AMALGAMATION OF COMPANIES

There are many forms of business combinations to obtain the economies of large scale production
or to avoid the cut throat competition. They are amalgamation, absorption, external
reconstruction etc. The term amalgamation is used when two or more existing companies go into
liquidation and a new company is formed to take over the business of liquidated companies. The
term absorption is used when an existing company takes over the business of one or more
existing companies which go into liquidation. In external reconstruction, one existing company
goes into liquidation and a new company is formed to take over the former company.
Definitions as per Accounting Standard 14 (AS‐14)
a. Amalgamation – means an amalgamation pursuant to the provisions of the Companies Act
1956 or any other statute which may be applicable to companies.
b. Transferor Company – means the company which is amalgamated into another company.
c. Transferee Company – means the company to which a transferor company is amalgamated.
d. Reserve – means the portion of earnings, receipts or other surpluses of an enterprise (whether
capital or revenue) appropriated by the management for a general or a specific purpose other than
provision for depreciation or diminution in the value of assets or for a known liability.
Types of Amalgamation
As per AS‐14 there are two types of amalgamation (1) Amalgamation in the nature of merger and
(2) Amalgamation in the nature of purchase.
Amalgamation in the nature of Merger (Pooling Interest Method)
An amalgamation should be considered to be an amalgamation in the nature of merge when all
the following conditions are satisfied:
i. All the assets and liabilities of the Transferor Company or companies should become the assets
and liabilities of the transferee company before amalgamation.
ii. Shareholders holding not less than 90% of the face value of the equity shares of the transferor
company (excluding the proportion held by the transferee company) should become the
shareholders of the transferee company.
iii. The consideration payable to the above mentioned shareholders should be discharged by the
transferee company by the issue of the equity shares and cash can be payable in respect of
fractional shares.
iv. The business of the Transferor Company/ companies is intended to be carried on by the
transferee company.
v. No adjustment is intended to be made to the book values of the assets and liabilities of the
Transferor Company/ companies when they are incorporated in the financial statements of the
transferee company except to ensure uniformity of accounting policies.
Amalgamation in the nature of purchase
An amalgamation should be considered to be an amalgamation in the nature of purchase, when
any one or more of the conditions specified for amalgamation in the nature of merger is not
satisfied.

Purchase Consideration

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Purchase consideration is the amount which is paid by the transferee company for the purchase
the business of Transferor Company. As per AS‐14, consideration for amalgamation means the
aggregate of shares and other securities issued and the payment made in the form of cash or other
assets by the transferee company to the shareholders of the transferor company. Purchase
consideration does not include any payment to outsiders including debenture holders. The
purchase consideration may be calculated in the following ways:
1. Lump Sum Method: When the transferee company agrees to pay a fixed sum to the transferor
company, it is called lump sum payment of purchase consideration. For example, X Ltd
purchases the business of Y Ltd for a consideration of 10,00,000.
2. Net Worth (Net Assets) Method: Under this method, the net worth of the assets taken over by
the transferee company is taken as purchase consideration. Here, Purchase consideration = Assets
taken over at agreed values – Liabilities taken over at agreed values. The following points are
noted while calculating purchase consideration under this method:
a. Cash balance is usually included in assets. But if it is not taken over, it will not be included.
b. Fictitious assets should never be added.
c. Accumulated profits and reserves should not be considered.
d. The term ‘liabilities’ include all liabilities to third parties. But ‘trade liabilities’ include only
trade creditors and bills payable.
e. The term ‘businesses will always mean both the assets and liabilities.
3. Net Payment method: Under this method, purchase consideration is the aggregate of all
payments in the form of cash, shares, securities etc. to the shareholders of the transferor company
by the transferee company. The following points are considered while calculating purchase
consideration under this method:
a. The assets and liabilities taken over by the transferee company are not considered.
b. Purchase consideration includes the payments to shareholders only.
c. Any payments made by the transferee company to some other party on behalf of the transferor
company are to be ignored.
4. Share exchange or Intrinsic Value Method: Under this method purchase consideration is
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 the shares between the transferee and transferor
companies.
Steps in accounting procedure of amalgamation, absorption and external reconstruction
a. Calculation of purchase consideration.
b. Ascertainment of discharge of purchase consideration.
c. Closing the books of transferor companies.
d. Passing opening entries in the books of purchasing or transferee company.

