Accounting For Amalgamation

Today we are going to talk about Amalgamation which is the most important topic for the students of accounting.


Amalgamation-

When two or more than two existing companies join to form a new company we called it as amalgamation. In the process of amalgamation existing companies loose their existence and the new company is created.

Suppose you are running your company (may be limited or private limited) which is in the business of cement manufacturing, you also have the lots of competitor who have the same business. one day you and one of your competitor agrees to merge(join) and form new company. The process is called amalgamation.

Accounting standard 14 and Amalgamation:

AS 14 defines Amalgamation as “Amalgamation means Amalgamation pursuant to the provision of company act 1956 or any other statue which may be applicable to the companies”.  

Amalgamation and Income tax:

Income tax defines Amalgamation as “Merger of one or more companies with another companies or merger of two or more than two company to form one company in such a manner that:

1) All the assets and liabilities of amalgamating companies immediately before the amalgamation become the properties of amalgamated company by the virtue of amalgamation.

2) Shareholder holding at least 3/4^th in the value of shares in the amalgamating companies become the shareholder of amalgamated company by the virtue of amalgamation”.

Transferor company (Amalgamating) and Transferee company (Amalgamated:

Before proceeding further, we need to understand the meaning of these two terms. The company that is transferring its assets and liabilities to another company by the virtue of amalgamation, we called it as transferor company (also called Amalgamating company) and the company in which it is been transferred is called transferee company (also called amalgamated company).

Take an example, X ltd and Y ltd are dissolve and new company XY ltd is formed. Here x ltd and y ltd are transferor company and new company XY ltd is called transferee company.

Now, why  amalgamation is done?

The reason is to gain the market shares in production that is to increase their production capacity and become the leader in their industry. Another reason is to eliminate competition and have the economies of large scale production. Apart from that, widening of product range, market penetration, and enhancement of technical know-how are also some of the reasons.

100 years of stock market shows us that amalgamation can also be created to hide accounting fraud. Sometimes it is seen that whenever any fraud has occurred, there was a frequent acquisition or amalgamation taking place on the part of the company. so these are some points that should be kept in mind by good accountant.



 Amalgamation and Acquisition:

There is a difference between these two terms. Acquisition occurs when one existing company takes over another existing company. Suppose, x ltd purchase y ltd, by paying some payment ( legally called purchase consideration, ) we called it as acquisition. Here x ltd is absorbing Y ltd and thus Y ltd has been dissolved or liquidated. Therefore, shareholders of Y ltd become the shareholders of x ltd.

        In the case of Amalgamation, there must be two or more existing companies that merge into the new company but in the case of acquisition, there can be one existing company that absorbs (yes absorption and acquisition have similar meaning) another existing company.



Amalgamation and External Reconstruction:



External Reconstruction takes place when new company is formed to take over an existing company. When x ltd is wounded up and with its assets and liabilities a new company Y ltd is formed,, the process is called external reconstruction. With these examples, it is clear that amalgamation and external reconstruction has some difference.

Purchase consideration:

Purchase consideration is the total payment made by transferee company to the transferor company for the assets and liabilities taken over by it. If X ltd acquires all the assets and liabilities of Y ltd and because of that total payment given to Y ltd is $100,000 then this amount is called purchase consideration. So in short, purchase consideration is the total payment that is made to purchase the business. Purchase consideration can be in the form of shares, other securities or in the form of cash or assets.

 Accounting for Amalgamation as per AS 14:

Accounting standard- 14 deals with accounting for amalgamation. The standard says that amalgamation can be of two types.

1) Amalgamation in the nature of merger.

2)Amalgamation in the nature of purchase.

There are some criteria which must be followed to regard amalgamation in the nature of merger.

1) All the assets and liabilities of transferor company become after amalgamation, the assets and liabilities of transferee company.

2) Not less than 90% of the shareholder of transferor company become after amalgamation, the shareholder of transferee company.

3) All the assets and liabilities of transferor company are transferred at book value.

4) There should be an intention of transferee company to run the existing business of transferor company after amalgamation.

5) Purchase consideration given to the shareholder of transferor company should be in shares except some cash can be given for fraction of shares.

All the five conditions mentioned above must be satisfied otherwise, it would be regarded as Amalgamation in the nature of purchase.

Accounting in the case of amalgamation in the nature of Merger:

Pooling of interest method is used in accounting for amalgamation in the case of merger. Under this method, transferee company does not make any changes to the asset and liabilities of transferor company. That is, they are not taken at their revalued amount but are taken at the book value. All the reserves should also be transferred whether it is capital reserve, general reserves or statutory reserves. All the five conditions stated above apply to this method.

We must note that the difference between purchase consideration and the share capital will be adjusted with the Reserves of the transferor company.

