UNIT 13 AMALGAMATION OF COMPANIES – BASIC CONCEPTS

Structure

13.0 Objectives
13.1 Introduction
13.2 Objectives of Amalgamation
13.3 Reconstruction
13.3.1 External Reconstruction
13.3.2 Internal Reconstruction
13.4 Difference between Amalgamation, Absorption and Reconstruction
13.5 Important terms in Amalgamation
13.6 Methods of Accounting for Amalgamation
13.7 Treatment of Reserves on Amalgamation
13.8 Treatment of Goodwill arising on Amalgamation
13.9 Purchase Consideration
13.10 Let Us Sum Up
13.11 Key Words
13.12 Answer to Check Your Progress
13.13 Terminal Questions

13.0 OBJECTIVES

After studying this unit, you will be to:

 Understand the concept of amalgamation;
 State the objectives of amalgamation;
 Identify the difference between external and internal reconstruction;
 Describe the methods of amalgamation;
 Explain the treatment of Reserves and Goodwill on amalgamation; and
 Determine the amount of purchase consideration on amalgamation.

13.1 INTRODUCTION

For the purpose of enjoying the economies of scale and to reduce the cut throat competition, two
or more than two joint stock companies may combine their undertakings and become one joint
stock company. It can be done either by one of the existing joint stock companies taking over the
other combining company or companies, the latter being dissolved or by standing a new joint
stock company, which takes over all the combining joint stock companies. It is being done either
by Amalgamation or Absorption.

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The meaning of these terms is as follows:
Amalgamation: When two or more companies same in all respects go into liquidation and the
new company is formed to take over their business is called amalgamation. For example, if a
new company C Ltd. is formed to take over A Ltd. and B Ltd. which are existing companies, it is
an example of amalgamation.
Absorption: Under absorption, no new company is formed, whereas an existing company
purchases another existing company, it is called absorption.

13.2 OBJECTIVES OF AMALGAMATION

Amalgamation means the merging of two or more than two companies for eliminating
competition among them or for growing in size to achieve the economies of scale.
Amalgamation is a broad term which includes mergers (uniting of two existing companies) and
acquisition (one company buying out another company).There are many objectives of
amalgamation. Some of the objectives are as follow: Let us discuss them in detail.
(i) To have a better control over the market and also to increase the market share and area •
of operations.
(ii) To eliminate the cut-throat competition and rivalry among competing the amalgamating
companies.
(iii) To enjoy the economies of large scale production.
(iv) To utilize the services of professional experts.
(v) To increase the availability of funds for the future investment plans.
(vi) To achieve all other advantages of combination.

13.3 RECONSTRUCTION

Reconstruction is entirely of different nature. The objective is not to bring about a combination
of companies but merely to reorganize a company which has suffered huge losses which are to
be written off. Reconstruction may be of two types:

13.3.1 External Reconstruction

It is not exactly similar to amalgamation. In external reconstruction, existing company is wound
up by selling its business to newly formed company which is generally similar named or owned
by the same shareholders.

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13.3.2 Internal Reconstruction
It is altogether a different form of business combination. In internal reconstruction, the company
continues with its legal entity and is only internally reorganized. In this, rearrangement and
reduction of share capital is done. Under internal reconstruction, the share capital is reduced to
its real worth and the same amount is used to eliminate the accumulated losses, fictitious assets
and to write down the overvalued assets of the company.

13.4 DIFFERENCE BETWEEN AMALGAMATON, ABSORPTION AND

RECONSTRUCTION

Basis Amalgamation Absorption Reconstruction

Formation A new company is No new company is Company is
formed. formed. reconstructed.
Liquidation All the companies The company whose The company which
which go for business is purchased is reconstructed goes
amalgamation are by another company into liquidation.
liquidated. goes into liquidation.
Financial Position of Financial position of Financial position of Financial position of
the Company all the involved the absorbing the old company is
companies is same. company is bad and is usually
comparatively sound considered as the sick
than the absorbed unit.
company.
Objective To eliminate the To expand the To write off the
competition among business and to accumulated losses
the amalgamated achieve the economies and offering the real
companies. of large scale worth of the business
production. to the shareholders.
Position of Shareholders of the Shareholders of the Most of the
shareholders in new amalgamated selling company may shareholders of the
company companies become become the old company continue
the shareholders of shareholders of the to be the shareholders
the new company. purchasing company of the new company
with the proportionate
share.

