Accounting for Merger and Acquisitions 39

Notes

Unit 2: Accounting for Merger and Acquisitions

Structure:
2.1 Introduction
2.2 Definitions
2.3 Types of Amalgamations and its Accounting
2.4 Accounting for Amalgamation in the Books of Transferee Company – (i) The
Pooling of Interests Method and (ii) The Purchase Method
2.5 Accounting for Amalgamation in the Books of Transferor Company
2.6 Treatment of Reserves:
2.6.1 Statutory Reserves
2.6.2 Amalgamation after the Balance Sheet Date
2.7 Disclosure
2.8 Limited Revisions to AS 14 of Accounting Standard 14 – Accounting for
Amalgamation
2.9 Companies Act, 1956 and AS 14
2.10 AS 14 and International Accounting Standards
2.11 Summary
2.12 Check Your Progress
2.13 Questions and Exercises
2.14 Key Terms
2.15 Check Your Progress: Answers
2.16 Case Study
2.17 Further Readings

Objectives
After studying this unit, you should be able to:
● Quite often, two or more companies separately incorporated under the Companies
Act, 1956 are merged together and resulting in winding up of one or more
companies. In this process, there may arise goodwill or capital reserve (being the
difference between the purchase price paid and the net assets acquired) in the
books of the accounting company.
● AS 14 aims to provide for accounting treatment of mergers and also the treatment
of goodwill/capital reserve arising there from. The Standard does not deal with
acquisitions where an investor acquires whole or part of capital of some other
company and does not result in dissolution of the acquired entity.

2.1 Introduction
The direct relationship between good accounting practices and better economic
outcomes is widely recognized. There are numerous instances in India and around the
world of bad accounting practices leading to corporate failures. With so much activity
happening on the acquisition front by Indian companies in cross-border markets, it is an
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opportune time to evaluate whether within the framework of accounting standards the
Notes
structuring of the M&A transaction can be done.

2.2 Definitions
The following terms are used in this Standard:
(i) Amalgamation means an amalgamation pursuant to the provisions of the
Companies Act 1956.
(ii) Transferor company means the company which is amalgamated into another
company.
(iii) Transferee company means the company into which a transferor company is
amalgamated.
(iv) 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 specific purpose other than a provision for depreciation or diminution
in the value of assets of for a known liability.
(v) Amalgamation in the nature of merger is an amalgamation which satisfies all
the following conditions:
● All the assets and liabilities of the transferor company become, after
amalgamation, the assets and liabilities of the transferee company.
● Shareholders holding not less than 90% of the face value of the equity
shares of the transferor company become equity shareholders of the
transferee company by virtue of the amalgamation
● 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 fractional shares.
● The business of the transferor company is intended to be carried on, after
the amalgamation, by the transferee company.
● No adjustment is intended to be made to the book value 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.
(vi) Amalgamation in the nature of purchase is an amalgamation which does not
satisfy any one or more of the conditions specified above.
(vii) Consideration for the amalgamation means the aggregate of the shares and
other securities issued and the payment made in the form of cash or other
assets by the transferee company to the shareholders of the transferor
company.
(viii) Fair value is the amount for which an asset could be exchanged between a
knowledgeable, willing buyer and a knowledgeable, willing seller at an arm’s
length transaction.

2.3 Types of Amalgamations and its Accounting

As per AS 14, there are two types of amalgamations:
(i) Amalgamation in the nature of merger; and
(ii) Amalgamation in the nature of purchase

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2.4 Accounting for Amalgamation in the Books of Transferee Notes

Company
There are two methods of accounting for amalgamation:
(i) The pooling of Interests Method: Under the pooling of interests method, the
assets, liabilities and reserves of the transferor company are recorded by the
transferee company at their existing carrying amounts in the financial
statements of the transferred company. This method is applicable in the books
of transferee company in case of amalgamation in the nature of merger
(ii) The Purchase Method: Under the purchase method, the transferee company
records the amalgamation by incorporating the assets and liabilities taken over,
at their fair values at the date of amalgamation.
The difference between the purchase consideration and the fair value of identifiable
assets and liabilities is recorded as Goodwill or Capital Reserve. The asset and liabilities
not taken over by transferee company are disposed off by transferor company. This
method is applicable in the books of transferee company in case of amalgamation in the
nature of purchase.

