LECTURE 5: Accounting for business Combinations-Amalgamation of Companies

Accounting for business Combinations-Amalgamation of Companies

Objectives


At the end of this lecture you will be able to:
§  Explain the motives for business combinations
§  Describe the implication of combinations and their implications to the business
§  Prepare books of accounts of the vendor company, and for the new company

Contents

§  Motives behind business combinations
§  Methods of business combinations
§  Meaning and Reasons for Amalgamations
§  Journal Entries on Amalgamation in the books of a Vendor and a Purchaser
§  Preparation of Financial Statement of a new company after amalgamation

Introduction:

Amalgamation exists when two or more companies come together and cease their going concerns, later on decide to form a completely new entity with a different name.
An amalgamation is distinct from a merger on consolidation; because neither of the combining companies continue to exist as a legal entity. Rather, a completely new entity is formed to stock the combined assets and liabilities of both companies. There shall be two tasks simultaneously involved: (i) two companies dying/liquidated and (ii) another new company is born/formed
In accounting; our task is to report what is happening to the two companies by preparing their books of accounts necessary for users. In amalgamation there shall be necessary to close the books of the old companies and then to open the books of the newly formed business. Journal entries will be particularly useful in this situation.
What happens after amalgamation has taken place?
  1. It results in the formation of a new, strong, stable and large company. It also results in the growth and expansion of this newly formed company.
  2. The joined companies cooperate with each other and diversify (expand) their business activities.
  3. After amalgamation, two or more companies dissolve (disintegrate) and lose their individual legal status (existence), hence they no longer exist anymore. However, they again re-establish themselves, but now jointly, by forming a new company having a unique name.
  4. Thus, amalgamation results in the formation of a new (separate) company which has a unique name, logo, identity and existence.
  5. The management of amalgamated company is led (directed) by members of two or more companies getting amalgamated.

Amalgamation of Limited Companies

For a purchaser, an amalgamation may arise from the desire to diversify, the need to find an outlet for surplus funds; buying out a competitor; rationalising production; marketing and sales rationalisation or reducing research and development

For a vendor/a seller company, estate duty factors often force a sale and joining a group may mitigate these; family conflicts or illness may force a crisis and lack of a beneficiary may influence the founder of a business to sell out on withdrawal. A more common reason is the desire to grow big; this is because joining a group mostly gives access to new facilities and more opportunities both within and outside the country.

The principal forms of amalgamation include the following:
1.      Formation and promotion of a new company (the purchasing company)
When a new company is formed, it will take over the assets of two or more existing companies, the latter being wound up on completion of the transfer. Alternatively, the new company may become a holding company, it acquires and hold the shares of another company
2.      Amalgamation by absorption (more details in the next lecture)
Where one existing company purchases and takes over the entire business of another company; and the latter is wound up
3.      Amalgamation by the acquirement of a controlling interest
Where one company purchases not less than forty percent of the issued capital of another company, and both companies retain their separate existence.(this is a kind of situation similar to consolidation; in the early years after the World War II, it was referred to as a take-over bid)
4.      Share exchange; two companies simply exchange shares in each other and there are no changes in the formal structure of each
5.      Amalgamation by formation of a new company- the old company being wound up/liquidated

Amalgamation by Formation of New Company- the Old Company being wound up


This is the common situation that is discussed in this topic. We shall have examples of two companies being wound up and then a new company being formed as a separate entity with another different management. A striking example of this amalgamation is a combinations of British Motor Corporation and Leyland Motors Ltd into the British- Leyland Corporation. The old company ceased to exist and a new company issued fresh stock certificates to the shareholders of the old companies. In the amalgamation of limited companies, it is necessary to obtain shareholders sanctions to the scheme of amalgamation and the sale of the assets to the new company, and the two appoint liquidators whose duty is to
(a)    Carry the scheme into effect s
(b)   Wind up the vendor company
The liquidators however really act as the vendor of the new company from whim they receive the purchase consideration; i.e usually fully paid up shares in the new company and sometime cash or debentures. The cash and or shares are distributed to the shareholders of the old companies.

