Unit - 4

Amalgamation of companies

4.1Concepts and accounting treatment as per Accounting Standard: 14 (ICAI) (excluding intercompany holdings).

Introduction

AS 14 (Revised) deals with the accounting to be made in the books of Transferee company in the case of amalgamation and the treatment of any resultant goodwill or reserve.

An amalgamation may be either in the nature of merger or purchase. The standard specifies the conditions to be satisfied by an amalgamation to be considered as amalgamation in nature of merger or purchase.

An amalgamation in nature of merger is accounted for as per pooling of interests method and in nature of purchase is dealt under purchase method.

The standard describes the disclosure requirements for both types of amalgamations in the first financial statements. We will discuss the other amalgamation aspects in detail in subsequent paragraphs of this unit.

AS 14 (Revised) does not deal with cases of acquisitions. The distinguishing feature of an acquisition is that the acquired company is not dissolved and its separate entity continues to exist.

Definition of the Terms used in the Standard

              Amalgamation means an amalgamation pursuant to the provisions of the Companies Act, 2013 or any other statute which may be applicable to companies and includes ‘merger’.

              Transferor company means the company which is amalgamated into another company.

              Transferee company means the company into which a transferor company  is amalgamated.

Types of Amalgamations

Amalgamations fall into two broad categories. In the first category are those amalgamations where there is a genuine pooling not merely of the assets and liabilities of the amalgamating companies but also of the shareholders’ interests and of the businesses of these companies. These are known as Amalgamation in nature of merger. In the second category are those amalgamations which are in effect a mode by which one company acquires another company and, as a consequence, the shareholders of the company which is acquired normally do not continue to have a proportionate share in the equity of the combined company, orthe business of the company which is acquired is not intended to be continued. Such amalgamations are amalgamations in the nature of 'purchase'.

Methods of Accounting for Amalgamation

1. Pooling of Interest Method/Merger Method
2. Purchase Method

Amalgamation in the nature of Merger (Pooling of Interest Method)

Amalgamation in the nature of merger is an amalgamation 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.

Amalgamation in the nature of Purchase

Amalgamation in the nature of purchase is an amalgamation which does not satisfy any one or more of the conditions specified above.

Methods of Accounting for Amalgamations

There are two main methods of accounting for amalgamations.

              the pooling of interests method and

              the purchase method.

POOLING OF INTERESTS METHOD

Pooling of interests is a method of accounting for amalgamations the object of which is to account for the amalgamation as if the separate businesses of the amalgamating companies were intended to be continued by the transferee company. Accordingly, only minimal changes are made in aggregating the individual financial statements of the amalgamating companies.

Under this method, the assets, liabilities and reserves of the transferor company are recorded by the transferee company at their existing carrying amounts (after making adjustment required in next paragraph).

If, at the time of the amalgamation, the transferor and the transferee companies have conflicting accounting policies, a uniform set of accounting policies is adopted following the amalgamation. The effects on the financial statements of any changes in accounting policies are reported in accordance with AS 5.

PURCHASE METHOD

Under the purchase method, the transferee company accounts for the amalgamation either

              By incorporating the assets and liabilities at their existing carrying amounts  or

              By allocating the consideration to individual identifiable assets and liabilities of the transferor company on the basis of their fair values at the date of amalgamation. The identifiable assets and liabilities may include assets and liabilities not recorded in the financial statements of the transferor company.

CONSIDERATION

Consideration for the amalgamation means 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 determining the value of the consideration, an assessment is made of the fair value of its elements.

Many amalgamations recognise that adjustments may have to be made to the consideration in the light of one or more future events. When the additional payment is probable and can reasonably be estimated at the date of amalgamation, it is included in the calculation of the consideration. In all other cases, the adjustment is recognised as soon as the amount is determinable [AS 4].

Treatment of Reserves of the Transferor Company on Amalgamation

If the amalgamation is an ‘amalgamation in the nature of merger’, the identity of the reserves is preserved and they appear in the financial statements of the transferee company in the same form in which they appeared in the financial statements of the transferor company. Thus, for example, the General Reserve of the transferor company becomes the General Reserve of the transferee company, the Capital Reserve of the transferor company becomes the Capital Reserve of the transferee company and the Revaluation Reserve of the transferor company becomes the Revaluation Reserve of the transferee company. As a result of preserving the identity, reserves which are available for distribution as dividend before the amalgamation would also be available for distribution as dividend after the amalgamation.

