Amalgamation of Companies Objectives, Methods, Procedure, Types

Table of Contents:-

What is Amalgamation of Companies
Objectives of Amalgamation of Companies
Methods of Accounting for Amalgamation of Companies
Treatment of Reserves on Amalgamation of Companies
Treatment of Goodwill Arising on Amalgamation of Companies
Purchase Consideration of Amalgamation of Companies
Important Terms in Amalgamation of Companies
Procedure for Amalgamation of Banking Companies
Types of Amalgamation of Companies

What is Amalgamation of Companies?

Amalgamation of companies means merging two or more companies to eliminate competition among them or to grow in size to achieve economies of scale. Amalgamation of companies is a broad term that includes merger (uniting of two existing companies) and acquisition (one company buying out another company).

To capitalize on economies of scale and alleviate intense competition, two or more joint-stock companies may amalgamate their operations and emerge as a single joint-stock entity. This consolidation can be achieved either through one of the existing joint-stock companies acquiring the other participating company or companies, with the latter being dissolved, or by establishing a new joint-stock company that assumes control over all the combined joint-stock entities. This process is executed through either amalgamation or absorption.

The meanings of these terms are given as follows:

1. Amalgamation

Amalgamation occurs when two or more companies, identical in all respects, undergo liquidation, and a new company is formed to take over their business. For instance, if a new company, C Ltd., is established to absorb the operations of existing companies A Ltd. and B Ltd., it is considered an example of amalgamation.

2. Absorption

Under absorption, no new company is formed. Instead, an existing company acquires another current company, called absorption. For example, when an existing company purchases the operations of another existing company, it is referred to as absorption.

Objectives of Amalgamation of Companies

There are several objectives of amalgamation of companies. Let’s discuss them in detail:

(i) To enhance control over the market and expand market share and operational reach.

(ii) To mitigate cutthroat competition and rivalry among the amalgamating companies.

(iii) To capitalize on the economies of large-scale production.

(iv) To leverage the expertise of professional experts.

(v) To augment the availability of funds for future investment plans.

(vi) To realize all other advantages associated with combination.

Methods of Accounting for Amalgamation of Companies

There are two primary methods of accounting for the amalgamation of companies:

The pooling of interest method and
The purchase method

The pooling of interest method is applicable in circumstances involving an amalgamation like a merger. The objective of the purchase method is to account for the amalgamation by applying the same principles as those used in everyday purchase transactions.

The Pooling of Interests Method

Under the pooling of interests method, the transferee company records the transferor company’s assets, liabilities, and reserves at their existing carrying amounts after making the necessary adjustments. If, during the amalgamation, the transferor and transferee companies have conflicting accounting policies, a consistent set of accounting policies is adopted post-amalgamation. The impacts on the financial statements resulting from any changes in accounting policies are disclosed by Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items, and Changes in Accounting Policies.

The Purchase Method

Under the purchase method, the transferee company accounts for the amalgamation by either incorporating the assets and liabilities at their existing carrying amounts or by allocating the consideration to individual identifiable liabilities and assets of the transferor company based on their fair values at the date of amalgamation. The identifiable assets and liabilities may include those not recorded in the financial statements of the transferor company.

When assets and liabilities are restated based on their fair values, the determination of appropriate values may be influenced by the intentions of the transferee company. For instance, the transferee company might have a specialized use for an asset unavailable to other potential buyers. Additionally, the transferee company may plan to implement changes in the activities of the transferor company, requiring the creation of specific provisions for expected costs, such as scheduled employee termination and plant relocation costs.

Treatment of Reserves on Amalgamation of Companies

If the amalgamation of companies is an ‘amalgamation like a merger,’ the identity of the reserves is maintained, and they appear in the transferee company’s financial statements in the same form as they did in the financial statements of the transferor company.

For example,

The general reserve of the transferor company is transformed into the General Reserve of the transferee company,
The capital reserve of the transferor company is converted into the Capital Reserve of the transferee company, and
The revaluation reserve of the transferor company is reclassified as the Revaluation Reserve of the transferee company.