Let us take an example, take a look at the following Balance sheet of transferor company:

Liabilities		Amount
Share capital		1,00,000
Reserves and surplus		80000
Debenture		60000
Creditors		40000
Total		280000
Assets		Amount
Land & Building		115000
Plant and Machinery		85000
Debtors		20000
Stock		50000
Cash		10000
Total		280000

Suppose, the purchase consideration given by the transferee company is $120000, then the journal Entries in the books of transferee company would be:

Particular	Amount	Amount
Land &Building a/c             Dr	115000
Plant & Machinery a/c       Dr	85000
Debtors                                    Dr	20000
Stock                                          Dr	50000
Cash                                           Dr	10000
To, Creditors		40000
To, Debenture		60000
To, Reserve and surplus (80000-20000)		60000
To, purchase Consideration		120000

Here in the above balance sheet we can see that the difference between share capital and purchase consideration is adjusted with reserve and surplus.

Accounting in the case of Amalgamation in the nature of purchase:

Purchase method is used to account for amalgamation in the nature of purchase. Under this method, all the assets and liabilities of transferor company is taken at the revalued amount and not on the book value. The adjustment should be made either on the goodwill or with capital reserve. Suppose, If net asset (that is excess of asset over liability) is more than purchase consideration then the difference will be recorded in capital reserve account. On the other hand, if purchase consideration is more than the net asset then the difference will be recorded in goodwill account.

In the purchase method, not all the liabilities are recorded in the books of transferee company, only the outside liabilities are recorded. Similarly, fictitious assets are not recorded in the books of the transferor company.

Take an example, Following is the balance sheet of transferor company:

Liabilities		Amount
Share capital		1,00,000
Reserves and surplus		80000
Debenture		60000
Creditors		40000
Total		280000
Assets		Amount
Land & Building		115000
Plant and Machinery		85000
Debtors		20000
Stock		50000
Cash		10000
Total		280000

 

Suppose also that Land and building is revalued at 150000 and Debtors at 50000; and purchase consideration discharged is $250000

Then the journal entries in the book of transferee company would be:

Particular	Amount	Amount
Land &Building a/c             Dr	150000
Plant & Machinery a/c       Dr	85000
Debtors                                 Dr	50000
Stock                                      Dr	50000
Cash                                        Dr	10000
Goodwill                                Dr	5000
To, Creditors		40000
To, Debenture		60000
To, purchase Consideration		250000

 

Here we can see that the excess purchase consideration (250000) over net asset (245000) is adjusted with Goodwill.

 So that was all about amalgamation hope you have understood a lot on this concept. if you have any queries relating to this matter, write me on the comment box below.

 

Valuation of Equity Shares

Today I am going to talk about valuation of shares. Just be relax cause this is going to be interesting topic. this topic is not only useful for students but also for those people who wants to invest in the share market because this will help them to know how to value the shares they are investing on.
so get ready.
There are three methods of valuing equity shares.

1. Intrinsic value method.(net asset method)
2. Yield method.
3. Fair value method.

1. Intrinsic value method:

This method says that add all the assets of the company (excluding any fictitious asset) and from it deduct its outside liabilities. The value that you get should be  divided by number of equity shares and that would be your intrinsic value per shares. what you have to remember is if you have any preference share capital in the given balance sheet you have to deduct it also from total assets.

yes you are understanding little bit but you need practical example: suppose the following balance sheet is given to you:

Liabilities:                                                               Amount

Share capital

1000 equity shares of $100 each fully paid up         100000
2000 preference shares of $10 each fully paid up     20000

10%debentures                                                          15000
creditors                                                                     8000


Total liabilities                                                         143000


Asset:

Machinery                                                                50000
Furniture                                                                   40000

stock                                                                          30000
cash and cash equivalent                                           20000

preliminary expenses                                                 3000

Total asset                                                                  143000


Now how to determine intrinsic value ?

first add all the assets excluding preliminary expenses so ( 50000+40000+ 30000+20000=140000).

second deduct 15000, 8000 and 20000 of preference share capital as well that is, 43000 from 140000 and we get (140000-43000=97000) this 97000 is the value of equity shareholder.

lastly,  divide 97000 by number of equity shares(here we have 1000 as our number of equity share) and you get 97000/1000=97 as your intrinsic value per share.

There are lots of things to note down while calculating intrinsic value.

• if in your questions revaluation of any asset is given, then you should take revalued amount.
• in the above example Reserve and Surplus was not there but in your questions there will always be some Reserve and Surplus. If you find it, you don't have to deduct it because reserves and surplus are the value of equity shareholders so that should not be deducted from total assets.
• we are deducting preference capital because our aim is to determine intrinsic value of equity shares not preference shares so their value should be deducted from the total asset. apart from preference share capital, Arrear preference share dividend must also be deducted from total assets. Here in the above question, preference dividend was not there so we have not taken it in the calculation but if you find it, please deduct it also.
• Goodwill is to be added as per valuation. we know goodwill has its own method of valuation so we have to determine it on that basis.
• fictitious assets are not included in total assets because they don't have any value of their own. we can not sell it and get some money from that.
• and if you are learning intrinsic value of shares, I expect you to know the meaning of equity and preference shares.

By now I think you have understood clearly about valuing equity shares on the basis of intrinsic value. I suggest you to revise again all the above point and then we will learn more about the second method of valuation.

Take some tea or coffee and get ready again.

The next method is to value the shares on the basis of yield value.

