ACCOUNTING AND TAXATION ASPECTS

Accounting of Amalgamations
and Demergers
 Introduction

When a company just acquires

another company but does not
amalgamate that company
within itself, the shares
purchased from the promoters
and other shareholders are
shown as ‘investment’ in the
acquirer company’s books and
are accounted at the cost at
which they were acquired.

In the target company’s books

no adjustment is required at all.
 Accounting Fundamentals

Amalgamation Demerger
 Books of account and balance  Books of account and balance
sheet of two (or more) sheet of the demerged company
companies are required to be are required to be split into two or
more.
combined.
 The Institute of Chartered
 The ICAI has not prescribed
Accountants of India (ICAI)
has issued Accounting any Accounting Standard.
Standard 14 (AS 14) which
classifies different accounting  The accounting norms for (tax
methods applicable to different neutral) demergers are stipulated
types of amalgamations. in the Income Tax Act, 1961.
Accounting for Amalgamation
 Amity Business School

Accounting for Amalgamation

ACCOUNTING STANDARD 14

CLASSIFICATION OF AMALGAMATIONS

METHODS OF ACCOUNTING
 (AS 14)
Accounting for Amalgamations

 The Standard deals with accounting for amalgamations and

the treatment of any resultant goodwill or reserves.

 The Standard does not deal with cases of acquisition which

arise when there is purchase by one company (referred to as
the acquiring company) of the whole or part of the shares, or
the whole or part of the assets of another company (referred to
as the acquired company) in consideration for payment in cash
or by issue of shares or other securities in the acquiring
company or partly in one form and partly in the other.
 CLASSIFICATION OF AMALGAMATIONS

Amalgamation by way Amalgamation by way

of Merger of Purchase
 Amalgamation by way
of Merger
• Five Preconditions for Merger:
• All assets and liabilities of the transferor company become, after amalgamation,
the assets and liabilities of the transferee company.

• Shareholders holding not less than 90 percent of the face value of the equity
shares of the transferor company (other than the equity shares already held by the
transferee company or its subsidiaries or nominees) become the equity
shareholders of the transferee company by virtue of the amalgamation.

• The consideration for amalgamation received by those equity shareholders of the

transferor company who agree to become the 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 any
fractional shares.
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Amalgamation by way
of Merger

• The transferee company intends to carry on the business of the transferor

company after the amalgamation.

• No adjustment is intended to be made in 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 the uniformity of
accounting policies.
Amalgamation by Way of
Purchase
An amalgamation in which any one or more
of the five conditions mentioned earlier
are not satisfied, then it is considered as
amalgamation by way of purchase.
METHODS OF ACCOUNTINGAmity Business School

Pooling of Interest
Method Purchase Method
 Pooling of Interest Method

• In case of an amalgamation by way of merger, the method

prescribed is known as ‘pooling of interests method’.

• Under this method following norms are required to be adhered to:

 In preparing the transferee company’s financial statements, the assets, liabilities

and reserves of the transferor company should be recorded at their existing
carrying amounts and in the same form as at the time of amalgamation.
 Even the reserves under various heads in the transferor company’s books have
to be accounted under the same heads in the transferee company’s books.
Thus, ‘revaluation reserves’ of the transferor company will become or get added
to the ‘revaluation reserves’ of the transferee company and so on.
 The difference between the amount recorded as the share capital issued (plus
any additional consideration in the form of cash or other assets) and the amount
of share capital of the transferor company should be adjusted in reserves.
 Example
ABC Limited has paid-up share capital of Rs 100 crore consisting of 10 crore shares of Rs 10 face
value. XYZ Limited has paid-up share capital of Rs 50 crore consisting of 5 crore shares of Rs 10
face value. Decision has been taken to merge XYZ Limited with ABC Limited by using pooling of
interests method. The pre-merger balance sheets of ABC Limited and XYZ Limited are given in
Table 2 Market Price (MP), Book Value (BV) and Reinstatement Value of Net Fixed Assets per
share (RV) of ABC Limited are Rs 80, Rs 65 and Rs 120 respectively. In case of XYZ Limited, the
MP, BV and RV are Rs 240, Rs 130 and Rs 150 respectively. The firm of chartered accountants
doing valuation has assigned weightages of 3:1:3 for MP, BV and RV respectively.
Accordingly, the exchange ratio has been calculated as given in Table 1 below:

(see on the next slide)

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 Purchase Method

• In amalgamation by way of purchase, while preparing financial statements, the

transferee company is required to follow the ‘purchase method of accounting’.

