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Accounting Standard 14 caters to accounting for amalgamations and the treatment of the resulting goodwill or the reserves. AS 14 basically applies to companies. However, some of its requirements are also applicable to the financial statements of other enterprises.
One must note that AS 14 does not cater to the cases of acquisitions. Such acquisitions may take place when the acquiring company purchases whole or part of the shares or whole or part of the assets of the acquired company.
Furthermore, these acquisitions are undertaken in return for either payment in cash, by issue of shares or other securities in the acquiring company or partly in one form and partly in another.
The fact that differentiates an acquisition from amalgamation is that the acquired company is not dissolved. That is, it continues to exist as a separate legal entity.
Types of Amalgamations
There are broadly two categories of amalgamations. These include:
Amalgamation in the Nature of Merger
For an amalgamation to be termed as Merger, following conditions need to be satisfied:
- Upon amalgamation, all assets and liabilities of the transferor company become the assets and liabilities of the transferee company. Here the Transferor Company means the company that gets amalgamated into another company. On the other hand, the Transferee Company is a company into which the Transferor Company gets amalgamated.
- Shareholders having not less than 90% of the face value of equity shares of the Transferor Company (these shares do not include equity shares that are held in the Transferor Company by the Transferee Company, their subsidiaries or nominees immediately before amalgamation) become the equity shareholders of the Transferee Company by the way of amalgamation.
- The shareholders of the Transferor Company who get ready to become equity shareholders of the Transferee Company receive consideration. Such a consideration is given wholly in the form of equity shares in the Transferee Company. However, cash may be paid with regards to any fractional shares.
- Upon valuation, business of the Transferor Company is intended to be carried out by the Transferee Company .
- No changes or adjustments are intended to be made in the book values of assets and liabilities of the Transferor Company when such assets and liabilities are consolidated in the financial statements of the Transferee Company. Such adjustments however are made only for maintaining uniformity of accounting polices.
Thus, in this case, there is a genuine pooling of not only the assets and liabilities of the amalgamating companies but also of the shareholders interests and the businesses of such companies.
Therefore, the accounting treatment for the amalgamations in the nature of merger should confirm that the resulting figures of assets, liabilities, capital and reserves represent the total of relevant figures of the amalgamating companies.
Amalgamation in the Nature of Purchase
These include amalgamations where one company acquires another company. Accordingly, the shareholders of the company being acquired do not continue to hold proportionate equity shares in the combined company.
Also, the business of the acquired company is also not proposed to be continued upon such amalgamation
Methods of Accounting for Amalgamation
There are basically two methods of accounting for amalgamations. These include: Pooling of Interest Method and Purchase Method.
Pooling of Interest Method
This method is used in circumstances when an amalgamation fulfills the criteria for a merger as mentioned above. As per this method, assets, liabilities and reserves of the Transferor Company are recorded at their existing carrying amounts by the Transferee Company.
However, such amounts are recorded after making certain adjustments so as to bring uniformity in the accounting policies after amalgamation. Accordingly, if the Transferor and the Transferee Companies have contrasting accounting policies at the time of amalgamation, a uniform set of accounting policies are adopted post amalgamation.
Furthermore, the impact of such changes in the accounting policies on the financial statements is reported as per AS 5, that is, prior period and extraordinary items and changes in accounting policies.
There are two ways in which Transferee Company accounts for Amalgamation under the purchase method. These include accounting for amalgamation:
- Either by incorporating assets and liabilities at their existing carrying amounts or
- Assigning consideration to individual identifiable assets and liabilities of the transferor company based on their fair value. Furthermore, these identifiable assets and liabilities could include assets and liabilities that are not recorded in the financial statements of the transferor company. It must be noted that fair values assigned by the Transferee Company may be guided by the intentions of the Transferee Company.
The consideration paid upon amalgamation to the Transferor Company can comprise of securities, cash or other assets. In order to ascertain the amount of consideration, the fair value of each of its components is calculated.
There are a number of techniques that are used to determine the fair value. For instance, in case the consideration comprises of securities, the value fixed by the statutory authorities may be taken as the fair value of such securities.
Likewise, where the consideration comprises of assets, fair value is assessed by making a reference to the market value of the assets that are given up. In case, the market value of the assets given up cannot be assessed reliably, then assets are taken at their respective net book values.
Furthermore, the consideration to be paid upon amalgamation may require adjustments with reference to one or more future events. In cases where additional payment is expected to be made and which can be reasonably determined at the date of amalgamation, such an additional payment must be included in the consideration.
However, where it is not possible to determine the amount of such additional payment at the date of amalgamation, the adjustment to the consideration can be made when such additional amount is determinable.
Treatment of Reserves on Amalgamation
Amalgamation in the nature of Merger
In case of Amalgamation in the nature of Merger, the identity of the reserves is preserved upon amalgamation. In other words, reserves are reflected in the financial statements of the transferee company in the same form in which such reserves appeared in the financial statements of the Transferor Company.