Yield value Method :

First step is to determine "profit available for equity shareholder"

for this we need to determine average profit of the company and from the average profit deduct the amount that need to transfer to reserves. sometimes in the question it is given that 10% of profit must be transfer to reserves, in that case we have to compute 10% of average profit and then deduct it from average profit.
The second item that need to be deducted is the preference share dividend.

suppose the average after tax profit of the company is $10000.

company transfer 5% of the profit to the reserves.

and in the balance sheet it is given like that "10% 500preference shares of $10 each   $5000"
                                                   " 1000 equity shares of $100 each (fully paid)           $100000"

in the above case, profit available for equity shareholder would be:

Average profit                                           10000

less: transfer to reserves 10% of 10000 =  1000

less: preference shares dividend            =   500
       (10% of 5000)

total   profit available for equity shares      8500

The second step is to determine Expected Return

The formula of expected return is:

profit available for equity shareholder      *100
           P
aid up Equity share capital

so, in the above example our equity share capital is 100000 therefore, our expected return would be

8500/100000*100=8.5%

The third and final step is to determine yield value

formula is :

expected return/normal return* paid up value

therefore in the above example, suppose the normal return is 5% and paid up value of each share is $100 each.

yield value of shares = 8.5%/5%*100=$170


one thing must be noted here that it is the paid up value which should be multiplied not the face value . in the be given example if paid up value had been 80$ each and face value had been 100 $ each, we would multiply with 80$ not with 100$. and in that case our yield value would be;

8.5%/5%*80=$136

Till now hope I have been successful in making you understand the concept so far. the final method remains is valuation on the basis of fair value which is nothing but the average of intrinsic value and yield value.

here comes your formula :

Fair value=  intrinsic value+ yield value
                                     2

Practical questions:

1. Balance sheet of x ltd as on 31.12.2016

liabilities:

share capital:
15000 equity shares of 10$ each, fully paid                                     150000
20000 equity shares of $10 each, $6 paid                                         120000
9% cumulative preference shares                                                      60000

long term loan                                                                                    140000
sundry creditors                                                                                  80000
                                  Total                                                                550000

Assets:

Sundry fixed asset                                                                             220000
investments                                                                                        40000
stock in trade                                                                                      80000
sundry debtors                                                                                    40000
cash and bank                                                                                     40000
profit and loss account                                                                       130000

                               Total                                                                    550000

Other information:

1. current cost of sundry fixed asset is $370000 and that of stock is $100000
2. Investment could fetch only $10000.
3. 50% debtors are doubtful.
4. preference dividend is in arrears for the last five years.

Find out the intrinsic value per share of x ltd by net asset method.
                                                                                    For answer click here
Q2.

On the basis of the following information , calculate the intrinsic value of equity shares:

5000, 6% preference shares of $100 each ,                                      500000
30000 equity shares of $10 each fully paid                                      300000

total tangible asset (other than goodwill)                                         949000
total outside liabilities                                                                        95000

average net profit after tax                                                                 62560

expected normal yield for equity shares is 7% of capital employed. Goodwill is to be taken at 5 years' purchase of super profit.
                                                                                For Answer click here

Q3. From the following information, calculate the value per equity shares under yield method

2000, 9% preference shares of $100 each                                           200000
50000 equity shares of $10 each , $8 per share paid up.                     400000
expected profit per year before tax                                                      218000
rate of tax                                                                                               50%
transfer to general reserve                                        20% of profit
normal earning rate                                                                                15%


Q4. From the following, information calculate fair value of shares:

share capital (fully paid up)

Equity   100000 shares of $10 each
12% preference shares of $50 each

Reserve and surplus         $150000
preliminary expenses        $30000

The valuation of asset revealed that assets as per accounts are under valued by $250000

The average pre-tax profit of past three years were $500000.  tax rate 50%

it is anticipated that, due to favourable market condition, pre-tax profit will increase by 20%

Equity shareholder expect a return of 15%.

                                                    

                                                            * **------------***






 

Valuation of Equity shares -solutions to the problems

Answer 1.
                                                                       For questions click here

Sundry Fixed Asset           370000
stock                                  100000
investment                          10000
sundry debtors                    20000
cash and bank                    40000
                  
     total                              540000

less sundry creditors        80000
       long term loan          140000
      preference share        60000
      preference dividend   27000

      
Net asset available for equity = 233000

Add notional call 4*20000= 80000

total                                     313000

intrinsic value per share = 313000/35000
                                       =8.94 (fully paid)

partly paid = 8.94(-)4=4.94

 

Valuation of shares-- solutions to the problems

Answer 2.                                                                 For questions click here

Total capital Employed= 949000(-)95000
                                      =854000

normal profit = 7% of 854000
                       =59780

Average ne profit =62560

Super profit = 62560(-) 59780
                   =2780

Goodwill= 5*2780
               =13900


Total tangible asset =949000
Goodwill                =13900
total asset                =962900

less: total liability =95000

Asset available for shareholder= 962900(-)95000
                                                 =867900

less: preference share capital=500000
        preference share dividend=30000


Asset available for Equity shares holders= $337900

number of equity shares= 30000

intrinsic value per share = 337900/30000
                                        =11.26

(preference share dividend are assumed to be in arrear)