INTRODUCTION TO AMALGAMATIONS OF COMPANIES

 

UNIT STRUCTURE

1. Learning Objectives
2. Introduction
3. Meaning and Objectives of Amalgamation of Companies
4. Meaning of Different Terms Used in Amalgamation
5. Provisions for Amalgamation of Companies as Per Accounting Standard 14
6. Basis for Arriving At Purchase Consideration
7. Accounting Entries in the Books of Transferee Company
8. Let Us Sum Up
9. Answers to check your progress
10. Further readings
11. Possible Questions.

LEARNING OBJECTIVES

 
After going through this unit, you will be able to:
explain the meaning of ‘Amalgamation of Companies’
describe the objectives of amalgamation of companies
explain the different terminology in amalgamation
describe the provisions for amalgamation of companies as per Accounting Standard 14
illustrate accounting treatment on ‘Purchase of Business

INTRODUCTION


In the preceding unit (Unit 11) you have learnt about the accounting process in case of Purchase of Business. In this unit we will discuss the accounting problems on amalgamation of companies.  Dictionary meaning of ‘amalgamation’ is, ‘to join together to form a single organisation’ (Oxford English Dictionary). It means blending of two or more existing business enterprises to carry the existing or expanded or new business activities. In amalgamation, two or more firms join hands to take the advantage of various economic issues

           
Generally amalgamation is done between two or more companies engaged in the same line of activity. Again the companies may also combine for diversification of activities or for expansion of services such as banking, transport, communication and so on. Such business combination is generally termed as ‘Amalgamation’. In this unit we will confine ourselves to discuss meaning and objectives of amalgamation of companies, different terminology used in amalgamation, certain provisions as per Accounting Standard 14, basis for calculation of consideration for amalgamation and accounting entries in the books of transferee company under Purchase Method of Amalgamation.   


 
 

MEANING AND OBJECTIVES OF AMALGAMATION OF COMPANIES


Amalgamation of companies means to form one company by merging two or more companies. It may also mean that one company has acquired another company. In India, accounting problems regarding amalgamations are dealt with in accordance with the Accounting Standard (AS) - 14 issued by the Institute of Chartered Accountants of India (ICAI). In India, Amalgamation is used in the same sense as Business Combination is used in the USA. In case of amalgamation, as the transferor company is dissolved, its assets and liabilities find place in the financial statements of the transferee company, prepared subsequent to the date of amalgamation.
There are two types of amalgamation: According to AS-14 amalgamation is divided into the following two categories for accounting purposes:
(A) Amalgamation in the nature of merger; and
(B) Amalgamation in the nature of purchase.
These are discussed in the next section under the subhead Accounting Standard 14.

Objectives of amalgamation of companies
        Here you should know the reasons for which companies amalgamate with one another. The following are the main objectives of amalgamation of companies:
(a) To avoid competition: The main purpose of amalgamation of   companies is to avoid competition among themselves. This will give the company an edge over its competitors.

(b)  To reduce cost: The amalgamated company can derive the  operating cost advantage through lowering the cost of production. This is possible because of ‘economies of large scale’.

(c) To gain financially: The amalgamated company can derive financial gain which may be in the form of tax advantage, higher credit worthiness and lower rate of borrowing.

(d)  To achieve growth: The amalgamated company can pool its resources to facilitate internal growth and to prevent the advent of a new competitor.

(e) To diversify the activities: The risk of a company can be lowered by diversifying its activities into two or more industries. At times, amalgamation may act as hedging the weak operation with a stronger one.


CHECK YOUR PROGRESS


Explain the meaning of Amalgamation of Companies.



MEANING OF DIFFERENT TERMS USED IN AMALGAMATION


It will be worthwhile here to explain certain terms used in Amalgamation.
(a)   Amalgamation means an amalgamation pursuant to the provisions of the Companies Act, 1956 or any other statute which may be applicable to companies.
(b)   Transferor company means the company which is amalgamated into another company.
(c)   Transferee company means the company into which a transferor company is amalgamated.

(d)   Reserve means the portion of earnings, receipts or other surplus of an enterprise (whether capital or revenue) appropriated by the management for a general or a specific purpose other than a provision for depreciation or diminution in the value of assets or for a known liability.