Preserving the identity ensures that reserves available for distribution as dividends before the amalgamation remain available for distribution after the amalgamation. The recorded amount of share capital issued, including any additional consideration in cash or other assets, is adjusted to account for the disparity with the transferor company’s share capital.

If the amalgamation is an ‘amalgamation-like purchase,’ the identity of reserves, excluding statutory accounts mentioned earlier, is not preserved. The consideration amount is deducted from the value of the net assets acquired by the transferee company from the transferor company. If the result is negative, the difference is debited to goodwill arising from the amalgamation and managed as described above. If the impact is positive, any difference is credited to Capital Reserve.

Treatment of Goodwill Arising on Amalgamation of Companies

Goodwill arising from amalgamation of companies represents a payment made in anticipation of future income, and it is appropriate to treat it as an asset to be systematically amortized over its useful life. Due to the nature of goodwill, estimating its useful life with reasonable certainty is often challenging. Therefore, a prudent basis is used for this estimation. Accordingly, it is suitable to amortize goodwill over a period not exceeding five years unless a somewhat more extended period can be justified.

Regarding the balance of the Profit and Loss Account:

– In the case of an ‘amalgamation like a merger,’ the balance from the Profit and Loss Account in the financial statements of the transferor company is combined with the corresponding balance in the transferee company’s financial statements. Alternatively, it may be transferred to the General Reserve if one exists.

– In the case of an ‘amalgamation like a purchase,’ the balance from the Profit and Loss Account in the financial statements of the transferor company, whether debit or credit, loses its identity.

Purchase Consideration of Amalgamation of Companies

Purchase Consideration is the amount paid by the transferee company for acquiring the business of the transferor company. In simpler terms, the consideration for amalgamation encompasses the total value of shares and other securities issued, as well as payments in cash or other assets made by the transferee firm to the shareholders of the transferor firm. This calculation should exclude the amount of liabilities the transferee company assumes, as this company will directly pay those. Payments made to debenture holders should be excluded from the purchase consideration. The accurate calculation of the purchase consideration is essential and can be determined in the following ways.

(1) Lump Sum Payment Method

When the transferee company agrees to pay a fixed sum to the transferor company, it is termed a lump sum payment of the purchase consideration. For example, if A Ltd. acquires the business of B Ltd. and agrees to pay a total of Rs. 25,00,000, it is an illustration of a lump sum payment.

(2) Net Assets Method

In this approach, the purchase consideration is determined by calculating the net worth of the assets acquired by the Transferee Company. The net price is computed by adding the agreed-upon value of assets taken over by the transferee company. Many considerations should be taken into account few of them are given below:

– Include only the value of those assets that the transferee company acquires.
– Deduct the value of only those liabilities the Transferee Company has assumed.
– Cash balance is typically included in assets but should only be had if it is taken over.
– Goodwill, an intangible but valuable asset, is included in purchases.
– Do not add fictitious assets that have not been written off.
– This method is employed only when the Net Payment method cannot be adopted.

(3) Net Payment Method

In this method, the purchase consideration is calculated by aggregating various payments made by the transferee company, such as shares, securities, cash, etc. No deduction is made for any assumed liabilities, even if taken on by the purchasing company. Therefore, the purchase consideration is the sum of all payments, whether in the form of shares, securities, or cash.

Important Terms in Amalgamation of Companies

Some essential terms in the amalgamation of companies are as follows:

(1) Transferor Company: It refers to a company amalgamating into another.

(2) Transferee Company: It is the company into which the transferor company amalgamates.

(3) Amalgamation: Amalgamation is essentially of two types:

(i) Amalgamation in the nature of merger: This type of amalgamation satisfies the following conditions:

a) Following amalgamation, all the liabilities and assets of the transferor company seamlessly transition to become the assets and liabilities of the transferee company.
b) Shareholders holding at least 90% of the face value of the equity shares of the transferor company become equity shareholders of the transferee company.
c) The consideration for the amalgamation receivable by those equity shareholders of the transferor company is discharged by the transferee company through the issue of equity shares in the transferee company, with cash payment only for fractional shares.
d) After amalgamation, the transferee company is intended to continue the business operations of the transferor company.
e) No adjustment is intended to be made to the book value of the assets and liabilities of the transferor company when incorporated into the transferee company’s financial statements except to ensure uniformity of accounting policies.

