The following points highlight the top two methods of accounting for amalgamation. The methods are: 1. Pooling of Interests Method 2. Purchase Method.
1. Pooling of Interests Method:
This method is followed in case of an amalgamation in the nature of merger. Under this method, the assets, liabilities and reserves of the transferor company are recorded by the transferee company at their existing carrying amounts and in the same form as at the date of the amalgamation.
The balance of the Profit and Loss Account of the transferor company is aggregated with the balance of the Profit and Loss Account of the transferee company or transferred to the General Reserve, if any.
The difference between the amount recorded as share capital issued plus any additional consideration in the form of cash or other assets on the one hand and the amount of share capital of the transferor company on the other hand is adjusted in reserves.
If, at the tune of the amalgamation, the transferor and transferee companies have conflicting accounting policies, a uniform set of accounting policies is adopted following the amalgamation.
The effects on the financial statements of any changes in accounting policies are reported in accordance with Accounting Standard (AS) 5 (Revised)—’Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’.
2. Purchase Method:
This method is followed in case of an amalgamation in the nature of purchase. Under this method, the transferee company accounts for the amalgamation either by incorporating the assets and liabilities of the transferor company at their existing carrying amounts or by allocating the consideration to individual identifiable assets and liabilities of the transferor company on the basis of their fair values at the date of amalgamation.
The identifiable assets and liabilities may include assets and liabilities not recorded in the financial statements of the transferor company. Where assets and liabilities are restated on the basis of their fair values, the determination of fair values may be influenced by the intentions of the transferee company.
For example, the transferee company may have a specialized use for an asset. Also, the transferee company may intend to effect changes in the activities of the transferor company which may necessitate the creation of specific provisions for the expected cost, for example, planned employee termination and plant relocation costs.
The reserves (whether capital or revenue or arising on revaluation) of the transferor company, other than the statutory reserves, are not included in the financial statements of the transferee company.
To record the statutory reserves (such as Foreign Projects Reserve Account under sec. 80 HHB and Reserve created under sec. 80 HHD of the Income-tax Act) of the transferor company in the books of the transferee company, the relevant statutory reserve account is credited and the corresponding debit is given to a suitable account like amalgamation adjustment account which is disclosed in the balance sheet.
When the identity of this statutory reserve is no longer required to be maintained, both the statutory reserves account and the corresponding debit account are reversed.
Any excess of the amount of the consideration over the value of the net assets of the transferor company acquired by the transferee company is recognised in the transferee company’s books of account as goodwill arising on amalgamation. If the amount of the consideration is lower than the value of net assets acquired, the difference is credited to capital reserve.
The goodwill arising in amalgamation, as per Accounting Standard 14, should be amortised to income on a systematic basis over its useful life. The amortisation period should not exceed five years unless a somewhat longer period can be justified.
The factors which may be considered in estimating the useful life of goodwill arising on amalgamation include:
(a) The foreseeable life of the business or industry;
(b) The effects of product obsolescence, changes in demand and other economic factors;
(c) The service life expectancies of key individuals or groups of employees;
(d) Expected actions by competitors or potential competitors; and
(e) Legal, regulatory or contractual provisions affecting the useful life.
The following points which are common to the two methods described above are also noteworthy:
The consideration for the amalgamation may include non-cash element at fair value. In case of issue of securities, the value fixed by the statutory authorities may be taken to be the fair value. In case of other assets, the fair value may be determined by reference to the market value of the assets given up.
Where the market value of the assets given up cannot be reliably assessed, such assets are valued at their respective net book values.
Where the scheme of amalgamation provides for an adjustment to the consideration contingent on one or more future events, the amount of the additional payment is included in the consideration if payment is probable and a reasonable estimate of the amount can be made.
In all other cases, the adjustment is recognised as soon as the amount is determinable. It is as per Accounting Standard (AS) 4 (Revised) on Contingencies and Events Occurring after the Balance Sheet Date.