Different motives for amalgamation of companies:

  • When a firm wants to enter a new market
  • When a firm wants to introduce new products through research and development
  • When a forms wants achieve administrative benefits
  • When need to increased market share
  • To lower cost of operation and/or production
  • To gain higher competitiveness
  • For Financial leveraging,
  • To improve profitability and EPS
  • To weaken competitors
  • For collaboration Gains and strategies
  • Tax Benefits
  • Diversification
  • Increase Brand Value
  • Generate cost efficiency through economies of scale;;
  • Get out the target company of a difficult financial situation
  • When the sense signals of financial distress
  • To stabilise earnings
  • To take over the market by weakening competitors
  • To share strategies and new technologies
  • Greater value generation
  • Gaining cost efficiency
  • Lower the labour costs, through staff reductions

Vendor, Purchase Price and Going Concern

In many cases, a company is formed for the purpose of acquiring and working an old established business. The person who sells the business to the company is known as the vendor, and the money paid for the business is called the purchase price. The purchase price is generally paid partly in cash and partly in shares.
During amalgamation, one company will be closed off (the seller) while another company will be formed and taking over the new business (the vendor). Accounting entries in both sides will be recorded to finalise the deal and to continue with new business

In the books of the Vendor company

In amalgamation, the vendor is the company that is closing off his business in order to join power with another vendor. In practice, there has to be more than one company. In the vendor’s books, liquidation will have to take place in order to close off the books of the business before he joins a new business.

Accounting entries required to close the books of the Vendor Company


1.      Open the realisation account and transferring all assets (except fictitious) assets at book value
Dr Realisation account
Cr all assets individually

2.      Transfer all liabilities taken over by purchasing company at book value
Dr Liabilities
Cr Realisation account bat book value

3.      When the purchasing company agrees on a purchase price
Dr Purchasing Company
Cr Realisation account
4.      If any Asset is not taken over it will be sold
Dr Bank
Cr realisation with Purchase proceeds

5.      If any liability is not taken over- it will be paid
Dr Liability
Cr Bank

6.      If expense of realisation are born by vendor company
Dr Realisation
Cr Bank
7.      If expense is born by a purchasing company and it will not be included in the purchase price
Dr Realisation account
Cr Bank
8.      If the purchasing company pays the expense separately
Dr Realisation
Cr Bank
9.      When expense is received from the purchasing company
Dr Bank
Cr Realisation
10.  When the purchasing company needs the purchasing price
Dr. Bank
Cr. Purchasing Company
11.  To close share capital account
Dr. Preference share capital
Cr. Preference share holder account
12.  To transfer equity capital and reserves and surplus
Dr. Equity share capital
Dr. General reserve
Dr. profit and loss
Dr. any fund showing accumulated profit
Cr. Sundry shareholders
13.  If there is any fictitious asset like preliminary expenses
Dr. Sundry shareholders
Cr. Preliminary expenses
Cr. Profit and Loss
14.  To close shareholders account
Dr. Shareholders
Cr. Shares in purchasing company
Cr. Bank
Cr. Debentures

In the books of the Purchasing Company (this is s newly formed company)
                                                  
It will be assumed as if the new company is buying the assets and liabilities of the old companies. They will always have some agreements during formation, regarding payments of liabilities and other formation costs. Or the purchasing company may simply decide tom clear off all the liabilities on their purchase consideration. The new company may even decide to issue new shares to outsiders immediately after formation.

Journal Entries to open the books of the Purchasing Company/a new company


1.      On agreement of business purchase
Dr. Business purchase account
Cr. Liquidator of vendor
2.      On taking over assets and liabilities from Vendor Company
Dr. Assets individually
Cr. Liabilities
Cr. Business purchase account
3.      On payments to vendor company
Dr. Liquidator of vendor
Cr. Bank
Cr. Share capital
Cr,. Debenture
4.      If the expense of realisation is paid separately
Dr. Goodwill
Cr. Bank
5.      If the amount is included in the purchase- no entry is required


Illustration
Grand Ltd and Place Ltd carry on business of a similar nature and it is agreed that they should amalgamate. A new company, Grand Place Ltd is to be formed with the assets and liabilities of the existing companies with certain exceptions are to be transferred. At the date of the amalgamation, the statements of financial positions of the two companies were as follows:


Grand
Palace
Grand
Palace
Tshs
Tshs
Tshs
Tshs
Freehold Property
    5,250,000
     3,000,000
Shares ( Tshs 1 each)
           7,500,000
             4,000,000
Plant and Machinery
    1,250,000
         750,000
General Reserve
           4,000,000
                            -  
Motor vehicles
        500,000
                     -  
Profit and Loss
           1,000,000
             1,000,000
Stock
    3,000,000
     3,900,000
5% Debentures
                           -  
             3,000,000
Debtors
    4,100,000
     1,050,000
Creditors
           3,750,000
             1,600,000
Bank
    2,150,000
         900,000
  16,250,000
     9,600,000
         16,250,000
             9,600,000

