Amalgamation& External Recontruction

Meaning of AmalgamationWhen two or more existing companies go

into liquidation and a new company is formed to take over their business , it is known as amalgamation.

The institute of chartered accountants of India has issued Accounting Standard 14 (AS 14) on accounting for amalgamation. This standard specifies the procedure of accounting for amalgamation and the treatment of any resultant goodwill or reserve.

Types of AmalgamationFrom Accounting point of view :

A. Amalgamation in the nature of merger.

B. Amalgamation in nature of purchase.

Amalgamation in the nature of MergerAn amalgamation should be considered in nature

of merger if it fulfills following conditions :1. All assets & Liabilities of the transferor

company become the assets & liabilities of transferee co. after amalgamation.

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

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

4.The consideration for 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 issue of equity shares in the company, except that cash may be paid in respect of any fractional shares.

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.

In this way there is a pooling of assets and liabilities of the combining companies under amalgamation. It must be ensured that the resultant figures of the assets, liabilities, capital and reserve of the combining entity more or less represent the addition of the relevant figures of the amalgamation entities.

Amalgamation in the nature of PurchaseAn amalgamation in nature of purchase

takes place when any one or more of the conditions specified for the amalgamation in nature of merger is not satisfied.

Under this nature of amalgamation one company acquires another company and equity shareholders of the combining entities do not continue to have proportionate share in the equity of the combined entity or the business of the combined entity is not intended to be combined after amalgamation.

AbsorptionWhen one or more existing companies go into

liquidation and some existing company buys the business, it is known as absorption.

The major characteristics of the absorption are as follows :

1.There is no formation of any new company.2.There is an absorption of one or more

existing companies by one existing company.3.There is only liquidation of absorbed

company while the absorbing company retains its legal entity.

External ReconstructionExternal reconstruction is effected by

liquidating the company. It is just like by absorption.

In it a new company is formed to purchase the business of an existing company.

The assets and liabilities of the existing company are transferred to the newly formed company.

X ltd goes into liquidation and a new company Y ltd comes into existence to take over the business of X ltd, this is the case of the External Reconstruction.

Difference between Amalgamation, Absorption & ReconstructionBasis No of Distinction

Amalgamation

Absorption Reconstruction

1.Formation of a New Company.

2.No Liquidating Companies

3.Objective

New company is formed in aAmalgamation.

At least two companies wind up their business.

The aim of the amalgamation is to remove the competition among the entities.

No new company is formed in absorption.

At least one company is required to wind up its business.

Generally weaker units are taken over by strong units

New company is formed in External Reconstruction.One company is required to wind up its business.

The aim of the external reconstruction is to write off the accumulated losses and fictitious assets.

Basis No of Distinction

Amalgamation

Absorption Reconstruction

4.Position of companies

The position of the companies is almost same.

The position of purchasing company is comparatively better than vendor company.

The position of vendor company is bad because of accumulated losses and fictitious assets.

Purchase ConsiderationPurchase Consideration refers to the amount paid

by the purchasing company to the vendor company for the purchase of business.

The purchase consideration for amalgamation includes the shares and other securities issued and payment made in cash or other assets by the transferee company to the shareholders of transferor company.

It should not include the amount of liabilities taken over by transferee company, which will be paid directly by this company.

Payments made to debenture holders should not be considered as part of purchase consideration.

Methods of Purchase Consideration1. Lump sum Method2. On basis of Value of Shares or Shares

Exchange Method3. Net Payment Method.4. Net Worth or Net Assets Method.

Lump sum MethodUnder this method, purchased consideration is

specified at a particular figure and goodwill or capital reserve is arrived at on the basis of this figure.

For example, a Company ABC ltd purchase the business of the company XYZ ltd at an agreed price of Rs.10,00,000 in all. Here the amount of Rs. 10,00,000 is the purchase consideration.

On basis of Value of Shares or Shares Exchange MethodUnder this method, the purchase consideration is

required to be calculated on the basis of intrinsic value of shares.

Intrinsic value is calculated by dividing the net assets available for equity shareholders by the number of equity shares.

This value determines the ratio of exchange of the shares between the transferee and transferor companies.

Intrinsic value of share = Net assets available for Equity Shareholders Number of equity shares

E.g. Suppose A ltd and B ltd are two companies involved in same business. Their capital is Rs. 6,00,000 and Rs. 2,00,000 (each of Rs.10).The two companies arrived to amalgamate in AB ltd. If each share of A ltd and B ltd is valued at Rs. 10 and Rs. 20 respectively for the purpose of amalagmation, the purchase consideration will be as under :

A ltd B ltd60000 shares@Rs.10 600000 -20000 shares@Rs.20 - 400000

Note: While issuing shares to individual shareholders of the selling company, these may be in fractions. A company cannot issue shares in fraction but it can issue fractional certificates or coupons or pay cash for the fractions.