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Accounting entries in the books of transferor company

1. For transferring assets to Realization A/c:

Realization A/c Dr
To Assets A/c (individually at book value)

(Note :( a). Fictitious assets should not be transferred to Realization A/c (b). If cash in hand and
bank are not taken over by transferee company should not be transferred to Realization A/c. But
it can be taken as opening balance of cash or bank A/c and (c). Other assets, even if they are not
taken over, should be transferred to Realization A/c)

2. For transferring liabilities (outside liabilities only) to Realization A/c:

Liabilities A/c Dr (individually at book value)
To Realization A/c
(Note :( a). If any liability is not taken over by transferee company should not be transferred to
Realization A/c, (b). Items in the nature of provisions are to be transferred to Realization A/c and
(c). Any fund which denotes both liability and reserve, the portion of liability should be
transferred to Realization A/c).
3. For purchase consideration due from transferee company:

Transferee Company A/c Dr

To Realization A/c
4. On receiving or discharging purchase consideration:

Equity shares in Transferee company A/c Dr

Preference shares in Transferee company A/c Dr
Debentures in Transferee company A/c Dr
Cash/ Bank A/c Dr
To Transferee company A/c

5. For sale of assets not taken over by Transferee Company:

Cash/ Bank A/c Dr (Sale proceeds)
To Realization A/c

6. For discharging liabilities not taken over by transferee company:

Liability A/c Dr
Realization A/c Dr (if excess amount paid)
To Cash/ Bank A/c
To Realization A/c (If less payment is made)

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7. For liquidation (realization) expenses:

a. If liquidation expenses are met by transferor company.

Realization A/c Dr
To Cash/ Bank A/c
b. If liquidation expenses are met by transferee company.
No entry is required.

8. for closing preference share capital:

Preference share capital A/c Dr.
Realization A/c Dr. (if excess amount paid)
To Preference shareholders A/c
To Realization A/c (if less amount paid)

9. For paying off Preference shareholders:

Preference shareholders A/c Dr.
To Preference shares in Transferee company A/c
To Cash/ Bank A/c (if any)
To Debentures A/c (if any)

10. For transferring equity share capital, reserves etc.

Equity share capital A/c Dr
General reserve A/c Dr
P&L A/c Dr
Dividend equalization reserve A/c Dr
Security premium A/c Dr
To equity shareholders A/c

11. For transferring fictitious assets:

Equity shareholders A/c Dr
To P&L A/c
To preliminary expenses
To Discount/ expense on issue of shares/ debentures

12. For closing Realization A/c:

a. For loss on realization (if debit > credit).
Equity shareholders A/c Dr
To Realization A/c
b. For profit on realization (if credit > debit).
Realization A/c Dr
To Equity shareholders A/c

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13. For payment to equity shareholders:
Equity shareholders A/c Dr
To Equity shares in Transferee company A/c
To Cash/ Bank A/c (if any)
After payment to equity shareholders, all accounts in the book of transferor company will
be closed.
Accounting entries in the books of transferee company
(Amalgamation in the nature of purchase)
1. For purchase consideration due assets and liabilities taken over:
Assets A/c Dr. (At revised, otherwise at book value)
Goodwill A/c Dr (if credit > debit)
To Liabilities A/c (At revised, otherwise at book value)
To Liquidator of transferor company (purchase consideration)
To Capital reserve (if debit > credit)

2. For payment of purchase consideration:

Liquidator of transferor company A/c Dr.
To Share capital A/c
To Debenture A/c
To Bank A/c
(Note: if shares are issued at premium, security premium A/c is credited with premium. If
shares are issued at discount, discount on issue of shares A/c is debited with discount).

3. For payment of liquidation expenses by transferee company:

Goodwill/ Capital reserve/ P&L A/c Dr
To Cash/ Bank A/c

4. For payment of formation expenses:

Preliminary expenses A/c Dr
To Cash/ Bank A/c

5. If there are both Goodwill and Capital reserve A/c, Goodwill may be set off against Capital
reserve:
Capital Reserve A/c Dr
To Goodwill A/c

6. If any liability (including debenture) is discharged by transferee company:

Liability A/c Dr (Amount payable)
To Share capital/ Debenture/ Bank A/c
7. To record Statutory Reserves of transferor company:
Amalgamation Adjustment A/c Dr
To Statutory Reserve A/c

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(Note: Amalgamation adjustment A/c is shown on the assets side of the company’s
Balance Sheet under the head “Miscellaneous Expenditure”).

