should be allocated to individual identifiable assets and liabilities on the basis of their fair values at the date of amalgamation.

Difference between the Purchase Consideration and Net Assets transferred: Any excess of the amount of purchase consideration over the value of the net assets of the transferor company acquired by the transferee company should be recognized as goodwill in the financial statement of the transferee company. Any short fall should be shown as capital reserve. Goodwill should be amortized over period of five years unless a somewhat longer period can be justified.

In simple terms, where in case of purchase method- the amount to be transferred to capital reserve or to be recorded as Goodwill- can be computed in the following 3 steps-

Step I- Find out the Net assets amount using the following formula- Total assetsOutside liabilities (Non-current liabilities + Current Liabilities)

Step II- Compute the purchase consideration using any of the methods as given under Purchase consideration computation.

Step III- (a) If Step I- Step II= Positive amount- then it is capital reserve- since the assets received more than the amount paid as purchase consideration to acquire them.

(b) If Step I- Step II= Negative amount- then it is to be recorded as Goodwill (intangible asset) - since the amount paid for acquiring business is more than the Net assets, which is technically due to its goodwill.

Treatment of reserves under purchase method

No reserves, other than statutory reserves, of the transferor company should be incorporated in the financial statements of transferee-company.

The balance of Profit and Loss account, general reserves of the transferor company are not recorded at all.

Though, normally, in an amalgamation in the nature of purchase, the identity of reserves is not preserved, an exception is made only in respect of statutory reserves and such reserves shall retain their identity in the financial statements of the transferee company in the same form in which they appeared in the financial statements of the transferor company, till the time their identity is required to be maintained to comply with the relevant statute.

This exception is made only in those amalgamations where the requirements of the relevant statute for recording the statutory reserves in the books of the transferee company are complied with. Statutory reserves of the transferor company should be incorporated in the balance sheet of transferee company by way of the following journal entry.

Amalgamation Adjustment Reserve A/c Dr.

To Statutory Reserves

‘Amalgamation Adjustment Reserve’ is debited to bring in the statutory reserves of the transferor company. This is represented as deduction from the reserves of the transferee company after amalgamation.

Once after the time period to show such statutory reserves is over, both the reserves and the aforesaid account are reversed. 'Amalgamation Adjustment Reserve’ has to be shown as a separate line item - which implies, that this debit "cannot be set off against Statutory reserve taken over" and therefore, the presentation will be as follows:

Reserves

6. JOURNAL ENTRIES TO CLOSE THE BOOKS OF VENDOR COMPANY

In case of amalgamation under any of the above methods, there shall be an accounting treatment both in the books of vendor (transferor) and vendee (transferee) companies.

We will now, understand the treatment in the books of vendor under this sectionSince the books of the vendor will be closed upon amalgamation- the assets and the liabilities at the book values are transferred to a separate account called as the “Realization account”. 

The purchase consideration receivable is credited to the Realization account. On the receipt of the purchase consideration, it is debited to equity shareholders and preference shareholders’ account. The balance of realization account (either profit/loss) is transferred to the equity shareholders’ account.

Those assets and liabilities which are not taken over by vendee company but settled by the vendor company are also shown in the books of the vendor only. 

7. ENTRIES IN THE BOOKS OF PURCHASING COMPANY

In the books of the purchasing/ vendee/ transferee company, the assets and liabilities which are taken overs are recorded at the agreed values and where there is no agreed value then at the book values. 

1. Debit Business Purchase Account and Credit Liquidator of the vendor company with the account of the purchase consideration. Thus -

(Amount payable to Zed Ltd. as per agreement dated....) 

2.  

1. Debit assets acquired (except goodwill) at the value placed on them by the purchasing company; 
2. Credit liabilities taken over at agreed values and credit Business Purchase Account with the amount of purchase consideration; and 
3. If the credits as per (ii) above exceed debits as per (i) above, the difference should be debited to Goodwill Account, in the reverse case, the difference should be credited to Capital Reserve.

Note: The amount of Goodwill or Capital Reserve that shall be included will be the amount as has been arrived at only in foregoing manner.

In the above case the entry to be passed shall be:

(Various assets and liabilities taken over from Zed Ltd.Goodwill ascertained as a balancing figure) 

3. On the payment to the vendor company the balance at its credit, the entry to be made by Wye Ltd. shall be: 

(Payment of cash and issue of shares in satisfaction of purchase consideration)

4. 

(Debentures issued)

5. If the purchasing company is required to pay the expenses of liquidation of the vendor company, the amount should be debited to the Goodwill or Capital Reserve Account, as the case may be. In the instant case, the entry shall be:

(Amount paid towards liquidation expenses on Zed Ltd.) 

Typical adjustments which shall be noted while working out the problems

Entries at par value - The students will note that purchasing company is left with a large debit in the Goodwill Account (Step No. 2) accompanied by quite a large amount in the Securities Premium Account (Step No. 3). The two cannot be adjusted. However, it would be permissible to negotiate on the basis to the market value of the shares but to make entries only on the basis of par of shares of purchasing company. This will mean that Goodwill Account (or Capital Reserve) will be automatically adjusted for the securities premium.

Inter Company-owing - Should the purchasing company owe an amount to the vendor company or vice versa, the amount will be included in the book debts of one company and trade payables of the other. This should be adjusted by the entry:

The entry should be made after the usual acquisition entries have been passed. At the time of preparing the Realization Account and passing the business purchase entries, no attention need be paid to the fact that the two companies involved owed money mutually.

Adjustment of the value of stock - Inter-company owings arise usually from purchase and sale of goods; it is likely, therefore, that at the time, of the sale of business, the debtor company also has goods in stock which it purchased from the creditor company - the cost of the debtor company will include the profit made by the creditor company. After the takeover of the business it is essential that such a profit is eliminated. The entry for this will be made by the purchasing company. If it is the vendor company which has such goods in stock, at the time of passing the acquisition entries, the value of the stock should be reduced to its cost to the company which is acquiring the business; automatically goodwill or capital reserve, as the case may be, will be adjusted. But if the original sale was made by the vendor company and the stock is with the company acquiring the business, the latter company will have to debit Goodwill (or Capital Reserve) and credit stock with the amount of the profit included in the stock.Inter-company Loans- Where there is any loan taken by the transferor company from the transferee company then the amount of the loan shall be taken over by the transferee company and adjustment entry to be passed as follows-

(Elimination of the inter-company loans taken by the transferor from transferee company).