3.Net Payment Method.

Under this method the purchase consideration is arrived at by merely adding every component of purchase consideration in respect of which the purchasing company makes payment.

The following Points should be considered at the time of calculation of purchase consideration:

1.The assets & liabilities taken over by the transferee co. are not to be considered.

2. Any payment whether in cash or shares made by the transferee co. for shareholders must be considered.

3. If creditors and debtors are taken over by transferee co. to discharge subsequently such amount should not be considered in purchase consideration.

4. If the liquidation expenses of the transfer co. are to be born by transfer co., these should not be increased in purchase consideration.

5. Any payments made by the transferee co. to some other party on behalf of the transferor co. are to be ignored.

6. When liabilities are taken over by transferee co. they are neither added or deducted to the amount of purchase consideration.

4.Net Worth or Net Assets Method.Under this method, purchase consideration is

the difference between the value of the assets taken over and the liabilities assumed.

Net asset or Net worth =Assets taken over – Liabilities assumed(at agreed value) (at agreed value)

Important points to be considered : Assets taken over by purchasing Co. should be valued at

agreed price. All assets means not just the tangible assets e.g. cash and

bank but the intangible assets e.g. goodwill, trademarks etc. all taken at agreed value.

The liabilities assumed by purchasing company are deducted at their agreed value. The term liabilities does not include undistributed profits like reserve fund ,general fund, share premium, insurance fund.

The consideration for the amalgamation should include any non-cash element at fair value. In case of issue of securities, the value fixed by the statutory authorities may be taken to be their fair value.

Where the scheme of amalgamation provide for an adjustment to the consideration contingent on one or more future events, the amount of additional payment should be included in the consideration if payment is probable and a reasonable estimate of the amount can be made.

The following entries should be passed in the books of transferor and transferee companies in the case of amalgamation

In books of Transferor co.1. For transferring assets taken over by the transferee company.

Realisation a/c Dr. To Various assets (individually)(at book value)Note : Assets on which some provisions has been made are to be

transferred to realisation account at their gross figures and provisions made should be transferred along with liabilities.

2. For transferring liabilities taken over by the transferee company.Various liabilities a/c Dr. (at book value)

To Realisation a/cNote: Only those liabilities are to be transferred which have been

assumed by the transferee co. If there is any fund which partially represents liability and partially represents undistributed profit, then that portion which represents liability should be transferred to realisation a/c.

3. For Purchase consideration

Transferee Company’s a/c Dr. To Realisation a/c4. For receiving PC from the transferee Co.

Bank a/c Dr.Shares in transferee Co. a/c Dr.

To Transferee Co a/c5.For assets sold bt the transferor co. not taken over by

the transferee co.Bank a/c Dr.Realisation a/c (if loss on sale of assets)Dr.

To Assets a/c To Realisation a/c (if profit on sale of

assets)

6. For Liquidation Expenses (a) If expenses are to be met by transferor co.

Realisation a/c Dr.To Bank a/c

(b)If Expenses are to be met by transferee co. there are two alternatives :

First alternative : No entrySecond alternative :(i) Transferee Co. a/c Dr.

To Bank a/c(ii) Bank a/c Dr.

To Transferee co.’s a/c7. For liabilities not taken over by the transferee co. when paid by

the transferor co.Various liabilities a/c Dr.Realisation a/c (if excess payment is made)To Bank a/c

orTo Shares in transferee Co. a/cTo realisation a/c (if less payment is made)

8. For transferring preference share capitalPreference share capital a/c ..Dr.Realisation a/c(if excess is to paid) ..Dr.To Preference Shareholders a/cTo Realisation a/c (if less is to be paid)

9. Preference Share Holders ..Dr.To equity/Preference Shares of transferee co.

Note : If the arrears of the dividend are to be paid to preference Shareholders, then such excess amount should be debited to realisation a/c and credited to preference shareholders a/c. If the preference shareholders have agreed to get less than the amount of capital, then reverse entry is to be passed.