Accounting entries in the books of transferee company

(Amalgamation in the nature of merger)
1. For purchase consideration due and assets and liabilities taken over:
Assets A/c Dr (Individually at book value)
To Liabilities A/c (Individually at book value)
To Reserves of Transferor Company A/c
To P & L A/c
To Liquidator of transferor company A/c (purchase consideration)
(Note: The difference between debit and credit is adjusted in the reserves of Transferee
Company)

2. For payment of purchase consideration:

Liquidator of transferor company A/c Dr
To Share capital A/c
To Debenture A/c
To Bank A/c
(Note: if shares are issued at premium, security premium A/c is credited with premium.
If shares are issued at discount, discount on issue of shares A/c is debited with
discount).

3. Payment of liquidation expense by transferee company:

General Reserve/ P & L A/c Dr
To Cash/ Bank A/c

4. For the payment of formation expenses:

Preliminary expenses A/c Dr
To Cash/ Bank A/c

VALUATION OF GOODWILL & SHARE

1. Describe the concept of Goodwill.

Ans.: Goodwill is the value of the reputation of the firm judged in respect of its capacity
to bring in, unaided profits. Goodwill is an asset that cannot be seen but can be
imagined. Hence it is known as an “intangible asset.”
Q.2 What are the bases of Valuation of Goodwill? Explain
For the valuation of Goodwill the following Profits are calculated -
(1) Actual Average Profit or Future Maintainable Profit
(2) Super Profit
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Ans.: (1) Calculation of Actual Average Profit : It can be calculated by using the
following three steps :
Step –I : Calculation of Adjusted Profit : Rs.
Net Profit Before Tax xxx
Add :
Abnormal Expenses & Losses (If debited in P&L A/c) xxx
-------
Less :
Abnormal Income and Profit (If credited in P&L A/c) xxx
Preference Share Dividend xxx
Provision for Taxation xxx
Provision for Bad and Doubtful Debt xxx
(Due to Accounting Error)
Income from Non-Trade Investments xxx
(If Unequal Income in Every Year) xxx
-------
Adjusted Profit xxx
-------
Step II : Calculation of Average Profit :
Simple Average Profit = Total adjusted profit of given number of year
Number of years
If past adjusted profit shows any trend of raising or falling then weighted average profit
will be calculated.

Weighted Average Profit = Total Product of Profits & Weights

Total No. of Weight
Step III : Calculation of Actual Average Profit or Future Maintainable Profit :

Rs.
Average Profit xxx
Add :
(i) Expenses that will not incur in future xxx
(ii) Income and Profit that will arise in future xxx
(iii) Savings in depreciation due to decrease in value
of Fixed Assets xxx
-------
xxx
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Less :
(i) Expenses that will incur in future xxx
(ii) Income and profit that will not arise in future xxx
(iii) Fair remuneration of the owner xxx
(iv) Income from non-Trading Investment xxx
(v) Additional depreciation on increased value of assets xxx
(vi) Provision for bad debts in future xxx
-----
Future Maintainable Profit or Actual Average Profit xxx
-----
(2) Super Profit :
Super Profit = Actual Average Profit – Normal Profit
To calculate normal profit - (a) Average capital employed, and (b) Normal rate of return
is computed. These can be calculated as follows :-
(A) Capital Employed :
Total of Assets – Outside Liabilities
To calculate the total of assets the following points should be kept in mind:-
(b) Fixed assets and intangible assets will be taken at their realizable value otherwise at
book value.
(c) Fictitious assets and goodwill given at cost will not be included.
(d) Non-trade investments will not be taken.
Average Capital Employed :
Average Capital Employed can be calculated by following three formulae:
(i) Opening Capital Employed + Closing Capital Employed
2
(ii) Opening Capital Employed + ½ of current years profit after tax and preference
dividend
(iii) Closing Capital Employed – ½ of current years profit after tax and preference
dividend
(B) Normal Rate of Return : The rate of earnings which normally applies in similar
concerns or which is expected by the investor to apply in similar concern is known as
normal rate of return.
Q.3 Explain the various methods of Valuation of Goodwill.
Ans.: There are three methods of valuation of goodwill, the selection of method will
depend on the circumstance of a particular business.
(1) AVERAGE profit Method : This method is based on the assumption that the buyer
of business will earn certain amount of profit or super profit during the life time of
business. So he must pay some of the years profits as goodwill to the seller.
Goodwill = Future Maintainable Profit or Actual Average Profit

