Amalgamation, Absorption & External reconstruction

In this topic, we will cover some important points of Amalgamation methods, Absorption, purchase consideration & External reconstruction in corporate accounting. For daily updates for articles, notes, books, ebooks, and online courses directly in your inbox, you can subscribe to our newsletter below via your email.

Amalgamation:

Accounting Standard 14, deals with Amalgamation. Amalgamation is a combination of one or more companies into a new entity. In financial terms, Amalgamation is a fusion between two or more companies to consolidate their business activities by establishing a new company having a separate legal existence.

Types or methods  of Amalgamation and Method of accounting of amalgamation:

There are two types or methods of amalgamation :

Methods or types of Amalgamation

1. a) Amalgamation in the nature of Merger
2. b) Amalgamation in the nature of Purchase
3. a) Amalgamation in the nature of Merger:

AS 14 provides following conditions for amalgamation in the nature of merger:

1) Assets and Liabilities: All Assets and liabilities of the transferor company after amalgamation become the assets and liabilities of the transferee company.

2) Share Capital: Shareholders holding not less than 90% of the face value of equity share capital in the transferor company become shareholders of the transferee company after amalgamation.

3)  Discharge of Purchase consideration: The purchase consideration is discharged by the transferee company fully by way of equity shares except the fractions which are issued by way of cash.

4) Business: The business of the transferor company is intended to be carried out by the transferee company.

5) Book Value: No adjustments are to be made at book values of assets and liabilities except to ensure the uniformity of the accounting policies.

1. b) Amalgamation in the nature of Purchase:

Amalgamation in the nature of purchase is described as an amalgamation which does no satisfies one or more conditions of amalgamation in the nature of merger. In purchase method one company makes an complete purchase of interests of the equity shareholders of another company.

Types or Methods of Accounting for  Amalgamation:

types or Methods of Amalgamation

a) Pooling of Interests Method:

 This method is used when amalgamation is in the nature of Merger. This method has the following features

1) Reserves, Assets and liabilities:  All the reserves, assets and liabilities of the transferor company should be recorded at the existing carrying amounts and in the same manner as at the date of amalgamation in the transferee company’s financial statements.

2) Profit and Loss account: The balance of profit and loss account both companies should be merged or transferred to general reserve account.

3) Accounting Policies: Uniform accounting policies should be followed in case of variation among both the companies. The effect on the financial statement of such changes should be reported in accordance with AS 5.

4) Share capital:   The difference between the amount recorded as share capital issued (purchase consideration) and the amount of share capital of the transferor company should be adjusted in Reserves.

b) Purchase Method:

Methods of Amalgamation

As per guidelines of AS 14, the accounting of amalgamation is in nature of purchase is done by “Purchase Method” having the following features:

1) Assets and liabilities: In this method the transferee company records the assets and liabilities on the basis of either book value or fair value as agreed by them.

2) Profit and Loss account: The balance of profit and loss account of the transferor company need not be carried forward.

3) Statutory Reserve: All statutory reserves of the transferor company should be recorded in financial statement of the transferee company.

4) Purchase consideration and Net Assets:  The excess amount of the purchase consideration and Net Assets is debited to Goodwill account whereas the deficit is credited to Capital Reserve. However, AS 14 specifies that the amount of Goodwill should be written off within 5 years. 

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Q2) What is Purchase consideration? Explain the various methods of calculating Purchase consideration.

Purchase Consideration: Purchase consideration refers to the consideration payable by the transferee company to the transferor company for taking over the assets and liabilities of the company.

AS 14 defines the term purchase consideration as 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”.

There are various methods of Computations of Purchase Considerations, which are given below:

 Lumpsum Method: Under this method purchase consideration will be paid in lumpsum as per the agreement of the companies valuations.

Eg: Y ltd takes over Z ltd for the amount of Rs. 20,00,000. Here Rs. 20,00,000 is he purchase consideration.

2) Net Asset Method: Under the Net Assets Method, Purchase consideration is calculated by adding up all the taken over assets on agreed value of the transferor company and deducting the taken over liabilities at agreed value. If agreed value is not mentioned the value appearing in the books of the transferor company should be taken into consideration. All Fictitious assets should be ignored

3) Net Payment Method:  In this method, all payments made by the transferee company like Preference shares, Equity shares and cash are added together to find out the purchase considerations

Eg: X ltd had taken over Y ltd and agreed to pay Equity shares of Rs.  4,00,000, Preference shares for Rs. 2,00,000 and cash Rs. 50,000 

4) Intrinsic Worth Method: Under this method, purchase consideration is derived on the proportion in which the shares of the transferee company are exchanged for the shared of the transferor company. The ratio of exchange is usually determined on the basis of the Intrinsic or yield of shares.

Eg: A Ltd is absorbed by B ltd. It was decided that the holder of every 3 shares in A ltd was to receive 5 shares in B ltd 

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Q3) Distinguish between Amalgamation, Absorption, and Reconstruction of companies

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Q4) Short note on Amalgamation Adjustment Account:

Amalgamation is a union between two or more companies to consolidate their business activities by establishing a new company having a separate legal existence. This account is used when there is no adjustment account available. It is an extra account made for recording the transaction taking place at the time of amalgamation for legal compliance when there is no adjustment account available. According to Accounting standard 14 “Accounting for amalgamation” issued by ICAI, an amalgamation adjustment account arises when certain statutory reserves need to be maintained by the transferee company which was previously maintained in the books of transferor company. Examples of statutory reserves are- investment allowance reserves, development rebate reserve, export profits reserves etc. The balance amount which is left in the Amalgamation Adjustment Account is shown on the asset side under the head “Miscellaneous Expenditure to the extent not written off”.

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Q5) Distinguish between Internal and External Reconstruction.

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