Accounting Aspects of Mergers

Submitted By: Submitted To:Chandan Sinha Dr.Meena SharmaMBA-IB (2009-11) UBS, Chandigarh

Contents

•Accounting Standards: background•Triggering off Event•Accounting Methods for Amalgamation : AS 14•Pooling of Interest Method•Purchase Method•Balance Sheet : Post Merger•Treatments of Reserves on Amalgamation•Battle Over Merger Accounting

Accounting Standards: background

•ICAI constituted Accounting Standards Board in April 1977

•International Accounting Standards Committee – 30 international accounting standards

•ICAI formulated 15 accounting standards•ASB trying to integrate them to maximum

extent

Triggering off Event

Ethyl corporation (US) : joint owners GM and Standard Oil $40 mn profit on the sale of its half

share in the corporation GM showed it as proceeds of the part of

its trading income for the year Standard Oil did not bring in the surplus

in any P/L account, took the surplus to reserves

Accounting for Amalgamation (AS 14)

Accounting Methods :1.Amalgamation in the nature of Merger

(Pooling of Interest Method)2.Amalgamation in the nature of Purchase

(Purchase Method)

Pooling of Interest Method: conditions

1. Assets and liabilities of transferor company become assets and liabilities of transferee company after amalgamation

2. Shareholders holding not less than 90% of face value of equity shares of transferor becomes equity shareholders of transferee company

3. Cash may be paid for fractional shares

Pooling of Interest Method: conditions

4. Business of transferor company is intended to be carried on by the transferee company after amalgamation

5. No adjustments to be made to the book value of assets and liabilities of the transferor company when they are incorporated in the financial statements of transferee company, except to ensure uniformity of accounting practices

Purchase Method: conditions

•Amalgamation which does not satisfy any one or more conditions of Pooling of Interest Method

Features of Pooling of Interest Method

•Assets and liabilities of the two firms are combined according to their book value on the acquisition date.

•Total asset value of the joint company equals the sum of assets of the separate firms

•Accounting income is higher than in the purchase method: Depreciation calculated based on the historical book value of assets

* It is no longer allowed

Purchase Method

•Asset and liabilities of the merged company are presented at their market values as on the date of acquisition: refers to the value, which was recorded before the final settlement of the acquisition deal at the time of bargaining

•May overrate depreciation charges: book value of assets used in accounting is generally lower than the fair value if there is inflation in the economy

Balance Sheet: relevance post merger

Pooling of Interest Method: assets, liabilities and reserves should be stated at same book value as transferor company’s books

Purchase Method: transferee company free to restate the assets at their ‘fair value’

Consideration discharged otherwise than by way of shares only: Purchase Method

Relevance of the option given in AS 14

Following norms ignored in considering credit worthiness :-

1.Any intangible asset appearing in the balance sheet like goodwill, trademark, patent etc.

2.Any revaluation of fixed assets for a period of five years

Lenders may ignore revaluation reserveAmalgamation surplus

Examples of Pooling of Interest Method

Amalgamation of TOMCO with Hindustan Lever :

Assets and liabilities of TOMCO transferred & vested to the company w.e.f. 1st April, 1993.

Amalgamation accounted for under ‘pooling of interests’

Differences, aggregating Rs 6,74.76 lakh (net assets less paid up value of shares and other reserves) added to the company’s General Reserve in the previous year

Examples of Pooling of Interest Method

Amalgamation of WIL and WSL (1994-95):

Rs thousand Rs thousand

Fixed Assets (net of depreciation provided)

1,92,193 82,576

Investments 33,903 1

Current Assets 1,566,975 1,87,800

1,793,071 2,75,327

Less: Current liabilities & provisions

7,35,268 43,248

Less: Loan Funds 5,97,309 1,19,413

4,60,494 1,12,666

Rs thousand Rs thousand

Less: Arrears of depreciation accounted

- 6,762

- 1,05,904

Less: Transfers to specific reserves 49,738 844

4,10,756 1,05,060

Less: Investment of the company in WIL and WSL extinguished on amalgamation

1,14,655 39,045

2,96,101 66,105

Less: 2,65,105 equity shares of Rs 10 each issued to minority shareholders of WIL and WSL

389 2,262

Surplus on amalgamation transferred to General Reserve

2,95,712 63,753

Examples of Purchase Method

Amalgamation of Escorts Tractors Ltd with Escorts Ltd. (1995-96)

assets and liabilities as on April 1, 1995 of Erstwhile ETL incorporated in the accounts of the company at their fair market value

difference between the fair values of assets & liabilities taken over, credited to amalgamation reserve

impairment of certain assets taken over, adjustments relating to pre amalgamation period

Examples of Purchase Method

1995-96(Rs crore)

Adjustments relating to pre amalgamation period 0.22

Recognition of leave encashment liability under AS 15

0.21

Fees paid for technical know how as part of disengagement agreement with New Holland

15.69

Reserve for contingent liabilities on account of sales tax

27.50

Provision for inter-corporate deposits placed with MS shoes East Ltd and Montari Industries Ltd

0.85

Provision for doubtful advances o.42

Deposits written off 0.21

45.10

Amalgamation with Retrospective Effect

In most cases there is a time lag of 1 or 2 years between the sanction from court/ BIFR and the appointed date fixed in the scheme

Certain companies in the past have incorporated the results of say, 31 months of transferor company into 12 months results of transferee

Others like Amblal Sarabhai Enterprises Ltd. reopened their accounts of last 2 yrs. & incorporated the results in that period & again re- adopted the accounts by taking sanctions from shareholders

Dividend to the shareholders of transferor company•Shareholders of transferor company are

entitled to the dividend w.e.f the appointed date

e.g. ‘Appropriations made in the accounts of Hindustan Lever : Arrears of dividend payable to the shareholdrs of TOMCO after amalgamation’

Treatments of Reserves on Amalgamation•In case of Pooling of Interest method,

reserves of the transferor company should be preserved by the transferee company

•In case of a sick company absorbed by a profitable company P/L debit balance of a transferor company should also be preserved initially before it being set off

•Treatment of the reserves should be as per the clause mentioned in the scheme

Treatments of Reserves on AmalgamationIn the books of Y Ltd. (Rs. lakh)

Profit & Loss Debit Balance Dr 292

Fixed Assets Dr 303

Current Assets Dr 673

To Equity Share Capital (Outside Shareholders)

13

To Loans 668

To Current Liabilities 270

To Revaluation Reserves 164

To Capital Reserve 36

To Investment Allowance Reserve

42

To Capital Reserve(Balancing Figure)

55

To Investments 20

Merger Accounting: Intricacies

•When shares are allotted by the transferee company at premium, can it pass entries recognizing share premium?

YES, value of shares along with premium has to be recorded in the books

Merger Accounting: IntricaciesSakthi Soya Ltd: Abridged P/L account for the year ended 31-03-1993 (Rs. in Lakh)

Profit/ (loss) before tax (981.84)

Prior year expenses (15.73)

Prior year income/ excess provision written back

35.63

Loss brought forward (1042.46)

2004.40

Less : Surplus in revaluation of assets 2027.58

Surplus transferred to Capital Reserve 23.18

The Battle Over Merger Accounting

•“The (purchase) accounting method itself would prove an obstacle to a merger that both parties want to consummate. As a result, the wave of consolidations that has enhanced productivity, encouraged innovation, and stimulated dynamism in the U.S. economy may notably decline." - Merrill Lynch

References

•Mergers et Al by Ramanujam

•http://blogs.siliconindia.com/mergers/Mergers__Acquisitions__A_Conceptual_Overview-bid-10xKT2zV63179066.html