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13.5 IMPORTANT TERMS IN AMALGAMATION
Some Important Terms in Amalgamation are as under
(1) Transferor Company: This means the company which is amalgamated into another
company.
(2) Transferee Company: It is a company in which transferor company amalgamate.
(3) Amalgamation: Amalgamation is basically of two types:
(i) Amalgamation in the nature of merger: Amalgamation in the nature of merger is an
amalgamation which satisfies all the following conditions: .
a) All the assets and liabilities of the transferor company become, after
amalgamation, the assets and liabilities of the transferee company.
b) Shareholders holding not less than 90% of the face value of the equity shares of
the transferor company (other than the equity shares already held therein,
immediately before the amalgamation by the transferee company or its
subsidiaries or their nominees) become equity shareholders of the transferee
company by virtue of the amalgamation.
c) The consideration for the amalgamation receivable by those equity shareholders
of the transferor company who agree to become equity shareholders of the
transferee company is discharged by the transferee company wholly by the issue
of equity shares in the transferee company, with the exception that cash may be
paid only in respect of fractional shares.
d) The business of the transferor company is intended to be carried on, after the
amalgamation, by the transferee company.
e) No adjustment is intended to be made to 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 uniformity of the
accounting policies.
(ii) Amalgamation in the nature of purchase: Amalgamation in the nature of purchase is
an amalgamation which does not satisfy any one or more of the five conditions stated
above.
(4) Assets purchased and Business purchased: If it is mentioned in the question that the
transferee company has purchased the assets of the Transferor company, it means that
Transferee Company has acquired all the assets including cash and not the liabilities of
the business of the transferor company. If it is mentioned that the Transferee company
has purchased the business of the transferor company, it means that Transferee Company
has 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 overdraft, outstanding expenses, pension fund, provident fund,

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 workmen profit sharing fund etc. The term trade liabilities include creditors and bills
payable which are associated with sale/purchase of goods and services.

13.6 METHODS OF ACCOUNTING FOR AMALGAMATION

There are two main methods of accounting for amalgamation: (a) The pooling of interest
method; and (b) The purchase method.
The use of the pooling of interest method is confined to circumstances which meet the criteria
referred to in paragraph 3(e) for an amalgamation in the nature of merger. The object of the
purchase method is to account for the amalgamation by applying the same principles as are
applied in the normal purchase of assets. This method is used in accounting for amalgamations in
the nature of purchase.
The Pooling of Interests Method
Under the pooling of interests method, the assets, liabilities and reserves of the transferor
company are recorded by the transferee company at their existing carrying amounts (after
making the adjustments required).
If, at the time of the amalgamation, the transferor and the 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, 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 either by
incorporating the assets and liabilities 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, which is not available to other
potential buyers. The transferee company may intend to effect changes in the activities of the
transferor company which necessitate the creation of specific provisions for the expected costs,
e.g. planned employee termination and plant relocation costs.

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13.7 TREATMENT OF RESERVES ON AMALGAMATION