Additional Information
Assets and liabilities are to be taken over at book value with the following exceptions:
(i)                 Goodwill of Grand Ltd and Palace Ltd is to be valued at Tshs.4,000,000 and Tshs. 1,500,000 respectively
(ii)               Motor vehicles of Grand Ltd are to be valued at Tshs.1,500,000.
(iii)              The debentures in Palace Ltd are to be discharged by the issue of 6% debentures in Grand Palace Ltd at a premium of 4%.
(iv)             The debtors and bank of Palace Ltd are to be retained by the liquidators and the sundry creditors are to be paid by the proceeds
Required:
a)      Compute the basis on which shares in Grand Palace Ltd will be issued to shareholders in the existing companies
b)      Prepare the statement of financial position of a new company immediately after completion of amalgamation

Solution- Straight Approach
Calculation of Purchase Price
The purchase price/purchase consideration will be calculated based on the number of shares
Total Purchase Price = Total Assets – Total Liabilities

                       
Grand
Palace
Tshs.
Tshs.
Goodwill
                 4,000,000
                1,500,000
Freehold Property
                 5,250,000
                3,000,000
Motor Vehicles
                 1,500,000
                               -  
Plant and Machinery
                 1,250,000
                    750,000
Inventory
                 3,000,000
                3,900,000
Accounts Receivables
                 4,000,000
                               -  
Bank
                 2,150,000
                               -  
               21,150,000
                9,150,000
Less: Liabilities taken Over
Accounts Payables
                 3,750,000
                               -  
Debentures
                                 -  
3,000,000
Purchase Price
               17,500,000
                6,150,000
                                               

Total Purchase Price = 17,500,000 + 6,150,000 = 23,650,000

The basis of shares issued in Grand = 17,500,000/7,500,000 = 3:7
The basis of shares issued in Place Ltd = 6,150,000/4,000,000 = 16:25

In the Books of Grand Palace Ltd
Entries in the books of Purchasing Company
                                                                                               

Dr.
Cr
Business Purchase
           Loan of Grand
            Loan of Palace
23,650,000

17,500,000
  6,150,000
Goodwill
Freehold Premises
Plant and Machinery
Motor vehicles
Inventory
Accounts Receivables
Bank
          Business Purchase
5,500,000
8,250,000
2,000,000
1,500,000
6,900,000
4,100,000
2,150,000







30,400,000
Business Purchase
      Accounts Payables
       Debentures
6,750,000

3,750,000
3,000,000
Palace Ltd (Vendor)
        Debentures
        Debenture Premium
3,000,000

2,885,000
115,000
Shareholders (Grand-Palace Ltd)
          Share Capital
23,650,000

23,650,000


Grand Palace Statement of Financial Position
Goodwill
                 5,500,000
Freehold Property
                 8,250,000
Motor Vehicles
                 2,000,000
Plant and Machinery
                 1,500,000
Inventory
                 6,900,000
Accounts Receivables
                 4,100,000
Bank
                 2,150,000
               30,400,000
Equity and Liabilities

Share Capital
23,650,000
Debentures
                 2,885,000
Debenture Premium
                             115,000
Account Payables
                 3,750,000
30,400,000


In the Books of Grand Ltd

Realisation A/C
Freehold property
                      5,250,000
Accounts Payables
                      3,750,000
Plant and Machinery
                      1,250,000
 Grand Palace
                   17,500,000
Motor Vehicles
                          500,000
Inventory
                      3,000,000
Accounts Receivables
                      4,100,000
Bank
                      2,150,000
Profit and Loss
                      5,000,000
                    21,250,000
                   21,250,000


Sundry Shareholders A/C
Grand Palace
17,500,000
Share Capital
7,500,000
General Reserve
4,000,000
Profit and Loss
1,000,000
Realisation
5,000,000
17,500,000
17,500,000


Grand Palace Ltd A/C
Grand Palace
17,500,000
Sundry Shareholders
17,500,000
17,500,000
17,500,000


In the Books of Palace Ltd

Realisation A/C
Freehold property
                      3,000,000
Cash (Accounts Receivables)
                      1,050,000
Plant and Machinery
                          750,000
 Grand Palace
                      6,150,000
Inventory
                      3,900,000
 Debentures
                      3,000,000
Accounts Receivables
                      1,050,000
Sundry Shareholders
                      1,500,000
                    10,200,000
                   10,200,000


Sundry Shareholders A/C
Grand Palace
6,150,000
Share Capital
4,000,000
Cash
                     350,000                     
General Reserve
                                     -  
Profit and Loss
1,000,000
Realisation
1,500,000
6,500,000
6,500,000

                                                          

                                                    Cash A/C                                                                                          

Balance b/d
900,000
Accounts Payables
1,600,000
Realisation (Accounts Receivables)
                      1,050,000
Shareholders
                    350,000
1,950,000
1,950,000

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