2.5 Accounting for Amalgamation in the Books of Transferor

Company
AS 14 is silent on the accounting for amalgamation in the books of transferor
company. It has given accounting treatment only for the transferee company. Therefore,
accounting for amalgamation in the books of transferor company should be recorded as
per normal principles and practices of accounting, whether it is amalgamation in the
nature or merger or in the nature of purchase.

2.6 Treatment of Reserves

In case of amalgamation in the nature of merger, the identity of the reserves of
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. The General Reserve, the Capital Reserve and the
Revaluation Reserve of the transferor company becomes the General Reserve, the
Capital Reserve and the Revaluation Reserve of the transferee company. The difference
between the consideration payable (in term of share capital of the transferee company or
cash or otherwise) and amount of the share capital of the transferor company should be
adjusted in the reserves of the transferee company.
In case of ‘amalgamation in the nature of purchase’, the identity of the reserves,
other than the statutory reserves is not preserved. The amount of the 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 credited
to Capital Reserve.The goodwill/capital reserve, so created, appears in the balance
sheet of the transferee company.

2.6.1 Statutory Reserves

Statutory reserves are those reserves, which are required and created as per the
provisions of some law, and generally, there is a restriction on the utilization of this
reserve. If a Statutory Reserve is appearing in the balance sheet of the transferor

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company, then it should appear in the balance sheet of Transferee Company also, after
Notes
amalgamation. This can be ensured as follows:
(a) In case of amalgamation in the nature of merger: As already stated, in case
of merger, all the reserves of the transferor company are shown in the balance
sheet of the transferee company, the Statutory Reserves will appear together
with other reserves in the balance sheet of transferee company. So, no
separate treatment is required for Statutory Reserves in case of amalgamation
in the nature of merger.
(b) In case of amalgamation in the nature of purchase: In case of purchase, the
transferee company is required to record the Statutory Reserves of transferor
company and for this purpose, a separate entry is required as follows:
Amalgamation Adjustment A/c Dr.
To Statutory Reserves A/c
The Amalgamation Adjustment A/c will appear under the heading
‘Miscellaneous Expenditures’, and Statutory Reserves would appear under the
heading ‘Reserves and Surplus’ in the balance sheet of transferee company
after amalgamation.
Later on, when the identity of the Statutory Reserves is not to be maintained or
required, both these accounts should be contra-cancelled by the following
entry:
Statutory Reserves A/c Dr.
To Amalgamation Adjustment A/c

2.6.2 Amalgamation after the Balance Sheet Date

When an amalgamation is effected after the balance sheet date but before the
issuance of the financial statements of either party to the amalgamation, disclosure
should be made in accordance with AS 4, contingencies and events occurring after the
Balance Sheet date, but the amalgamation should not be incorporated in the financial
statements.

2.7 Disclosure
The following disclosures should be made in the first financial statements after the
amalgamation:
(a) names and general nature of business of amalgamating companies;
(b) effective date of amalgamation for accounting purposes
(c) the method of accounting used to reflect the amalgamation
(d) the amount of any difference between the consideration paid and the net
assets acquired, and the treatment thereof; and
(e) description and number of shares issued and ratio for exchange of shares

2.8 Limited Revisions to AS 14 of Accounting Standard 14 –

Accounting for Amalgamation
The Council of the Institute of Chartered Accountants of India has decided to make
the following limited revisions to Accounting Standard (AS) 14, Accounting for
Amalgamations.
It has been decided to substitute paragraph 42 of AS 14 by the following paragraph
(modifications made are shown as underlined):

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“42. Where the scheme of amalgamation sanctioned under a statute prescribes the
Notes
treatment to be given to the reserves of the transferor company after amalgamation, the
same should be followed. Where the scheme of amalgamation sanctioned under a
statute prescribes a different treatment to be given to the reserves of the transferor
company after amalgamation as compared to the requirements of this Statement that
would have been followed had no treatment been prescribed by the scheme, the
following disclosures should be made in the first financial statements following the
amalgamation
(a) A description of the accounting treatment given to the reserves and the
reasons for following the treatment different from that prescribed in this
Statement.
(b) Deviations in the accounting treatment given to the reserves as prescribed by
the scheme of amalgamation sanctioned under the statute as compared to the
requirements of this Statement that would have been followed had no
treatment been prescribed by the scheme.
(c) The financial effect, if any, arising due to such deviation.”
The limited revisions come into effect in respect of accounting periods commencing
on or after 1-4-2004.