If the amalgamation is an ‘amalgamation in the nature of merger', the identity of the reserves is
preserved and they appear in the financial statements of the transferee company in the same form
in which they appeared in the financial statements of the transferor company. Thus, for example,
the General Reserve of the transferor company becomes the General Reserve of the transferee
company; the Capital Reserve of the transferor company becomes the Capital Reserve of the
transferee company and the Revaluation Reserve of the transferor company becomes the
Revaluation Reserve of the transferee company. As a result of preserving the identity, reserves
which are available for distribution as dividend before the amalgamation would also be available
for distribution as dividend after the amalgamation. The difference between the amount recorded
as 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 is adjusted.
If the amalgamation is an ‘amalgamation in the nature of purchase', the identity of the reserves,
other than the statutory reserves dealt above, is not preserved. The amount of the consideration is
deducted from the value of the net assets of the transferor company acquired by the transferee
company. If the result of the computation is negative, the difference is debited to goodwill
arising on amalgamation and dealt with in the manner stated in above. If the result of the
computation is positive, the difference is credited to Capital Reserve.
13.8 TREATMENT OF GOODWILL ARISING ON AMALGAMATION
Goodwill arising on amalgamation represents a payment made in anticipation of future income
and it is appropriate to treat it as an asset to be amortized to income on a systematic basis over its
useful life. Due to the nature of goodwill, it is frequently difficult to estimate its useful life with
reasonable certainty. Such estimation is, therefore, made on a prudent basis. Accordingly, it is
considered appropriate to amortize goodwill over a period not exceeding five years unless a
somewhat longer period can be justified.
Balance of Profit and Loss Account
In the case of an 'amalgamation in the nature of merger', the balance of the Profit and Loss
Account appearing in the financial statements of the transferor company is aggregated with the
corresponding balance appearing in the financial statements of the transferee company.
Alternatively, it is transferred to the General Reserve, if any.
In the case of an ‘amalgamation in the nature of purchase', the balance of the Profit and Loss
Account appearing in the financial statements of the transferor company, whether debit or credit,
looses its identity.

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13.9 PURCHASE CONSIDERATION

Purchase Consideration is the amount which is paid by the transferee company for the purchase
of the business of the transferor company. In other words, consideration for amalgamation means
the aggregate of the shares and other securities issued and payment in cash or other assets by the
transferee company to the shareholders of the transferor company. It should not include the
amount of liabilities taken over by the transferee company, which will be paid directly by this
company. Payments made to debenture holders should not be considered as part of purchase
consideration. The calculation of purchase consideration is very important and may be calculated
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 called a lump sum payment of purchase consideration. For
example, if A Ltd. purchases the business of B Ltd. and agrees to pay Rs. 25,00,000 in
all, it is an example of lump sum payment.
(2) Net Assets Method: According to this method, the purchase consideration is calculated
by calculating the net worth of the assets taken over by the Transferee Company. The net
worth is calculated by adding the agreed value of assets taken over by the transferee
company. Following points should be taken care of:
 Value of only those assets is included which are acquired by the transferee company.
 Value of only those liabilities will be deducted which have been taken over by the
Transferee Company.
 Cash Balance is normally included in assets but if it is not taken over it will not be
included. Goodwill is an intangible but valuable asset and as such is included in
assets.
 Fictitious assets not written off should not be added.
 This method is used only when the Net Payment cannot be adopted.
(3) Net Payment Method: Under this method, purchase consideration is calculated by
adding the various payments in the form of shares, securities, cash, etc. made by the
transferee company. No amount of liabilities is deducted even if these are assumed by the
purchasing company. Thus, purchase consideration is the total of all the payments
whether in shares, securities, or cash. For example, X Ltd. agrees to give for every 10
shares of Y Ltd. 15 shares of Rs. 10 each, Rs. 8 paid up. X Ltd. agrees to pay
Rs.15, 000 cash to discharge the creditors. The purchase consideration is calculated as
follows:

Shareholders of Y Ltd. will get:

6,000 ×15/10 = 9,000 shares of Rs. 10 each, Rs. 8 paid up Rs. 72,000
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 Cash Paid Rs. 15,000
Purchase Consideration Rs. 87,000
But sometimes it is specifically mentioned that company issued requisite number of shares and
also gave balance amount in cash. But “this balance” could not be ascertained and the total
purchase consideration amount is also meet specified, then in such a case the company has only
option to go with the net assets method.
The following points are to be kept in mind:
 The assets and liabilities taken over by the transferee company are not to be considered.
 The payments made by the transferee company for the shareholders, whether in cash
or shares must be taken in account.
 If debentures and creditors are taken over by the transferee company and subsequently
discharged then such am discharged then such amount should not be deducted from the
purchase consideration.