For instance, the General Reserve recorded in the financial statements of the Transferor Company is recorded as General Reserve in financial statements of the Transferee Company upon Amalgamation.
Thus, any difference arising between the share capital issued and the amount of the share capital of the Transferor Company gets adjusted in the reserves of the financial statements of the Transferee Company.
Amalgamation in the Nature of Purchase
In case of Amalgamation in the Nature of Purchase, the identity of the reserves is not preserved. However, these reserves do not include Statutory Reserves.
Statutory Reserves are the reserves that are required to be maintained in order to comply with a specific statute. Transferor Company may create certain reserves either to comply with or claim benefits under Income Tax Act, 1961.
The identity of such reserves need to be preserved for a specific period as per the Act. Similarly, there may be other reserves created by the Transferor Company in its financial statements to comply with the requirements of some other statutes.
Although, the identity of reserves is typically not preserved in case of Amalgamation in nature of purchase, an exception is made with regards to statutory reserves.
Accordingly, contrary to this provision, Statutory Reserves maintain their identity in the financial statements of the Transferee Company in the same manner in which such reserves appeared in the financial statements of the Transferor Company.
Furthermore, such reserves retain their identity for a period it must be retained so as to comply with the specific statute.
It must be noted this exception of the Statutory Reserves is made in only those amalgamations where the requisites of the specific statute for recording such statutory reserves in the books of the Transferee Company are met.
Accordingly, such Statutory Reserves are recorded in the financial statements of the Transferee Company by a debit to a suitable account head such as Amalgamation Adjustment Account. However, in the balance sheet, such an account appears as part of Miscellaneous Expenditure or other similar category.
Furthermore, when the identity of such Statutory Reserves is no longer required to be preserved, both the reserves as well as Amalgamation Adjustment Account are reversed.
Treatment of Goodwill Arising on Amalgamation
Goodwill arising on account of amalgamation depicts a payment that is made as a result of an expectation of a future income. Thus, it is suitable to treat it as an asset that can be amortized to income on a systematic basis over the useful life of the asset.
Owing to the nature of goodwill, it is difficult to determine the useful life of goodwill with reasonable certainty. As a result, such a determination is made on a prudent basis.
Consequently, it is considered relevant to amortize goodwill over a period not exceeding five years till the time reasons for amortizing goodwill for a longer period can be substantiated.
Balance of Profit and Loss Account
Amalgamation in the Nature of Merger
In case of Amalgamation in the nature of Merger, P&L balance reflected in the financial statements of the Transferor Company is accumulated with a similar balance appearing in the financial statements of the Transferee Company. Or else, such a balance is transferred to General Reserve, if any.
Amalgamation in the Nature of Purchase
In this case, the debit or credit P&L balance appearing in the financial statements of the Transferor Company loses its identity.
Treatment of Reserves Specified in a Scheme of Amalgamation
The Scheme of Amalgamation provided under Companies Act, 1956 or any other similar statute may suggest treatment for the reserves of the Transferor Company after Amalgamation. Where such a suggestion is specified, the same must be followed by the stakeholders.
However, in some cases, the scheme of amalgamation under a specific statute may suggest a different treatment for reserves of Transferor Company after amalgamation vis-a-vis the requirements of this accounting standard which could have been followed had there been no suggestion made by the scheme.
In these cases, the stakeholders need to make the following disclosures after amalgamation in the first financial statements:
- Description regarding the accounting treatment given to the reserves and underlying reasons for adopting such a treatment which is different from the one suggested in this accounting standard.
- Deviations in the accounting treatment given to the reserves as suggested by the Amalgamation Scheme under the Statute vis-a-vis the requirements of this accounting standard had there been no suggestion made by the Amalgamation Scheme.
- Financial effect arising as a result of such a deviation, if any.
Following are the disclosures that need to be made in the first financial statements after the amalgamation:
- Name and general nature of business of the amalgamating companies;
- Effective date of amalgamation for accounting purposes;
- The method of accounting used to reflect the amalgamation; and
- Particulars of the scheme sanctioned under a statute
In case of amalgamations that are accounted via Pooling of Interest Method, following additional disclosures must be made in the first financial statements after the amalgamation:
- Description and number of shares issued along with percentage of each companies equity shares exchanged for amalgamation
- Amount of any difference between consideration and value of net identifiable assets acquired and its treatment
In case of amalgamations that are accounted via Purchase Method, following additional disclosures must be made in the first financial statements after the amalgamation:
- Consideration for Amalgamation and description in respect of consideration paid or payable
- Amount of difference between consideration and value of the net identifiable assets acquired and its treatment. This includes period of amortization of any goodwill arising as a result of amalgamation.
Amalgamation After the Balance Sheet Date
There can be cases when an Amalgamation is undertaken after the balance sheet date but before the issuance of the financial statements of both the parties to amalgamation. In such cases, disclosure is made as per Accounting Standard 4: Contingencies and Events Occuring After the Balance Sheet Date, however, the amalgamation is not included in the financial statements.