Adjustments to reserves - Amalgamation in the Nature of Merger

When an amalgamation is accounted for using the pooling of interests method, the reserves of the transferee company are adjusted to give effect to the following:

      Conflicting accounting policies of the transferor and the transferee. A uniform set of accounting policies should be adopted following the amalgamation and, hence, the policies of the transferor and the transferee are aligned. The effects on the financial statements of this change in  the accounting policies  is reported in accordance with AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’

      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 the transferor company.

Adjustments to reserves - Amalgamation in the Nature of Purchase

If the amalgamation is an ‘amalgamation in the nature of purchase’, the identity of the reserves, other than the statutory reserves is not preserved. The amount of the consideration is deducted from the value of the net assets of the transferor company acquired by the transferee company. If the result of the computation is negative, the difference is debited to goodwill arising on amalgamation and if the result of the computation is positive, the difference is credited to Capital Reserve.

Certain reserves may have been created by the transferor company pursuant to the requirements of, or to avail of the benefits under, the Income-tax Act, 1961; for example, Development Allowance Reserve, or Investment Allowance Reserve. The Act requires that the identity of the reserves should be preserved for a specified period. Likewise, certain other reserves may have been created in the financial statements of the transferor company in terms of the requirements of other statutes. Though normally, in an amalgamation in the nature of purchase, the identity of reserves is not preserved, an exception is made in respect of reserves of the aforesaid nature (referred to hereinafter as ‘statutory reserves’) and such reserves 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, so long as 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. In such cases the statutory reserves are recorded in the financial statements of the transferee company by a corresponding debit to a suitable account head (e.g., ‘Amalgamation Adjustment Reserve’) which is presented as a separate line item. When the identity of the statutory reserves is no longer required to be maintained, both the reserves and the aforesaid account are reversed.

The Standard gives a title, which reads as "Reserve". This gives rise to following requirements.

1. The corresponding debit is "also" to a Reserve Account
2. That Reserve account will show a negative balance

But it has to be shown as a separate line item - Which implies, that this debit "cannot be set off against Statutory reserve taken over"

Treatment of Goodwill Arising on Amalgamation

Goodwill arising on amalgamation represents a payment made in anticipation of future income and it is appropriate to treat it as an asset to be amortised to income on a systematic basis over its useful life. Due to the nature of goodwill, it is frequently difficult to estimate its useful life with reasonable certainty. Such estimation is, therefore, made on a prudent basis. Accordingly, it is considered appropriate to amortise goodwill over a period not exceeding five years unless a somewhat longer period can be justified.

Factors which may be considered in estimating the useful life of goodwill arising on amalgamation include:

(a)          the foreseeable life of the business or industry

(b)         the effects of product obsolescence, changes in demand and other economic factors

(c)          the service life expectancies of key individuals or groups of employees

(d)         expected actions by competitors or potential competitors

(e)          legal, regulatory or contractual provisions affecting the useful life

Balance of Profit and Loss Account

In the case of an ‘amalgamation in the nature of merger’, the balance of the Profit and Loss Account appearing in the financial statements of the transferor company is aggregated with the corresponding balance appearing in the financial statements of the transferee company. Alternatively, it is transferred to the General Reserve, if any.

In the case of an ‘amalgamation in the nature of purchase’, the balance of the Profit and Loss Account appearing in the financial statements of the transferor company, whether debit or credit, loses its identity.

Disclosures

For all amalgamations, the following disclosures are considered appropriate in thefirst financial statements following the amalgamation:

1. Names and general nature of business of the amalgamating companies;
2. Effective date of amalgamation for accounting purposes;
3. The method of accounting used to reflect the amalgamation; and
4. Particulars of the scheme sanctioned under a statute.

For amalgamations accounted for under the pooling of interests method, the following additional disclosures are considered appropriate in the first financial statements following the amalgamation:

1. Description and number of shares issued, together with the percentage of each company’s equity shares exchanged to effect the amalgamation;
2. The amount of any difference between the consideration and the value of net identifiable assets acquired, and the treatment thereof.

For amalgamations accounted for under the purchase method, the following additional disclosures are considered appropriate in the first financial statements following the amalgamation:

1. Consideration for the amalgamation and a description of the consideration paid or contingently payable; and
2. The amount of any difference between the consideration and the value of net identifiable assets acquired, and the treatment thereof including the period of amortisation of any goodwill arising on amalgamation.

Amalgamation after the Balance Sheet Date

When an amalgamation is effected after the balance sheet date but before the issuance of the financial statements of either party to the amalgamation, disclosure is made in accordance with AS 4, ‘Contingencies and Events Occurring After the Balance Sheet Date’, but the amalgamation is not incorporated in the financial statements. In certain circumstances, the amalgamation may also provide additional information affecting the financial statements themselves, for instance, by allowing the going concern assumption to be maintained.