PROVISIONS FOR AMALGAMATION OF COMPANIES AS PER ACCOUNTING STANDARD 14


In order to provide a clear guideline for accounting for amalgamation, the Institute of Chartered Accountants of India has issued Accounting Standard 14 (AS-14) which deals with ‘Accounting for Amalgamation.’
         AS-14 is effective since the accounting period beginning on or after 1.4.1995 and is mandatory in nature. The statement to these standard states that ‘Amalgamation’ means ‘an amalgamation pursuant to the provisions of the Companies Act, 1956 or any other statute which may be applicable to companies’. As per AS 14 there are two types of Amalgamation:

  • Amalgamation in the nature of Merger; and
  • Amalgamation in the Nature of Purchase.

Amalgamation in the nature of Merger
The 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, is called amalgamations in the nature of ‘merger’.
An amalgamation which satisfies all of the following conditions is considered as amalgamation in the nature of merger:
(i)    All the assets and liabilities of the transferor company become the assets and liabilities of the transferee company.

(ii)        Shareholders holding not less than 90 per cent 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 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.
(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 (amalgamation in the nature of merger), there is a genuine pooling of assets and liabilities of the combining entities. In addition, equity shareholders of the combining entities continue to have a proportionate share in the combined entity.

 Amalgamation in the Nature of Purchase:
An amalgamation is considered to be in the nature of purchase when any one or more of the five conditions specified for amalgamations in the nature of merger as stated above is not satisfied. In this type of amalgamation, one company acquires another company and the equity shareholders of the combining entities do not continue to have a proportionate share in the equity of the combined entity or the business of the company which is acquired is not intended to be continued after the amalgamation.

           
For example, X Ltd. acquires the business of Y Ltd. with no intention to continue such business, it is a case of amalgamation in the nature of purchase and not in the nature of merger. Similarly, if shareholders of Y Ltd. holding 90% or more of the share capital do not become shareholders of X Ltd., the amalgamation is in the nature of purchase. Further, if the assets and liabilities are recorded at revised values in the books of the transferee company, it is an amalgamation in the nature of purchas

CHECK YOUR PROGRESS


What are various types of amalgamation? .

 

BASIS FOR ARRIVING AT PURCHASE CONSIDERATION



Now we shall discuss the different basis for arriving at purchase consideration.  In the preceding unit you have learnt the meaning of purchase consideration. The consideration for amalgamation to be paid to the transferor company is ascertained on some basis. The different basis for calculating the consideration for amalgamation is discussed below:

(i)    Lump sum method: Where the terms of amalgamation provide for payment of a specified sum of money, the consideration for amalgamation will be taken at that sum. For example, If Bear Ltd is amalgamated with Bull ltd and the total consideration for amalgamation payable by Bull Ltd. is Rs. 8,80,000 to be discharged by issue of 80,000 equity shares of Rs. 10 each, fully paid and the balance in cash. It is known as lump sum method of purchase consideration.
(ii) Intrinsic value of share method: In unit 10, you have found the meaning of Intrinsic Value. The realisable value of total net assets divided by the number of shares outstanding is the intrinsic value of a share. This value is also known as Asset Back Value of shares.

           
Where the terms of amalgamation provide for payment of consideration on the basis of intrinsic value of shares of the transferor company, it is known as ‘Intrinsic value of share method’ of payment of consideration for amalgamation. In such a case, the amount of consideration payable will be ascertained as under:

Number of shares of Transferor Company  X  Intrinsic Value of shares of  Transferor Company.

Example1
Uma Ltd. is taken over by Shiv Ltd. As per the terms of amalgamation, the consideration for amalgamation is to be discharged on the basis of intrinsic value of shares of Uma Ltd. The share capital of Uma Ltd. consists of 50,000 Equity shares of Rs. 10 each and the intrinsic value of each Equity share of Uma Ltd. is Rs 22.
Calculate the consideration for amalgamation.
Solution:
Since the number of shares of Uma Ltd. (transferor company) is 50,000 and the intrinsic value of its shares is Rs. 22, the consideration for amalgamation to be discharged by Shiv Ltd. on the basis of intrinsic value of  shares will be 50,000 x Rs. 22= Rs. 11,00,000.