Under the purchase method following norms are required to be adhered to:

A. With regard to assets and liabilities, the transferee company can

(a) record the assets and liabilities of the transferor company at their
existing carrying values, i.e., book values or

(b) allocate the consideration to the individual identifiable assets and

liabilities on the basis of their fair values at the date of
amalgamation.
The transferor company’s book value of net fixed assets is Rs 150 crore, book value of its net
current assets is Rs 350 crore, its borrowed funds are of Rs 400 crore and the consideration
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paid in the form of share capital issued is Rs 200 crore. Here, the net book value of the assets
works out to Rs 100 crore, against which the consideration paid is Rs 200 crore. The strict
interpretation of the wordings in AS 14 suggests that Rs 100 crore of goodwill built into the
consideration can be used to enhance the value of the individual assets up to Rs 100 crore
provided such enhancement is up to their individual fair values.

Example
 Purchase Method

• B. With regard to the reserves of the transferor company (whether

capital or revenue), the transferee company should not include them
in its books.
Only exception to this is the statutory reserves such as debenture
redemption reserves, which have to be shown in the transferee
company’s books under the same account heads and at the same
values as appearing in transferor company’s books at the time of
amalgamation.

On the other hand, any excess of the consideration over the value of the net
assets of the transferor company acquired by the transferee company should
be recognized in the transferee company’s financial statements as ‘goodwill’
arising on amalgamation; whereas, if the amount of the consideration is
lower than the value of the net assets acquired, the difference should be
treated as ‘capital reserve’.
 Example
Please refer to illustration under the pooling of interest method. It says that in case of XYZ
Limited, RV, i.e., reinstatement value per share of the fixed assets is Rs 150 per share. This
means that the total reinstatement value of the fixed assets of XYZ limited is Rs 750 crore. Now, if
ABC Limited decides to follow the purchase method and decides to account for the fixed assets at
Rs 750 crore, instead of their written down value (WDV) of Rs 610 crore and also decides to
account for other assets and liabilities at book values, the balance sheet of ABC Limited after
amalgamation will be as shown in Table 3.
Example continued…….
Please note the following things in reference to Table 3:

Due to the restatement of net fixed assets at Rs 750 crore, the total
value of assets has gone up by Rs 140 crore.

Accordingly, total reserves at Rs 1240 crore are higher by Rs 140

crore as compared to pooling of interest method (refer to Table 2)
where they are Rs 1100 crore.

However, under the pooling of interest method the entire reserves

of Rs 1100 crore are free reserves, whereas, in the purchase
method free reserves are only Rs 550 crore and capital reserves
are Rs 690 crore.
 Purchase Method

C. With regard to the norm of crediting the difference between

the consideration paid and net value of assets to ‘capital
reserve’ (where consideration is less than net value of assets),
there is a loophole provided in the AS 14 itself.

D. With regard to the goodwill, if any, as created above, AS 14

requires the said goodwill to be amortized over its useful life but
not exceeding five years.

E. AS 14 also provides that where the statutory reserves of

the transferor company have been recorded in the financial
statements of the transferee company under the same
accounting heads as in the books of the transferor company, a
corresponding debit should be given to the ‘amalgamation
adjustment account’, which should be disclosed under the
‘miscellaneous expenditure’.
Accounting for Demerger
Accounting for Demerger

The ICAI has, as yet, not prescribed any

accounting standard for demerger. However,
ironically, the Income Tax Act, 1961, has
defined the accounting norms for demerger.
Accounting for Demerger

The Act stipulates that all the assets and liabilities of the undertaking
being demerged must be transferred to the resulting company and must
be transferred at book values only.

If any asset of the undertaking being demerged has been revalued, such
revaluation needs to be ignored.

This means that while transferring to the resulting company the assets of
the undertaking being demerged, which were earlier revalued, have to
be restated at cost (less accumulated depreciation in case of fixed assets).

A peculiar situation would, however, arise if the company has already

capitalized these reserves by the issue of bonus shares. In such a case,
the transferor company would end up adjusting the diminution in the
value of assets against its general reserves.
 Accounting for Demerger

Transfer of Liabilities and Loans

Specific liabilities of the undertaking being demerged have to be

transferred to the resulting company.

Specific loans or borrowings including debentures raised, incurred

and utilized solely for the activities and operations of the undertaking
being demerged have to be transferred to the resulting company.

Common loans and borrowing have to be apportioned to the

resulting company in the same ratio as the book value of the assets
transferred to the resulting company bears to the total book value of
the assets of the demerged company prior to demerger.