(4) Intrinsic worth/value Method: This method is just an extension of net assets methods.
Under method, purchase consideration is required to be calculated on the basis of
intrinsic value of shares. The intrinsic value of a share is calculated by dividing the net
assets available for equity shareholders by the number of equity shares. This value
determines the ratio of exchange of shares between the transferor and transferee
company. Suppose A Ltd. and B Ltd. are two companies carrying on the business in the
same line of activity. Their capital is Rs. 6, 00,000 and Rs. 2, 00,000 (value of each share
Rs. 10). The two companies decided to amalgamate in C Ltd. If each share of A Ltd. and
B Ltd. is valued at Rs. 15 and Rs. 25 per share for the purpose of amalgamation. The
purchase consideration will be as under:
A Ltd. 60,000 shares @ Rs. 15 each Rs. 9, 00,000
B Ltd. 20,000 shares @ Rs. 25 each Rs. 5, 00,000

Check Your Progress A

1 State whether the following statements are True or False

a. In amalgamation two or more companies similar in all respect go into liquidation
and form a new company to take over their business is called amalgamation.
b. In absorption, one existing companies purchases another existing company.
c. Economics of large scale production is not one of the objectives of amalgamation.
d. To write off the accumulated losses and offering the real worth of the business to
the shareholders is one of the objectives of reconstruction of company.

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 e. All assets and liabilities of the transferor company become the assets and
liabilities of Transferee Company under amalgamation in the nature of merger.

13.10 LET US SUM UP

When two or more companies which are similar in all respect go into liquidation and form a new
company to take over the business is called amalgamation whereas in absorption, one existing
company purchases another existing company. There may be many objectives of amalgamation
like i) to have better control over the market and to increase the market operations and market
share, ii) to eliminate the cut throat competition and rivalry among competing the amalgamating
companies, iii) to enhance the availability of funds for future investment plans, iv) to utilize the
services of professional experts and v) to enjoy the benefit of economies of large scale
production.

In a situation of external reconstruction the main objectives is to reorganize the company in order
to set off the huge losses suffered by the company whereas in internal reconstruction, the
company continues with its legal entity and is only internally reorganized. Under this reduction
of shares capital is done to its real worth in order to write down the overvalued assets of the
company.

There are two methods of accounting for amalgamation

a) Pooling of Interest Method: Under this method the assets, liabilities and reserves of
Transferer Company are recorded by 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 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.

In amalgamation, Purchase consideration is the amount which is paid by the transferee company
for the purchase of business of the transferor company. This can be calculated by following
methods: i) Lump Sum payment method, ii) Net assets method, iii) Net payment method, iv)
Intrinsic worth method.

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13.11 KEY WORDS

Amalgamation: When two or more companies which are similar in all respect go into
liquidation and form a new company to take over the business is called amalgamation.

Absorption: In absorption, one existing company purchases the another existing company.

External Reconstruction: It refers to reorganization of existing company in order to set-off

huge losses. Existing company is merged with a newly formed company with same name and
same members and existing company is wounded up.

Internal reconstruction: It refers to a situation where the existing company continues with its
legal entity and is internally organised.

Purchase Consideration: It refers the amount of paid by Transferee Company for the purchase
of business of the transferor company.

13.12 ANSWERS TO CHECK YOUR PROGRESS

A (i) True (ii) True (iii) False (iv) True (v) True

13.13 TERMINAL QUESTIONS

1 What is Amalgamation? Describe the objectives of Amalgamation.

2 What do you mean by Reconstruction? Differentiate between External Reconstruction
and Internal Reconstruction.
3 What conditions are required to be fulfilled for amalgamation in the nature of merger?
Explain.
4 What are the methods of Accounting for amalgamation? Explain
5 What do you mean by Purchase Considerations? Explain the various methods for the
calculating of purchase consideration.
6 How would you treat the following at the time of amalgamation of companies?
i) Goodwill
ii) Reserves

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7. Write Short notes on the following:
i) Absorption
ii) The Pooling of the interest method
iii) Net payment method of Purchase Consideration
iv) Intrinsic worth method of Purchase Consideration
8 Differentiate between Amalgamation, Absorption and Reconstruction.

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