2.9 Companies Act, 1956 and AS 14

The Companies Act, 1956 does not specify any disclosure of amalgamation in the
financial statements. Schedule VI annexed to the Act, is also silent on this point. On the
other hand, AS 14 provides for accounting for amalgamation as well as disclosure
requirements about amalgamations in the balance sheet of the transferee company,
prepared after amalgamation. So, the disclosure requirements of AS 14 are appropriate
from the point of view of shareholders and readers of financial statements.

2.10 AS 14 and International Accounting Standards

AS 14 is based on IAS 22 and US GAAP, still there are many differences between
them.
Under AS 14, in case of purchase method, the transferee company can record the
assets acquired either at the carrying amounts in the books of transferor company or at
the fair value. However, in case of IAS 22 and US GAAP, only fair values have been
provided.
In case of amalgamation in the nature of purchase, the transferee company may
intend to effect changes in the activities of the transferor company. AS 14 necessitates
that in such a case, the transferee company should create specific provision for the
expected costs of say, employee termination, plant relocation, etc. However, IAS 22 and
US GAAP provide for detailed provisions for recognition of such liability.
Regarding goodwill, which arises in case of purchase method, there are varying
provisions. AS 14 says that it should be written off over a period of 5 years unless
somewhat longer periods can be justified. IAS 22 provides for a maximum period of 20
years, while US GAAP says that goodwill need not be written of unless impaired.
AS 14 provides for two types of amalgamation i.e. in the nature of merger and in the
nature of purchase. However under IAS 22 and US GAAP, the pooling of interest method
has been made redundant.

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AS 14 does not provide for treatment of merger related expenses. However IAS 22
Notes
and US GAAP state that the merger expense should be charged to the Profit and Loss
A/c of the merged entity (i.e., the transferee company).

2.11 Summary
Accounting Standard 14 deals with Accounting for Amalgamation. It gives
accounting to be made in the books of the transferee company. This standard is not
applicable when one company acquires or purchases the shares of another company.
The acquired company is not dissolved and its separate entity continues to exist.
Accounting for mergers can be handled by:
(i) Pooling of interest method: Under the pooling of interests method, the assets,
liabilities and reserves of the transferor company are recorded by the
transferee company at their existing carrying amounts in the financial
statements of the transferred company, and
(ii) Purchase method: The transferee company records the amalgamation by
incorporating the assets and liabilities taken over, at their fair values at the date
of amalgamation.
The method of calculating consideration are lump sum method, net asset method,
net payment method and intrinsic method.
AS 14 is silent on the accounting for amalgamation in the books of transferor
company. It has given accounting treatment only for the transferee company. Therefore,
accounting for amalgamation in the books of transferor company should be recorded as
per normal principles and practices of accounting, whether it is amalgamation in the
nature or merger or in the nature of purchase

2.12 Check Your Progress

I. State Whether the Following Statements are True or False

1. Under pooling of interest method, the reserves of the transferor company
should be recorded at their existing carrying amounts in the same form as at
the date of amalgamation.
2. The consideration for the amalgamation should include any non-cash element
at fair value.
3. The scheme of amalgamation may provide for an adjustment to the
consideration contingent on one or more future events.
4. When the purchasing company decides to compensate, the selling company
on the basis of agreed value of assets and liabilities, the method for calculating
purchase consideration is called ‘Net Payments’ Method.
5. When one existing company takes over the business of another company or
companies, it is known as absorption.

II. Multiple Choice Questions

1. Under the net payments method, purchase consideration is arrived at by
adding up the payments made to _________ in the vendor company.
(a) debt holders
(b) shareholders
(c) liabilities
(d) assets

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2. When there are one or more liquidations and no formation, it is known as

Notes
________.
(a) amalgamation
(b) merger
(c) takeover
(d) acquisition
3. When an existing company takes over the business of existing company/
companies, it is known as ________.
(a) amalgamation in the nature of merger
(b) amalgamation in the nature of purchase
(c) takeover
(d) acquisition
4. Items in the nature of accumulated profits or losses in the books of the vendor
company should be transferred to _________.
(a) transferor company
(b) transferee company
(c) both transferee company and transferor company
(c) in neither s’ books
5. If preference shareholders or debenture holders are to receive more or less in
liquidation, such amount should be adjusted through _________.
(a) Amalgamation adjustment
(b) Miscellaneous expenditure
(c) Capital Reserve
(d) Realization Account

2.13 Questions and Exercises

1. What is Amalgamation of Companies? And What are the types of
Amalgamation as per AS 14?
2. What is Merger and what is purchase of business?
3. What do you mean by Transferor Company and Transferee Company?
4. How is Purchase Consideration calculated as per (i) Net Asset method and
(ii) Net Payment Method?
5. What do you mean by Accumulated Profits? Mention any five items of
Accumulated Profits.
6. Which funds are strictly liabilities and which funds are accumulated profits?
7. How are realization expenses treated in Amalgamation of Companies and how
is the claim of Equity Shareholders settled?
8. Mention disclosures required under AS 14.