(iii) Share Exchange Method: Sometimes the transferee company takes over the business of the transferor company 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. 
Example2 
Milan Ltd. and Maya Ltd. decide to amalgamate. Maya Ltd is having a share capital of Rs. 1,00,000 divided into Equity shares of Rs. 10 each. The scheme of amalgamation states that for every 4 shares held in Maya Ltd .its shareholders are to get:
(i) Rs. 10 in cash ; and
(ii) 5 equity shares of Rs.10 each at par of Milan Ltd.
Calculate the consideration for amalgamation.

Solution:
(a)Calculation of No. of Equity shares of  Maya Ltd.:
Share Capital  =  Rs. 1,00,000
Face value of each equity share = Rs. 10
Therefore, the number of shares =  Rs. 1,00,000 ÷  Rs. 10 = 10,000

(b) Calculation of consideration for amalgamation:
Rs.
Cash (10,000 ÷ 4 x Rs.10)                 =     25,000

Shares (10,000 ÷ 4 x 5 x Rs.10)       =            1,25,000
Consideration                                           1,50,000

(iv)  Net asset method:  Under this method, the amount of consideration for amalgamation is determined on the basis of agreed value of assets and liabilities taken over. The amount payable by the transferee company is determined as follows:

 

Total agreed value of Assets taken over – Total agreed value of Liabilities taken over = Value of Net Assets taken over being the amount of consideration for amalgamation.



Example3
Y. Ltd. decides to amalgamate with X Ltd. X Ltd takes the assets of Y Ltd at Rs. 7,00,000, and amount payable to debenture holders of Y Ltd is Rs.3,00,000 and to creditors is Rs. 2,00,000 which are taken over by X Ltd. Ascertain the amount of consideration for amalgamation.
Solution:    
Calculation of Consideration for Amalgamation:       Rs.    
Value of Assets taken over                                          =    7,00,000
Less : Value of liabilities taken over :    Rs.                
Creditors                                    =        2,00,000
Debentures                   =          3,00,000                     5,00,000
Value of Net assets taken over being                     =    2,00,000

Hence the amount of consideration for amalgamation is Rs. 2,00,000.

CHECK YOUR PROGRESS



What are the different methods of calculation of purchase consideration for amalgamation of companies?

LET US KNOW
(a)  AS-14 states the accounting treatment to be followed by the transferee company only in case of amalgamation.
(b) The accounting treatment which is to be made by the transferee company depends on the nature of amalgamation.
(c)  AS-14 has not stated the accounting treatment to be followed by the transferor company. The transferor company will make the accounting treatment for liquidation consequent upon sale. In other words, it will pass entries for liquidation of its business and closure of its books of accounts.



Accounting ENTRIES In The Books Of Transferee


Company
It should be noted that AS-14 regulates the accounting treatment of amalgamation in the nature of merger and in the nature of purchase in the books of Transferee Company only.
        As per AS-14 there are two methods of recording the entries for the assets and liabilities taken over: Pooling of Interest Method and Purchase Method.
Here we will discuss accounting entries in the books of Transferee Company under Purchase Method only.
Features of the Purchase Method :
Before we proceed to discuss the accounting entries in the books of the transferee company it will be worthwhile to list out the features of the purchase method:

(i)    The assets and liabilities of the transferor company should be incorporated in either revalued figures or at their carrying amount.
(ii)   General reserve, capital reserve or revaluation reserve  of the transferor company other than the statutory reserves should not be included in the financial statements of the transferee company.
(iii)  Statutory reserve of the transferor company such as Development Allowance Reserve Account, Investment Allowance Reserve Account etc., should be carried forward in the books of the transferee company for legal compliance.
(iv)  The Amalgamation Adjustment Account should be disclosed under the head : Miscellaneous Expenditure in the asset side of the balance sheet. When it is found that the statutory reserve is no longer required to be maintained, both the Statutory Reserve and Amalgamation Adjustment Account will be eliminated by means of reverse entry.
(v)   Any excess of the amount of purchase consideration over the value of net assets of the transferor company acquired by the transferee company shall be treated as goodwill arising on amalgamation in the books of the transferee company. If the value of net assets is more than the purchase consideration than the difference is credited to Capital Reserve Account.

