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
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
Unit-IV: Amalgamation, External Reconstruction and Internal Reconstruction
1. AMALGAMATION AND EXTERNAL RECONSTRUCTION
2. INTERNAL RECONSTRUCTION AND CAPITAL REDUCTIONS