4.2 Internal reconstruction: concepts and accounting treatment excluding scheme of reconstruction.

Internal reconstruction

“Internal Reconstruction is recapitalization in the form of quosi - reorganization under which deficit is absorbed, a new company is not formed and the company reaches in a state of profit from a state of loss after this date.”

Accounting entries on internal reconstruction

1. Entry for share capital reduced without changing the face value of the shares-

Share Capital A/c

To Capital Reduction/Reconstruction A/c

2.     Entry if face value of the shares is also changed on reduction of capital a new category of share capital is created :

Share Capital A/c (Old)

To Share capital A/c (New)

To Capital reduction A/c

3.     Entry where rate of dividend on preference shares is changed under the scheme of reconstruction: Preference Share Capital A/c (OLD)

To Preference Share Capital A/c (New)

4.     Entry When debenture holder and creditors are also ready to reduce their claim against company: Debenture A/c

Creditors A/c

To Capital reduction A/c

5.     Entry in case of appreciation in the value of any asset:

Assets A/c

To Capital reduction A/c

6.     Entry if any contingent liability matures and is to be paid immediately the following entry is passed:

Capital reduction A/c

To Liability payable A/c

To Bank A/c

7.     Entry for utilizing the amount of capital reduction to w/o accumulated losses.

Capital Reduction A/c

To Profit & Loss A/c

To Preliminary Expenses A/c

To Discount on Shares /Debentures A/c

To Goodwill A/c

To Trade Assets A/c

To Patents/Copy rights

To Assets A/c

8.     For transferring any balance left in the capital reduction account to capital reserve account:

Capital reduction a/c Dr. (with the balance left)

To capital reserve a/c

9.     For extinguishing or reducing the uncalled liability of the member:

Equity Share Capital A/c

To Equity share Capital A/c

10. For writing off the part of paid up capital which is lost in operation or which is not representing by available assets:

Equity Share Capital A/c

To Equity Share Capital A/c

To Capital Reduction A/c

11. If the face value of shares remain unchanged

Equity Share Capital A/c

To Capital Reduction A/c

12. For reducing the capital by returning the excess capital:

Equity Share Capital A/c

To Equity Share Capital A/c

To Equity Shareholders A/c

13. For payment to Shareholders

Equity Shareholders A/c

To Bank A/c

14.  For uses of Capital reduction A/c

Capital Reduction A/c

To Accumulated Losses A/c

To Goodwill A/c

To Fictitious Assets A/c

To Other Assets A/c

To Capital Reserve A/c( Balancing Figure)

Internal reconstruction of a company can be carried out in the following different ways. These are as under:

1. Alteration of Share Capital; and

2. Reduction in Share Capital

Alteration of share capital

A company Limited by shares can alter its share capital under sec. 94 of companies Act 1956, if articles of Association of company permits it and a resolution has been passed in the general meeting of the company.

Methods of alteration in share capital

Share capital can be altered in following ways;

• Increase in share capital by issue of new shares - A company can increase its share capital by issuing new shares when it requires additional capital. If the company has issued all its authorized capital then it can increase its authorized capital by make changes in Memorandum of Association with the permission of S.E.B.I. For increasing the authorized share capital no journal entry is passed. But in relation to issue of new shares some entries will be passed as are generally passed in case of issue of shares.

Bank account dr.

To equity share capital a/c

( being the amount received on shares of Rs. Each )

• Consolidation of shares - When the shares of small denominations of a company are changed into shares of big denominations it is called consolidation of shares. The total capital of company does not change by consolidation of shares but the number of shares decreases.

(Old Denomination) Share Capital A/c Dr.

To (New Denomination) Share Capital A/c

(Being consolidation of … Shares of Rs. …………… Each into…….. Share of Rs. …………. Each)

• Sub-division of shares - When the shares of a company are subdivided in shares of small value, it is known as sub-division of shares. The total capital of the company does not get affected by sub-division of shares but the numbers of shares increases.

(Old denomination) Share capital A/c Dr.

To (New Denomination) Share Capital A/c

(Sub-division of …….. Shares of Rs……... Each into… ..shares of Rs. …..each)

• Conversion of shares into stock or stock into shares - A company can convert its fully paid up shares into stock or stock into fully paid up shares. By converting shares into stock, any amount of stock capital can be transferred to any other person. Following entry will be passed for such conversion.

