Amalgamation and External Reconstruction Notes, Corporate Accounting Notes B.Com 2nd & 4th Sem CBCS Pattern

Amalgamation and External Reconstruction Notes
Corporate Accounting Notes
B.Com 2nd and 4th Sem CBCS Pattern

Amalgamation and External Reconstruction (Part – A)

Q. What is amalgamation and external reconstruction? Explain its features. Explain its various types (2010, 2013) with examples. Distinguish between amalgamation and absorption.     2016

Q. Explain Amalgamation in the nature of merger and Amalgamation in the nature of purchase and distinguish between them. Also explain the treatment of reserve in case of amalgamation.      2014, 2015, 2018

Q. What is pooling of interest method and purchase method? Explain the differences between pooling of interest method and purchase method.                  2015, 2016

Q. Explain various methods for calculating purchase consideration with examples.        2010, 2014

Q. Practical Problems: Journal Entries for Amalgamation and External Reconstruction and Preparation of balance sheet 2010, 2012, 2014, 2017, 2019

Q. Write short notes on:

Ø  Purchase consideration        2015, 2017, 2019

Ø  Amalgamation in the nature of purchase.                    2012, 2018

Ø  Amalgamation in the nature of Merger                                         2012, 2018

Ø  Treatment of reserves in case of amalgamation in the nature of merger and purchase           2018

Introduction to External Reconstruction, Amalgamation and Absorption

External Reconstruction: The term ‘External Reconstruction’ means the winding up of an existing company and registering itself into a new one after a rearrangement of its financial position. Thus, there are two aspects of ‘External Reconstruction’, one, winding up of an existing company and the other, rearrangement of the company’s financial position. Such arrangement shall be approved by its shareholders and creditors and shall be sanctioned by the National Company Law Tribunal (NCLT). Such a step usually involves the writing off of a debit balance on Profit and Loss Account, elimination of all fictitious assets if any from the Balance Sheet, and the consequent readjustment of share capital.

Amalgamation: Amalgamation means the merging of two or more than two companies for eliminating competition among them or for growing in size to achieve the economies of scale. Amalgamation is a broad term which includes mergers (uniting of two existing companies) and acquisition (one company buying out another company).

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.

Features of Amalgamation

1) Two or more companies are liquidated in the process of amalgamation.

2) Amalgamation involves formation of a new company.

3) Normally companies of same size and same nature are amalgamated for the purpose of expansion.

4) Amalgamation of companies results in combination of companies.

Absorption: Absorption of Company is a business arrangement in which an existing company takes over the business of another entity. It does involve formation of a new company. In such arrangement the absorbed company is liquidated and the purchasing company will continue its operation. Absorption is mainly done with a view to use the strength of an existing company to exploit the opportunities exists in the market.

Difference between Amalgamation and Absorption:

1) Two or more companies are liquidated in the process of amalgamation. One or more companies are liquidated in absorption.

2) Amalgamation involves formation of a new company. However, Absorption of companies does not involve formation of a new company

3) There is no such matter of size of amalgamating companies. Generally, size of purchasing company is greater than that of vendor company in absorption.

Differences between amalgamation and external reconstruction

1. Amalgamation of companies involves liquidation of two or more companies, while external reconstruction involves liquidation of only one company,

2.  Amalgamation of companies results in combination of companies, but external reconstruction does not result in any such combination.

Differences between absorption and external reconstruction

1. Absorption of companies does not involve formation of a new company; however, external reconstruction involves formation of a new company,

2.  Absorption of companies results in liquidation of one or more companies while external reconstruction results in liquidation of only one company.

3. Absorption of companies involves combination of companies, whereas external reconstruction does not involve any combination.

Objectives of amalgamation of companies: 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.