Accounting entries under purchase method
Accounting entries under purchase method are given below:

    • For purchase consideration on acquisition of the business :

       

      Business Purchase A/c        Dr.                              (with the amount of
      To Liquidator of Transferor Company A/c       purchase consideration)

    (2)   On acquisition of assets and liabilities of the transferor company :



    Assets A/c             Dr.                   (with value of assets taken over)
    Goodwill A/c          Dr.                  ( with difference, see note below)
    To Liabilities A/c                       (with the value of liabilities taken over)                                                                                         
    To Business Purchase A/c    ( with the amount of purchase  consideration )
    To Capital Reserve A/c       ( with difference, see note below)


    Note: In (2) above if the total amount of the debit accounts is greater than the total amount of the credit accounts, the difference is credited to Capital Reserve Account.
    Similarly if the total amount of the credit accounts is more than the debit total, the difference is debited to Goodwill Account.
    (3)   On discharge of purchase consideration:



    Liquidator of Transferor Company A/c                Dr.     (amount of purchase consideration)   
    Discount on Issue of Shares/ Debentures A/c     Dr.     (amount of discount)
    To Share Capital A/c                                         (nominal value of shares)
    To Securities Premium A/c                                  (amount of premium, if any)
    To Debentures A/c                                             (nominal value of debentures issued)
    To Bank A/c                                                       (amount paid in cash)
    There may be either discount on issue of shares/debentures account
    or securities premium account.
    1. For maintenance of statutory reserves such as Development Rebate Reserve, Investment Allowance Reserve, Export Profit Reserve:

           
    Amalgamation Adjustment A/c      Dr.        (amount of reserve)
    To Statutory Reserves A/c

    1. If liquidation expenses of the transferor company are borne by the transferee company:

     

    Goodwill A/c                                          Dr.      ( amount of expenditure)
    To Bank A/c

                   

    1. For the formation expenses of the transferee company, if any :

     

            Preliminary Expenses A/c           Dr.   (amount of expenditure)
    To Bank A/c



    (7)   In case there are both Goodwill and Capital Reserve Account, Goodwill may be set off against capital reserves :



    Capital Reserve A/c                    Dr.    (amount of goodwill written off)
    To Goodwill A/c

    Note :    Capital Reserve Account and Goodwill Account should not appear simultaneously in the balance sheet.

    (8)   On payment of liability by the transferee company :

     

      Respective Liability A/c                 Dr.                 (amount payable)
    To Share Capital A/c
    To Debentures A/c                                           (As the case may be)
    To Bank A/c

     

    Example 4
    S Ltd., which is having 40,000 Equity shares of Rs. 10 each, is taken over by H Ltd.. H Ltd. agrees to make the following payments :
    (i) Cash @ Rs. 4.00 per share for every share held in S  Ltd.
    (ii) Issue 1 shares of Rs. 10 each at par for every 2 shares held in S  
    Ltd.
    (iii) Discharge of Rs. 1,00,000, 8% debentures of S Ltd. at 10% premium by issuing 10% Debentures in H Ltd. at par, and
    (iv) Rs. 90,000 cash to creditors of S  Ltd. in final settlement of their                      
    account.
    Determine the amount of consideration for amalgamation as per AS-14.
    Solution :
    Calculation of Consideration for Amalgamation:                  Rs.
    (i)    Cash for shareholders ( 40,000 x Rs.4.00)                =         1,60,000
    (ii)   Shares for shareholders (40,000 ÷ 2 x Rs.10)           =      2,00,000
    Consideration for Amalgamation                               =      3,60000

    Discharge of 8% Debentures and payment to creditors are not taken into account for determining consideration for amalgamation as these are payments made to the outsiders (discharge of liabilities).
    Example 5
    M Ltd. is taken over by S Ltd. on the following terms and conditions :
    (i) The assets of M Ltd. are valued at Rs.6,00,000.
    (ii) The liabilities of M Ltd. are valued at Rs. 2,00,000.
    (iii) Rs. 2,00,000 in cash is paid to the shareholders of M Ltd.
    (iv) The balance of consideration is discharged by issue of shares of Rs. 10 each at Rs. 20 per share.
    Show how the consideration for amalgamation is discharged by S Ltd. and number of shares issued to the shareholders of M ltd
    Solution :
    Net assets of M Ltd:                                                      Rs.
    Assets taken over                                                   = 6,00,000
    Less : Liabilities taken over                                  = 2,00,000
    Net Assets taken over being the amount           = 4,00,000 
    of consideration for amalgamation.                                             
    Net Assets of Rs. 4,00,000 taken over is the amount of consideration for amalgamation.
    Consideration  for amalgamation is discharged as follows :
    Rs.
    Consideration for amalgamation:                                                 4,00,000 
    Less: Discharged in Cash                                          2,00,000
    Therefore, amount to be discharged by Issue of Shares          2,00,000
    Number of shares to be issued =
    Amount to be discharged by the issue of shares ÷ Issue Price of each share 
    = Rs. 2,00,000 ÷ 20 = 10,000 shares