2.14 Key Terms

● Amalgamation: Means an amalgamation pursuant to the provisions of the
Companies Act,1956.
● Transferor company: The company which is amalgamated into another
company.

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● Transferee company: Means the company into which a transferor company is
Notes
amalgamated.
● Amalgamation in the nature of merger is an amalgamation which satisfies all
the following conditions:
– All the assets and liabilities of the transferor company become, after
amalgamation, the assets and liabilities of the transferee company.
– Shareholders holding not less than 90% of the face value of the equity
shares of the transferor company become equity shareholders of the
transferee company by virtue of the amalgamation.
– 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 fractional shares.
– The business of the transferor company is intended to be carried on, after
the amalgamation, by the transferee company.
– No adjustment is intended to be made to the book value 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.
● The Pooling of Interests Method: Under the pooling of interests method, the
assets, liabilities and reserves of the transferor company are recorded by the
transferee company at their existing carrying amounts in the financial
statements of the transferred company. This method is applicable in the books
of transferee company in case of amalgamation in the nature of merger.
● The Purchase Method: Under the purchase method, the transferee company
records the amalgamation by incorporating the assets and liabilities taken over,
at their fair values at the date of amalgamation.

2.15 Check Your Progress: Answers

I. True or False
1. True
2. False
3. False
4. True
5. False

II. Multiple Choice Questions

1. (b) Shareholders
2. (b) Merger
3. (a) amalgamation in the nature of merger
4. (b) Transferee company
5. (a) amalgamation adjustment

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2.16 Case Study Notes

1. The following are the Balance Sheets as on 31/12/2014 of X Co. Ltd. and Y Co. Ltd.:
Liabilities X Ltd. Y Ltd. Assets X Ltd. Y Ltd.
Equity share capital 10,00,000 6,00,000 Land and Buildings 3,00,000 –
(` 100 per share) Plant and Machinery 11,00,000 5,00,000
10% Debentures of 2,00,000 – Stock 1,60,000 80,000
` 10 each
Reserve Fund 3,40,000 – Debtors 1,40,000 90,000
Div Equalization Fund 40,000 – Cash 30,000 10,000
Employees Provident 30,000 –
Fund
Trade Creditors 1,00,000 80,000
Profit and Loss Account 20,000
17,30,000 6,80,000 17,30,000 6,80,000
The two companies agree to amalgamate and for a new company called Z Ltd.
which takes over assets and liabilities of both the companies. The authorized capital of
Z Ltd. is ` 100,00,000 consisting of 10,00,000 equity shares of ` 10 each.
The assets of X Ltd. are taken over at a reduced valuation of 10% with the exception
of Land and Buildings which are accepted at book value.
Both companies are to receive 5% of the net valuation of their respective business
as goodwill. The entire purchase price is to be paid by Z Ltd. in its fully paid shares. In
return for debentures in X Ltd. debentures of the same amount and denomination are to
be issued by Z Ltd.
Calculate purchase consideration for both the companies. Give journal entries to
close the books of X Ltd. and Y Ltd. and show the opening balance sheet of Z Ltd.
Hints: Calculation of purchase consideration
Particulars X Ltd. Y Ltd.
Assets are per Balance sheet 17,30,000 6,80,000
Less: 10% reduction for X Ltd. excluding land and buildings and cash 1,40,000
15,90,000
Less: Liabilities taken over
10% Debentures 2,00,000
Employees PF 30,000
Sundry creditors 1,00,000 3,30,000 80,0000
12,60,000 6,00,000
Add: Goodwill 5% of net valuation 63,000 30,000
Purchase consideration 13,23,000 6,30,000

2.17 Further Readings

1. Mergers, Restructuring and Corporate Control by J. Fred Weston, K. Wang,
S. Chung and Susan E. Hoag, Prentice-Hall of India Private Ltd.
2. M&A and Corporate Restructuring by Patrick A. Gaughan, Wiley Finance
Series.
3. AS 14 from icai.org website

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