10. For closing Realisation a/c(a) If profit

Realisation a/c ..Dr.To equity Shareholders a/c

(b) If LossEquity shareholders a/c ..DrTo Realisation a/c

11. For transferring equity share capital and accumulated profit Equity Share Capital a/c ..Dr.General reserve a/c ..Dr.Debenture Redemption Fund a/c ..Dr.Dividend equilisation Reserve a/c ..Dr.Securities Premium a/c ..Dr.Profit & Loss a/c ..Dr.Accident Compensation Fund a/c ..Dr.(to the extent it does not denote the liability)Shares Forfeited a/c ..Dr.Profit Prior to incorporation a/c ..Dr.Any other reserve or Fund a/c ..DrTo Equity shareholders a/c

12. For transferring accumulated losses and expenses not writtenoffEquity shareholders a/c ..Dr.To Profit & Loss a/c ( Debit balance)To Discount or exp on issue of shares or debentures a/cTo Preliminary ExpensesTo Underwriting commission

13. For paying ShareholdersEquity Shareholders a/c ..Dr.To Bank or Shares in Transferee co. a/c

Accounting entries in books of transferee Co.

There are two methods of accounting for amalgamation in the books of transferee company :

1.The pooling of Interest Method2.The purchase Method

Pooling of Interest methodThe following journal entries are to be passed in books of

transferee co. for incorporating the financial statements of the transferor co:

(1) On amalgamation of businessBusiness Purchase a/c ..Dr.(with amt of PC)To Liquidators of Transferee Co. a/c

(2) For recording assets & liabilities taken overSundry assets(individually) (Book Value)

To Sundry Liabilities(individually) (Book Value)

To Reserves a/c (Book Value)

To Business Purchase a/c (Book Value)

Note :The difference between debits & credits is adjusted in the reserves of transferee company.

Instead Of passing Two entries, one combined entry can be passed.Sundry assets a/c ..DrTo Sundry LiabilitiesTo Different reserves of transferee coTo Liquidators of transferor Co.

(3) For making payment to the liquidator of transferor co.Liquidators of transferor Co. a/c Dr.To Bank/Share Capital/Security Premium

(4) If Liquidation expenses are paid by the transferee company.General reserve or Profit & Loss a/c Dr.To Bank a/c

(5) For formation expenses of the transferee co.Preliminary Expenses a/c Dr.To Bank a/c

Purchase MethodThe following Journal entries are passed in the

books of transferee company for incorporation of the financial statements of the transferor co.

(1) For purchase of business from the transferor company :Business Purchase a/c ..Dr. (For PC)To Liquidation of transferor co.

(2) For recording assets & liabilities taken over Various assets a/c ..Dr. (at revised value, if any otherwise at book value)To various Liabilities a/c (with figures at which they are taken over)To Business Purchase a/c

Note : If credit is more than debit it is debited to Goodwill a/c but if the debit is more than credit then it is credited to capital reserve a/c.

(3) For making payment to the liquidator of the vendor company :Liquidators of transferor co. a/c..DrTo Bank a/cTo Share Capital a/c

(4) When Statutory Reserve is maintainedAmalgamation adjustment a/c ..DrTo Statutory Reserve a/c

(5) If liquidation exp are paid by transferee co.Goodwill a/c ..DrTo Bank

(6) For Formation exp of transferee co.Preliminary Expenses a/c ..DrTo Bank a/c

(7) When goodwill is written off against Capital reserveCapital reserve a/c ..Dr.

To Goodwill a/c

(8) If any liability is discharged by the transferee company

Respective Liability a/c ..Dr. (with payable amount)

To Share capital/debentures/bank a/c

Distinguish between Amalgamation in nature of merger and Amalgamation in nature of purchaseIn nature of Merger In nature of Purchase

1. In this case transferee co. must acquire whole business of the transferor co which includes all assets and liabilities of the transferor company.

1.Transferee co may or may not acquire all assets and liabilities of the transferor co.

2. Shareholders having 90% of the face value of equity shares of transferor co become the equity shareholders of the transferee co.

2.This condition is not applicable in case of amalgamation in the nature of purchase.

3.The claim of equity shareholders of the transferor co must be discharged by transferee co by issuing equity shares only, except in case of fractional shares.

3.The claim of equity shareholders of transferor company may be discharged by issuing equity shares or cash.

In nature of merger In nature of purchase

4.All assets & liabilities of the transferor co are taken over by transferee co at book value as shown by the balance sheet of the transferor co on the date of amalgamation.

4. Assets & Liabilities of transferor co may be taken at book value or agreed value, as per their agreement.

5. Difference between purchase consideration and net worth is taken as general reserve or net profit and loss a/c.

5. Such difference is taken as goodwill or capital reserve as the case may be.