(ii) Amalgamation-like Purchase: This type does not satisfy one or more of the above five conditions.

(4) Assets Purchased and Business Purchased

If mentioned in the question that the transferee company has purchased the assets of the transferor company, it means the transferee company acquired all the help, including cash, and not the liabilities of the transferor company’s business. Suppose it is mentioned that the transferee company has purchased the business of the transferor company. In that case, it means the transferee company acquired all the assets and liabilities of the transferor company.

(5) Liabilities and Trade Liabilities: The term “liabilities” includes trade creditors, bills payable, debentures, bank overdrafts, outstanding expenses, pension fund, provident fund, workmen profit-sharing fund, etc. The term “trade liabilities” encompasses creditors and bills payable associated with the sale/purchase of goods and services.

Procedure for Amalgamation of Banking Companies

Section 44A of the Banking Regulation Act 1949 outlines the procedure for amalgamating banking companies. The process is discussed below:

1. Banking companies can only be amalgamated with another banking company if the shareholders approve the merger scheme. This approval must be obtained in a meeting called for the purpose, with a majority in number representing two-thirds in value of the shareholders of each said company.

2. The approved scheme of amalgamation must be submitted to the Reserve Bank of India – RBI for its approval.

3. Any shareholder who has voted against the merger scheme or given written notice at or prior to the meeting is entitled to claim from the banking company the value of the shares he held. This value is determined by the RBI while approving the scheme.

4. Once the RBI sanctions the scheme of amalgamation, the combined company’s property and liabilities become the acquiring company’s property and liabilities.

5. After sanctioning the scheme of amalgamation, the RBI may further order the closure of the acquired bank and the acquired bank stands dissolved from the specified date.

Types of Amalgamation of Companies

The Institute of Chartered Accountants of India has introduced Accounting Standard 14 (AS 14) titled ‘Accounting for Amalgamations.’ The standard identifies two types of amalgamation:

1. Amalgamation in the nature of merger
2. Amalgamation in the nature of purchase

Amalgamation in the nature of merger is characterized by a genuine pooling not only of the assets and liabilities of the transferor and transferee companies but also of the shareholders’ interests and the companies’ businesses. The accounting treatment for such amalgamations should ensure that the resulting figures for assets, liabilities, capital, and reserves more or less represent the sum of the corresponding figures of the transferor and transferee companies.

As per para 3(e) of AS-14, amalgamation in the nature of a merger satisfies the following conditions:

(i) Following amalgamation, all assets and liabilities of the transferor company are transferred to the transferee company, becoming its assets and liabilities.

(ii) Shareholders holding at least 90% of the face value of the equity shares of the transferor company become equity shareholders of the transferee company by the amalgamation.

(iii) The consideration for the amalgamation, which is to be received by the equity shareholders of the transferor company opting to become equity shareholders of the transferee company, is fully settled by the transferee company through the issuance of equity shares. However, it should be noted that cash may be paid for any fractional shares.

(iv) Following the amalgamation, the transferee company intends to continue the operations of the transferor company.

(v) No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated into the transferee company’s financial statements, except to ensure uniformity of accounting policies. For example, suppose the transferor company follows the straight-line method of depreciation. In that case, the book value of the assets of the transferor company will be revised by applying the written-down method of depreciation.

If any of the above conditions is not met in an amalgamation, such amalgamation is referred to as an Amalgamation in the nature of purchase.

Conclusion

When two or more companies, identical in all respects, undergo liquidation to form a new company that takes over the business, it is called amalgamation. In contrast, absorption occurs when one existing company acquires another existing company. Amalgamation may have various objectives, such as:

i) To gain better control over the market, increase market operations, and expand market share.
ii) To eliminate cutthroat competition and rivalry among the amalgamating companies.
iii) To enhance the availability of funds for future investment plans.
iv) To use the services of HRD professionals.
v) To enjoy the benefits of economies of large-scale production.

