Chapter – 1
Mergers
Chapter outcomes:
1. Meaning and nature of mergers;
2. Different types of mergers;
3. Amalgamation, absorption and external reconstruction;
4. Purchase consideration;
5. Methods of calculating purchase consideration;
6. Accounting entries in the books of vendor company;
7. Accounting entries in the books of purchasing company;
8. Practical exercises;
Amalgamation, Absorption and Reconstruction
Amalgamation:
Amalgamation is the process whereby two or more
companies joint together to form a new company in
which existing companies are liquidated and a new
company is formed.
Example: A Ltd and B Ltd are amalgamated and C Ltd is
formed to take over their businesses.
A ltd and B ltd are called amalgamating companies.
C ltd is called new company
Absorption
Absorption is a process by which an existing company
takes over the business of one or more existing
companies. The company which takes over the business
other companies is known as purchasing company and
the companies which are taken over are called vendor
companies.
Example:
Oman Textile Mills Co. takes over the business of
Muscat Textile Mills Co. In this case, Oman Textiles
Mills Co. is purchasing company and Muscat Textiles
Mills Co. is vendor company.
Reconstruction
Reconstruction may be two types:
Internal Reconstruction
External Reconstruction
Internal reconstruction refers to the process of rearrangement of capital and liabilities in order to ensure
an optimum capital structure.
External reconstruction involves the liquidation of an
existing company in order to form a new company in
which the new company will take over the business of
liquidated company.
Example: Muscat Chemical Ltd is liquidated to form
Muscat Chemical (new) company Ltd.
Meaning of Purchase consideration
Consideration means the aggregate of the shares and
other securities issued and payment made in the form of
cash or other assets by the transferee company
(Purchasing company) to the shareholders of the
transferor company (Vendor Company).
The analysis of the aforesaid definition of ‘purchase
consideration’ makes it clear that the payments made by
the transferee company to discharge the debenture
holders and other outside liabilities and the cost of
winding up of transferor company shall not be
considered as part of purchase consideration.
Methods of calculation of purchase consideration
There are broadly two methods followed in the
calculation of purchase consideration:
1. Net Assets method;
2. Net payment method:
Under the net assets method, the purchase
consideration is calculated taking into account the
various assets and liabilities taken over by the
purchasing company. Here, the consideration will be
equal to the excess of assets taken over by the
purchasing company over the liabilities taken over by
the purchasing company
Under net payment method the amount of purchase
consideration is the sum total of the various payments
being made by the purchasing company against the
various assets and liabilities taken over.
This may include:
1. Issue of equity shares;
2. Issue of preference shares
3. Issue of debentures;
4. Payment of cash
Pro forma Journal entries in the books of vendor
company
The following journal entries are passed in the books of vendor company:
1. Transfer of assets taken over by the purchasing company:
Realization Account Dr. XXXX
Various assets account
Cr. XXXX
(Being the various assets taken over by the purchasing company)
2. Transfer of liabilities taken over the purchasing company :
Liabilities Account Dr. XXXX
Realization Account Cr.
XXXX
(Being the various liabilities taken over)
3.For the purchase consideration due from the purchasing company:
Purchasing Company Account Dr. XXXX
Realization Account Cr.
XXXX
(Being the purchase consideration due)
4. When the purchase consideration is received:
Shares in purchasing co. A/C
Dr. XXXX
Debentures in purchasing co. ac. Dr. XXXX
Bank Account
Dr. XXXX
Purchasing Company Account Cr.
XXXX
(Being the purchase consideration received)
5. For the sale of assets not taken over by the purchasing co:
Bank account
Dr. XXXX
Realization Ac. Dr. XXXX (if loss)
Asset Account
Cr.
XXXX
Realization account Cr.
XXXX (if profit)
(Being the asset sold)
6. For the payment of liabilities not taken over by the purchasing co:
Liabilities account Dr. XXXX
Realization Ac
Dr. XXXX (if loss)
Bank Account
Cr.
XXXX
Realization account Cr.
XXXX (if profit)
(Being the liabilities paid)
7. Profit or loss on realization:
If profit:
Realization Account Dr. XXXX
Equity Shareholders Ac. Cr.
XXXX
(Being the profit on realization transferred to shareholders account)
If loss:
Equity shareholders’ account Dr. XXXX
Realization Account
Cr.
XXXX
(Being the loss transferred to Equity shareholders account)
8. When the final settlement is made to shareholders:
Equity shareholders account Dr. XXXX
Equity shares in purchasing co. Ac.
Cr. XXXX
Preference shares in purchasing Co. Ac Cr. XXXX
Debentures in purchasing co.
Cr. XXXX
Bank account
Cr. XXXX
(Being the final settlement of the shareholders)
Pro forma Journal entries in the books of purchasing co
1. When the assets and liabilities are taken over by the
purchasing company:
Various assets account Dr. XXXX
Various liabilities account
Cr. XXXX
Liquidators of vendor company Cr. XXXX
(Being the assets and liabilities taken over and the purchase
consideration payable)
2. When purchase consideration is paid:
Liquidators of vendor co. account Dr. XXXX
Share capital account
Cr.
XXXX
Debentures account
Cr.
XXXX
Bank account
Cr.
XXXX
(Being the purchase consideration paid)