(a) Conversion of Shares into Stock :

Equity Shares Capital A/c Dr.

To Equity Stock A/c

(Equity shares of Rs. …….. Each fully paid up converted into equity stock of Rs. ……….)

(b) Conversion of Stock into Fully Paid Equity Shares :

Equity Stock A/c Dr.

To Equity Share Capital A/c

(Equity stock of Rs. ………… Converted into ……. Equity shares of Rs. ………. Each fully paid)

• Cancellation of unissued shares - Cancellation of unissued shares by a company does not amount to reduction of paid up share capital. As no accounting entry has been done in the books of company for such shares, therefore no entry is passed for cancellation of such shares, only the authorized capital is adjusted in the balance sheet of the company.

Reduction in share capital

A company can reduce its capital as per the provisions given in section 100 to 105 of companies Act, 1956. Following conditions are required to be fulfilled by a company to reduce its share capital :-

1. The articles of association of a company permit it to reduce its capital.
2. The company has passed a special resolution.
3. Court has approved the scheme of reduction in share capital.

Methods of reduction in share capital

1. Extinguishing or Reducing the Uncalled Amount on Shares : If the shares issued by company are not fully called up then the company can either partly or wholly eliminate the liability of shareholders on such shares. By eliminating the liability of uncalled amount, the paid up capital of company will not reduce but the company relinquishes its right of calling uncalled amount and the liability of shareholders for uncalled capital is eliminated.

(Old Denomination) Share Capital A/c Dr.

To (New Denomination) Share Capital A/c

(Uncalled amount of Rs…………. Per share cancelled).

2.     Refund of Excess Capital to Shareholders: If excessive capital has been collected or it is not used profitably by the company the company can return this excess capital.

When Denomination of Shares is Changed :

(Old Denomination) Share Capital A/c Dr. (Old Paid Up Capital)

To (New Denomination Share Capital A/c (New Paid Up Capital)

To Sundry Shareholders A/c (Amount Refunded)

(Conversion of Rs. ……….Shares into Rs. ……… fully paid shares and refund of Rs. … per share on ………… share)

Sundry Shareholders A/c Dr.

To Bank A/c

(Payment made to shareholders)

When Denomination of Shares is not Changed :

Share Capital A/c Dr. (Returnable Amount)

To Sundry Shareholders A/c (Returnable Amount)

(Rs……. Per share on …… Shares refunded to shareholders)

Sundry Shareholder A/c Dr.

To Bank A/c

(Payment made to shareholders in the form of accumulation losses)

3.     Reduction in Paid Up Share Capital : The capital reduction programme, capital lost is written off and new capital is raised from shareholders. To apply the capital reduction programme a Capital Reduction Account is opened in the books of the company. The amount sacrificed by debenture holders, share holders and creditors is credited in this account and it is used to write of f accumulated losses and deferred revenue expenditure, Accounting under this scheme is done as follows:

• When Denomination of Shares is Reduced :

(Old Denomination) Share Capital A/c Dr. (Old Capital)

To (New Denomination) Share Capital A/c (New Capital)

To Capital Reduction A/c (Reduction Amount)

• When Denomination of Shares is not Reduced Only Paid Value is Reduced:

Share Capital A/c Dr. (Reduction Amount)

To Capital Reduction A/c

• Balance of Any Reserve (If Any) Transferred :

Capital Reserve/General Reserve/Any

Particular Reserve A/c Dr.

To Capital Reduction A/c

• Sacrifice by Debenture Holders and Creditors :

Debenture A/c Dr.

Creditors A/c Dr.

To Capital Reduction A/c

• Increase in the Value of Assets or Decrease in the Value of Liability :

(Particular) Asset A/c Dr. (Increase of Amount)

(Particular) Liability A/c Dr. (Decrease of Amount)

To Capital Reduction A/c

• Various Accumulated Losses, Fictitious Assets and Loss on Assets and Liabilities Written Off :

Capital Reduction A/c Dr.

To P&L A/c/Preliminary Exp. A/c

To Discount on Issue of Shares/and Debentures A/c

To Goodwill/Patents

To (Particular) Assets A/c

To (Particular) Liability A/c

• Provision for Any Contingent Liability made :

Capital Reduction A/c Dr.

To Provision for Contingencies A/c

• Balance of Capital Reduction A/c transferred :

Capital Reduction A/c Dr.

To Capital Reserve A/c

References

1. Corporate Accounting by Raj Kumar Shah
2. Corporate Accounting by V K Goyal
3. Corporate Accounting by Prof. Amitabha Basu