In a situation of external reconstruction, the main objective is to reorganize the company to offset the substantial losses it has suffered. In contrast, the company continues with its legal entity in internal reconstruction and undergoes only internal reorganization. Under this scenario, the reduction of share capital is carried out to its actual worth, aiming to write down the overvalued assets of the company.

There are two primary methods of accounting for amalgamation of companies:

a) Pooling of Interest Method: Under this method, the assets, liabilities, and reserves of the Transferer Company are recorded by the Transferee Company at their existing carrying amounts.

b) Purchase Method: In this method, the transferee company accounts for the amalgamation either by incorporating the assets and liabilities at their existing carrying amounts or by allocating the consideration to individual identifiable liabilities and assets of the transferor company based on their fair values at the date of amalgamation.

In amalgamation, the purchase consideration is the amount paid by the transferee company for the purchase of the business of the transferor company. This can be calculated using the following methods:

Lump Sum payment method,
Net assets method,
Net payment method,
Intrinsic worth method.

FAQ

1. What is amalgamation in nature of purchase?

The amalgamation of companies may be deemed like a purchase when any one or more of the five conditions specified for amalgamations like a merger are not satisfied. These amalgamations serve as a means through which one company acquires another. As a result, the equity shareholders of the merging entities do not retain a proportionate share in the equity of the combined entity. Additionally, in such cases, the business of the acquired company is not intended to be continued after the amalgamation.

2. What are the Methods of Accounting for Amalgamation of companies?

It should be noted that the Accounting Standard addresses explicitly the accounting mechanism in the books of the transferee company.

As for the books of the transferor company, the regular accounting procedures, as elucidated later in this book through the realization accounts, will be followed for both types of amalgamations.

The accounting procedures for amalgamation in the books of the transferee company will vary depending on the type of amalgamation. There are two methods of accounting:

(i) Pooling of Interest Method; and
(ii) Purchase Method.

3. What is Amalgamation in the Nature of merger ?

Amalgamation in the Nature of Merger is a type of amalgamation that satisfies all the following conditions:

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

(ii) The consideration for the amalgamation, which is to be received by those equity shareholders of the transferor company opting to become equity shareholders of the transferee company, is fully settled by the transferee company through the issuance of equity shares, with the provision that cash may be paid for any fractional shares.

(iii) Shareholders holding at least 90 percent of the face value of the equity shares of the transferor company, excluding shares already held by the transferee company or its subsidiaries or their nominees before the amalgamation, become equity shareholders of the transferee company through the amalgamation.

(iv) No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated into the transferee company’s financial statements, except to ensure uniformity of accounting policies.

(v) After the amalgamation, the transferee company intends to continue the operations of the transferor company.

In this type of amalgamation, there is a genuine pooling of assets and liabilities of the combining entities. Moreover, equity shareholders of the combined entities maintain a proportionate share in the resulting entity.

The accounting treatment of such amalgamations should ensure that the resultant figures of assets, liabilities, capital, and reserves more or less represent the sum of the relevant statistics of the amalgamating companies.

4. What are the types of amalgamation?

Accounting problems related to amalgamation are addressed in AS-14 and categorized based on the type of amalgamation.

Types of Amalgamation: Amalgamation for accounting purposes can be classified into two groups.

(i) Amalgamation like merger
(ii) Amalgamation like purchase.

5. Explain meaning of amalgamation

The amalgamation of companies is defined in the standard as follows: Amalgamation means a company merging by the Companies Act, 1956 provisions, or any other applicable statute.

In practice, amalgamation can take the form of either merging one company with another or merging two or more companies to form a new company. In the case of amalgamation, the amalgamating company/ies are dissolved without winding up and connected with the amalgamating company.

From the notes above, we have observed that amalgamation involves merging two or more companies to form a new company. In comparison, absorption entails the takeover of the business of one or more companies by another existing company. However, the distinction between amalgamation and absorption is considered necessary regarding this accounting standard.