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 X Number of years (2 or 3)
Or Goodwill = Super Profit X Number of year (4 to 5)
Goodwill = Normal Capital Employed – Actual Capital Employed
(2) Capitalization Method :
(i) Capitalization of Super Profit Method : According to this method it is estimated that
how much capital will be required to earn super profit at a normal rate of return or
profit.
Value of Goodwill = Super Profit X 100
Normal rate of return
(ii) Capitalization of Average Profit : In this method first average profit is capitalized at
normal rate of return. This is known as normal Capital Employed
Normal Capital Employed = Actual Average Profit X 100
Normal rate of return
Then value of goodwill will be calculated as follows :-
Value of Goodwill = Normal Capital Employed – Actual Capital employed
(3) Annuity Method : According to this method the goodwill will be equal to the
amount of present value of future super profits because one has to pay goodwill today
but the amount of super profit will be earned in future. In this way loss of interest can be
compensated.
Value of Goodwill = Super Profit X present value of Rs. 1
Present value of Rs. 1 received annually for „n‟ year = 1(1/1+r)n/r
Here r = rate of interest, n = number of years.
Valuation of Shares
Q.1 under which circumstances valuation of Shares is needed?
Ans.: The Shares of a Company are to be valued at different occasions. These are:-
(i) When shares of one class are to be converted into shares of another class.
(ii) When shares want to take loan against the shares.
(iii) When shares are to be bought and sold.
(iv) When companies are amalgamated and a new company is formed. The new
company is to exchange the shares with the shareholder of old companies on the basis of
value of shares.
(v) When one or more existing companies are purchased by another existing company.
(vi) Acquisition of interest of dissenting shareholders under a scheme of reconstruction.
(vii) When government wants to compensate the shareholders on the nationalization of
a company.
(viii) When shares of a company are not quoted in stock exchange and holder is
interested to value them or wants to dispose them.
Q.2 What do you understand by Valuation of Shares? Discuss the different methods
of Valuation of Shares.

9|Page BY: DR. PRAKASH CHANDRA SWAIN, PH.D IN COMMERCE

Ans.: Generally investors invest in the shares of a company after confirming :-
(i) Whether his investment in shares will be safe or not; and (ii) whether he will receive a
fair return by fixed amount or not. To get the reply of these questions investors value the
shares and then think to investment. For this purpose the shares can be valued by the
following methods :-
(1) Net Assets Valuation Method : Under this method of valuation, it is ascertained that
what amount of assets is available with the company for every share, so this method is
known as “Assets backing Method.” Also known as “Net Assets Method” and “Balance
sheet Method” and “intrinsic value method” or break up value method.”
Following procedure will be adopted to value the shares by this method :-
Calculation of Net Assets :
Net Assets = Total Realizable value of assets – total outside liabilities
Note :
(i) Realizable value of fixed assets is not given then written down value will be taken.
(ii) Intangible assets will be considered if realizable value is given.
(iii) Investments (whether trading or not-trading) will be considered at their present
value.
(iv) The current assets will be considered after providing for bad debts and probable
loss.
(v) Fictitious assets will not be considered.
Alternative Method : The value of net assets can also be ascertained on the basis of
liabilities side of balance sheet
Share Capital xxx
Reserve and Surplus xxx
Profit on Revaluation xxx
Excess of Provision for Taxation xxx
Excess of Workman‟s Compensation Fund xxx
xxx
Less : Fictitious Assets xxx
Loss on Revaluation xxx
Contingent Liabilities xxx xxx
xxx

Calculation of Value Per Share :

(A) When Capital Structure of Company Consists of equity share Capital only :-
Case (1) : When normal value of all equity shares is equal and fully paid up:

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Value per Equity Share = Value of Net Assets
No. of Equity Shares issued by the Company
Case (2) : If the capital structure of company consists equity shares of different nominal
value of shares:
Value per share = Proportionate net asset of a particular category
No. of equity shares of same category
(B) If capital structure of the company consists of both (Equity and preference shares) type of
shares : -
(i) When preference shareholders are having both preferences for payment of dividend
and payment of capital :-
Value per Equity Share = Net Asset - (Preference share capital + Arrears of Preference
share Dividend)/ No. of preference shares
(ii) If Preference Shares are having the preference as regards capital only :-
Value per Equity Share = Net Assets – Preference share Capital
No. of Equity shares
Value per preference Share = Preference Share capital
No of Preference shares
(iii) If Preference Shares are having the preference regards dividend only :-
Value per Equity Share = Net Assets – Arrears of preference share dividend
No. of Equity shares + No. of preference Shares
Value per preference share=
Value per Equity Share + Arrear of preference share dividend
No. of Preference shares
(iv) If preference share are not having any preference by the articles, therefore the per
share value for equity share and preference will be:-
Value per share = Net Assets
No. of Equity Shares + No. of Preference share
Note : In (iii) and (iv) above, the same formula will be used, when the face value and
paid up value of equity shares and preference shares is same. If the paid up value is
different, the net assets will be distributed between the preference shares and equity
shares in their paid up value ratio and then the such proportionate net assets will be
divided by the number of shares of particular category.
(2) Yield Valuation Method : In this method the value of share is based on income
received Dividend) or receivable. To value share by this method, one of the following
basis may be used :-
(a) On the Basis of Dividend Rate : Investors who are in minority interested in
investing the amount for short period, give weight to the dividend that will be provided
by the company in near future. The following formula will be used to value the share:
Value per Equity share = Rate of Dividend X Paid Up Value Per Share

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 Normal Rate of Return
Explanation of the terms used in above formula :-
(i) Rate of Dividend = Amount of Dividend X 100
Total paid up capital
(ii) Normal Rate of Return = Normal rate of return means the return that is to be earned
by the company engaged in similar business.
(b) On the Basis of Expected Rate of Return : Generally companies do not distribute the
whole of the profit as dividend to shareholders and hence the value of the share should
be based on rate of earning.
Value of Equity Share = Expected Rate of Return X 100
Normal Rate of Return
Here the Expected Rate of Return will be calculated as :-
Expected Rate of Return = Profit available for equity shares X 100
Paid up Equity share Capital
(c) On the Basis of Earning Capacity or Actual Rate of Return : When amount is
invested for a long period, or a huge amount is invested the share should be ascertained
on the basis of earning capacity of the company.
Value per equity share = Actual Rate of Return X Paid up value per share
Normal Rate of Return
The actual Rate of Return can be ascertained by the following formula:-
Actual Rate of Return = Profit Earned X 100
Net Capital Employed
In above formula we have to ascertain:-
(i) Profit earned;
(ii) Net Capital employed
(i) Profit Earned: The term “Profit earned” means the “Profit before interest, transfer to
reserve & preference share dividend but after tax.”
(ii) Net Capital Employed:
Net Capital Employed (Assets Approach) =
Fixed assets (At revalued Price or at W.D.V.) + Trade Investment +Current Assets –
Current Liabilities
Net Capital Employed (Liabilities Approach) =
Equity share capital + Preference Share Capital + Reserve & Surplus + Debentures +
Long term Loan –fictitious Assets –Non trade investment +Revaluation Profit –
Revaluation Loss
Q.3 Write Short notes on the followings-
(1) Fair Value of Shares
(2) Value of Shares in case of Bonus Shares
(3) Valuation of Rights

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Ans.: (1) Fair Value of Shares: Fair value of share means the average of intrinsic value
of share and yield value of share. Formula: -
Fair value per Share = Intrinsic Value per Share + Yield Value per Share
2
(i) Intrinsic Value per Share is the value of share based on the Net Assets Method.
(ii) Yield Value per Share is the value of share based on dividend, expected rate of
return and earning capacity of the concern.
(2) Value of Shares in case of Bonus Shares : After bonus issue the number of shares
will increase in company’s books but net assets remains same. So, the intrinsic value of
share is reduced.
Value per Share = Net Assets (Existing Equity Fund)
No. of Shares (including Bonus Shares)
(3) Valuation of Rights : As per section 81 of the companies Act, 1956, provides that if a
public company increase its paid up capital by issuing new shares within a period of 2
years from its incorporation or within one year of first allotment of shares, whichever is
earlier, the existing shareholders have a right to purchase the new equity shares from
the company. If such shares are knows as Right shares, and this Right is known as
“Right of Pre-emption”.
The transfer of shares may be of 2 types as following :-
(i) Ex-Right : The value of right excluded in the market value of share because the
existing shareholders have a right to purchase the right share.
(ii) Cum-Right : The value of right included in the market value of share, because the
purchaser have a right to purchase the right shares.
Value of Rights = No. of Right Shares X (Market Price – Issue Price)
No. of Existing Shares +no. of rights share

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