Types of Amalgamation and their difference

According to AS – 14, Amalgamation is of two types:

a.       Amalgamation in the nature of merger

b.       Amalgamation in the nature of purchase

Amalgamation in the nature of Merger

According to AS-14 on Accounting for Amalgamation, the following conditions must be satisfied for an amalgamation in the nature of merger:

a. After amalgamation, all the assets and liabilities of the transferor company becomes the assets and liabilities of the transferee company.

b. Shareholders holding not less than 90% of the face value of the equity shares of the transferor company become the equity shareholders of the transferee company by virtue of amalgamation.

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

d. Purchase consideration should be discharged only by issue of equity shares in the transferee company except that cash may be paid in respect of any fractional shares.

e. No adjustments are required to be made in the book values of the assets and liabilities of the transferor company, when they are incorporated in the financial statements of the transferee company. If any one of the condition is not satisfied in a process of amalgamation, it will not be considered as amalgamation in the nature of merger.

Amalgamation in the nature of Purchase: An amalgamation will be treated as “Amalgamation in the nature of purchase” if any of the above mentioned conditions is not satisfied.

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

Basis of Distinction

Amalgamation in the Nature of Merger

Amalgamation in the Nature of Purchase

a)    Transfer of Assets and Liabilities

There is transfer of all assets & liabilities.

There need not be transfer for all assets & liabilities.

b)   Equity Shareholder’s holding 90%

Equity shareholders holding 90% equity shares in transferor company become shareholders of transferee company.

Equity shareholders need not become shareholders of transferee company.

 

c)    Purchase Consideration

 

Purchase consideration is discharged wholly by issue of equity shares (except cash for fractional shares)

Purchase consideration need not be discharged wholly by issue of equity shares.

d)   Same Business

 

The same business of the transferor company is intended to be carried on by the transferee company.

The business of the transferor company need not be intended to be carried on by the transferee company.

e)   Recording of Assets & Liabilities

 

The assets & liabilities taken over are recorded at their existing carrying amounts except where adjustment is required to ensure uniformity of accounting policies.

The assets & liabilities taken over are recorded at their existing carrying amounts or the basis of their fair values.

 

f)     Recording of Reserves of Transferor Co.

All reserves are recorded at their existing carrying amounts and in the same form.

Only statutory reserves are recorded at their existing carrying amounts.

g)    Recording of Balance of Profit & Loss A/c of Transferor

 

The balance of P&L A/c should be aggregated with the corresponding balance of the transferee co. or transferred to the General reserve account.

The balance of P&L A/c losses its identity and is not recorded at all.

 

 Purchase Consideration – Methods for calculation

Purchase Consideration refers to the consideration payable by the purchasing company to the vendor company for taking over the assets and liabilities of Vendor Company.

Accounting Standard – 14 defines the term purchase consideration as the “aggregate of the shares and other securities issued and the payment made in the form of ach or other assets by the transferee company to the shareholders of the transferor company”. Although, purchase consideration refers to total payment made by purchasing company to the shareholders of Vendor Company, its calculation could be in different methods, as explained below:

a. Lump sum method

b. Net Assets method

c. Net Payment Method

a. Lump sum Method: Under this method purchase consideration will be paid in lump sum as per the valuation of purchasing companies valuation. E.g., if it is stated that A Ltd. takes over the business of B Ltd. for Rs.15, 00,000 here the sum of the Rs.15, 00,000 is the Purchase Consideration.

b. Net Assets Method: Under this method P.C. shall be computed as follows:

Particulars

Rs.

Agreed value of assets taken over

Less: Agreed value of Liabilities taken over

XXX

XXX

Purchase Consideration

XXX

Note: i. The term “agreed value” means the amount at which the transferor company has agreed to sell and the transferee company has agreed to take over a particular assets or a liability Otherwise book value will be the agreed value.

ii. Fictitious assets (i.e., preliminary expenses, underwriting commission, discount on issue of shares, discount on issue of debentures and debit balance in P & L A/c) are not taken over.

c. Net Payment Method: Under this method P.C. should be calculated by aggregating total payments made by the purchasing company. E.g.: A Ltd. had taken over B Ltd. and for that it agreed to pay Rs.5, 00,000 in cash 4, 00,000 Equity Shares of Rs.10 each fully paid at an agreed value of Rs.15 per share then the P.C. will be ascertained as follows:

Particulars

Rs.