LET US SUM UP


In this unit we have discussed the following-

  • In amalgamation of companies, two or more companies are merged to carry on the business.
  • Accounting Standard 14 issued by ICAI deals with the accounting problems of amalgamation of companies.
  • Amalgamation are of two types-
    1. amalgamation in the nature of merger; and
    2. amalgamation in the nature of purchase.

  • Companies are amalgamated for various reasons like, to avoid competition, to achieve growth, to diversify business activities etc.
  • Different methods are followed for calculating the purchase consideration like, lump sum method, intrinsic value of share method, share exchange method and net asset method.
  • Accounting treatment in the books of Transferee Company.

ANSWERS TO CHECK YOUR PROGRESS


Answer To Check Your Progress 1          
Amalgamation of companies means to form one company by merging two or more companies. It may also mean that one company has acquired another company. In India, the accounting problems of amalgamation of companies are dealt with according to AS 14 issued by ICAI.

Answer To Check Your Progress 2
As per AS 14 there are two types of Amalgamation:
Amalgamation in the nature of Merger; and
Amalgamation in the Nature of Purchase.

Answer To Check Your Progress 3

    • Lump sum method;
    • Intrinsic value of share method
    • Share exchange method; and
    • Net asset method

     


FURTHER READINGS


  • Advanced Accounting Corporate  Accounting  by Dr. A Sehgal and Dr. D Sehgal, Taxman
  • Modern Accountancy  A Mukherjee amd M Hanif, Tata McGraw Hill
  • Corporate  Accounting   K R Das and others, LBS publication;
 

POSSIBLE QUESTIONS



1.    State whether the following are ‘true’ or ‘false’:
(a)   Amalgamation and Acquisition are synonymous terms.
(b)   There are two type of amalgamation
(c)   Purchasemethod is applied in case of amalgamation in the nature of merger.
(d)   When the amalgamation is in the nature of purchase, the assets and liabilities are always stated in the books of transferee company at book values.
2.     Fill in the blanks with appropriate word(s).
(a)   The Accounting Standard ______ deals with ‘Accounting for Amalgamations’.
(b)   The company into which another company is amalgamated, is called ______ company
(c)   The most important object of amalgamation is to get the effect of ____.
(d) The realisable value of total net assets divided by the number of shares outstanding is the ____. value of a share.
3.     Explain the meaning of amalgamation as AS 14.
4.     describe the feartures of amalgamation in the nature of purchase.
5.     What is meant by consideration for amalgamation as per AS-14 ?
6.     Distinguish between amalgamation in the nature of merger and amalgamation in the nature of purchase ?
7.     X Ltd., which is having 50,000 Equity shares of Rs. 10 each, is taken over    
by Y Ltd.. Y Ltd. agrees to make the following payments :
(i) Cash @ Rs. 5.00 per share for every share held in X  Ltd.
(ii) Issue 1 shares of Rs. 10 each at par for every 2 shares held in X 
Ltd.
(iii) Discharge of Rs. 2,00,000, 8% debentures of X Ltd. at 10% premium
by issuing 10% Debentures in Y Ltd. at par, and
(iv) Rs. 20,000 cash to creditors of X  Ltd. in final settlement of their                     
account.
Determine the amount of consideration for amalgamation as per AS-14.
8.     Q Ltd. is taken over by R Ltd. on the following terms and conditions :
(i) The assets of Q Ltd. are valued at Rs.3,00,000.
(ii) The liabilities of Q Ltd. are valued at Rs. 1,00,000.
(iii) Rs. 1,00,000 in cash is paid to the shareholders of Q Ltd.
(iv) The balance of consideration is discharged by issue of shares of Rs. 10 each at Rs. 15 per share. Show how the consideration for amalgamation is discharged by R Ltd. and number of shares issued to the shareholders of Q ltd.

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