Accounting for Amalgmations

Procedure for accounting for amalgamations:

An Amalgamation can be in the nature of  either uniting of interest which is refereed to as 'Amalgamation in the nature of merger' or 'Acquisition'.The conditions to be fulfilled for an Amalgamation to be treated as an 'Amalgamation in the nature of merger' are as follows:

• All assets & liabilities of the transferor company before amalgamation should become the assets & liabilities of the transferee company.
• The consideration payable to the shareholders should be discharged by the transferee company by issue of equity shares. Cash can be paid in respect of fractional shares.
• The business of the transferor company is intended to be carried on by the transferee company.
• The transferee company intends to incorporate into its balance sheet the book value of  assets & liabilities of the transferor company without any adjustment except to the extent needed to ensure uniformity of accounting policies. An Amalgamation which is not in the nature of merger is treated as an 'Acquisition'.

The Accounting treatment of an amalgamation in the books of the transferee company is dependent on the nature of amalgamation as stated above. For a Merger, the 'Pooling of Interest' method is to be used and for an acquisition the 'purchase' method is used.

Under the 'Pooling of Interest' method, the assets and liabilities of the merging companies are aggregated. Likewise, the reserves appearing in the balance sheet of the transferor company are carried forward into the balance sheet of the transferee company. The difference in capital on account of the exchange ratio is adjusted  in the reserves.

Under the 'Purchase' method the assets and outside liabilities of the transferor company are carried forward into the books of the transferee company at their fair market value.The difference between the purchase consideration and the net book value of assets over liabilities is treated as 'goodwill' that has to be amortized over a period not exceeding five years. If the purchase consideration is less than net book value of assets over liabilities, the difference is shown as 'capital reserve'.

                                                 Cash v/s stock compensation:

Whether to pay for an acquisition in cash or in stock is an important decision. The choice depends on three factors:

• Overvaluation : If the acquiring firms stock is overvalued relative to the acquired company;s stock, paying in stock can be less costly than paying in cash.
• Taxes: From the point of view of shareholders of the acquired firms, cash compensation is a taxable transaction whereas stock compensation is not.
• Sharing of risk and rewards: If cash compensation is paid, shareholders of the acquired company neither bear the risk nor enjoy the rewards of the merger.Whereas if stock compensation is paid, shareholders of the acquired company partake in the risks as well as rewards of the merger