Cash

4,00,000 E. Shares of Rs.10 each fully paid, at Rs.15 per share

5,00,000

60,00,000

Purchase Consideration

65,00,000

Methods of accounting for amalgamation of Companies

a)       Pooling of interest method: The pooling of interest method is applied in case of an amalgamation in the nature of merger. In this method, assets and liabilities of transferor company is recorded in same value as they would appear in transferor company balance sheet. Under the pooling of interest method, the difference between the consideration paid and the share capital of the transferor company is adjusted in the general reserve or other reserves of the transferee company.

b)      Purchase method: Purchase method is applied in the case of an amalgamation in the nature of purchase. In this method, assets and liabilities of Transferor Company are recorded at revised value. Under the purchase method, the difference between the consideration and net assets taken over is treated by the transferee company as goodwill (Dr) or capital reserve (Cr).

Treatment of Reserve in case of amalgamation

When amalgamation is in the nature of merger, there is no distinction between statutory or other reserves. In this type of amalgamation, the identity of the reserves of the transferor company 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.

If the amalgamation is an ‘amalgamation in the nature of purchase’, the identity of the reserves, other than the statutory reserves, is not preserved. Only the statutory reserve of Transferor Company is transferred to the transferee company’s balance sheet. The amount of the purchase 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 account.

Difference between Pooling of interest and purchase method of recording transactions relating to amalgamation.

Basis

Pooling of Interest Method

Purchase Method

a)    Applicability

The pooling of interest method is applied in case of an amalgamation in the nature of merger.

Purchase method is applied in the case of an amalgamation in the nature of purchase.

 

b)   Recording

In the pooling of interest method all the reserves of the transferor Co. are also recorded by the transferee Co. in its books of account.

In the purchase method the transferee Co. records in its books of accounts only the assets and liabilities taken over the reserves, except the statutory reserves of the transferor company are not aggregated with those of the transferee Co.

c)    Adjustment of the differences

 

Under the pooling of interest method, the difference between the consideration paid and the share capital of the transferor company is adjusted in the general reserve or other reserves of the transferee company.

Under the purchase method, the difference between the consideration and net assets taken over is treated by the transferee company as goodwill or capital reserve.

 

d)   Statutory reserves

 

In this method, the statutory reserves are recorded by the transferee co. like all other reserves without opening Amalgamation and Adjustment A/c.

In the purchase method, while incorporating the statutory reserves, the transferee Co. has to open amalgamation adjustment account debiting it with the amt. of the statutory reserves being incorporated.

CORPORATE ACCOUNTING CHAPTER WISE NOTES

Unit-I: Shares & Debentures

1. ISSUE OF SHARES AND SHARE CAPITAL

2. RIGHTS SHARES AND BONUS SHARES

3. BUY-BACK OF SHARES

4. REDEMPTION OF PREFERENCE SHARES

5. ISSUE AND REDEMPTION OF DEBENTURES

Unit II: Preparation of financial statements of companies

1. FINAL ACCOUNTS OF COMPANIES

2. ACCOUNTS OF BANKING COMPANIES

Unit-III: Valuations of Goodwill and Shares & Cash Flow Statement

1. VALUATIONS OF GOODWILL AND SHARES

2. CASH FLOW STATEMENT

Unit-IV: Amalgamation, External Reconstruction and Internal Reconstruction

1. AMALGAMATION AND EXTERNAL RECONSTRUCTION

2. INTERNAL RECONSTRUCTION AND CAPITAL REDUCTIONS

Unit-V: Accounts of Holding Companies

ACCOUNTS OF HOLDING COMPANY COMPLETE NOTES

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