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AS-14 specifically deals with the accounting for amalgamations and the treatment of any resultant difference arising on amalgamation in the books of Transferee Company. Based on the proprietary of the transaction, the standard classifies an amalgamation as either–

• an amalgamation in the nature of merger, or
• an amalgamation in the nature of the purchase.

As per standard, an amalgamation should be considered to be an “amalgamation in the nature of merger” when all the following conditions are satisfied:
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• All assets and liabilities of the transferor company be­come, after amalgamation, the assets, and liabilities of the transferee company.
• 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 amalgamation by the transferee company or its subsidiar­ies or their nominees) become equity shareholders of the transferee company by virtue of amalgamation.
• The consideration is discharged by the transferee company wholly by the issue of equity shares only, except that cash may be paid in respect of any fractional shares.
• The business of the transferor company is intended to be car­ried on, after the amalgamation, by the transferee company.
• 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 ac­counting policies.

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Based on above classification, the standard prescribes two methods of “Accounting for Amalgamation” as below:
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• The Pooling Of Interests Method – to be followed in case of “Amalgamation in the nature of merger”The object of Pooling of Interest Method is to account for the amalgamation as if the separate businesses of the amalgamating companies were intended to be continued by the transferee company. Accordingly, only minimal changes are made in aggregating the individual financial statements of the amalgamating companies.Accordingly, the assets, liabilities, and reserves of the transferor company are recorded by the transferee company at their existing carrying amounts (except for adjustments required to have uniform accounting policies).The identity of the reserves of transferor company 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.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 in Reserves in the financial statements of the transferee company.
• The Purchase Method – to be followed in case of “Amalgamation in the nature of purchase”.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.Consequently, 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 identity of the reserves, other than the statutory reserves, 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 (i.e. consideration is higher than the net assets), the difference is debited to Goodwill arising on amalgamation and if the result of the computation is positive, the difference is credited to Capital Reserve.Since the Goodwill arising on amalgamation represents a payment made in anticipation of future income it should be amortized to income on a systematic basis over its useful life. However, the amortization period should not exceed five years unless a somewhat longer period can be justified.

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However interesting part is that, the para-42 of the standard itself provide that “where the scheme of amalgamation sanctioned under a statute prescribes the treatment to be given to the reserves of the transferor company after amalgamation, the same should be followed” subject only to few additional disclosures in first financial statement of transferee company post amalgamation.

So, the standard itself allow the accounting treatment as prescribed in the scheme to override the treatment prescribed by the standard. Consequently, no uniformity is being maintained by various corporates in accounting for amalgamation that could have far-reaching implications on assets valuation and profitability of the merged entity for almost all time to come. As a result, net earnings, valuation, the amount of amortization, various profitability and assets cover ratios are permanently distorted.

Mentioned below are some of the real cases indicating how the provision of para-42 of a standard is being used by several corporates to account for amalgamation as it suits them whether the same is in compliance with basic principles of accounting or not.

A Ltd. (- a listed company)

Facts of the case – in brief:

Pursuant to the sanction of the Scheme, the Investment Division of the company has been transferred to D Ltd. at book values and the book value of net assets of the Investment Division of around Rs.20 crore has been debited to “Amalgamation Reserve Account”.

After demerger of Investment Division referred to above, B LTD. and C LTD. (Transferor Companies) have been merged with the company, as a going concern.

[Why demerger of Investment Division first? – Investment Division comprised of only Equity shares of C LTD. i.e. around 10% of total no. of Equity shares of C LTD. If it would not have been transferred by way of demerger, it would have been canceled in course of merger of C LTD. with the company]

In terms of the Scheme, the company recorded all the assets including investments and liabilities appearing in the books of account of C LTD. and B LTD. and transferred to and vested in the company at their fair values as on appointed date.

The difference of around Rs.100 crore between the fair value of net assets of C LTD. and B LTD. transferred to the company, and the value of equity shares allotted by the company for discharging purchase consideration has been credited to Amalgamation Reserve Account.

In terms of the Scheme, the balance of Rs.80 crore remaining in the Amalgamation Reserve Account (after adjusting debit made on demerger of Investment Division) has been transferred to Reserve for Amortisation of Brand Account. Further, out of the balance in Reserve for Amortisation of Brand Account, an amount equal to the annual amortization of brand (that was already existing in the books of transferee company) will be credited to the Profit and Loss Account each year so that overall depreciation/amortization gets reduced to that extent.

If the company would have followed the Purchase Method as per the AS-14, the resultant difference of around Rs.100 crores would have been debited to “Capital Reserve A/C” instead of treatment given by the company to the Revenue Reserve Account & Profit & Loss Account.

Another impact of the above treatment given is as follow:-

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• General Reserve is overstated on demerger of Investment division by Rs.20 crores forever
• Net worth is overstated by around Rs.100 crores
• Profit (before tax) for the year is overstated by Rs.6 crores (around 2.4%)

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(For future years it would be Rs.12 crores, since in current year impact for ½ year only)

As a result:

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• Book value per share is higher by Rs.20/share i.e. by almost 10% of BV
• EPS for the current year is higher by around Rs.1.20
• P/E Multiple lower by around 0.3 times as against present 9.1 times
• ROCE higher by 0.7%
• Borrowing capacity higher by Rs.200 crores considering a debt-equity ratio of 1:2, etc…

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So, effectively capital profit generated through book entry on amalgamation (not a cash profit) is turned into Revenue Profit, till evaluation of the reserve is fully reversed in future.

It is observed in several other cases that

• Revaluation is used to write off actual cash losses in the form of bad debts, slow moving inventory etc. without routing the same through profit and loss account.
• The resultant difference on the amalgamation between the fair value of assets & face value of shares issued is credited to “Securities Premium A/C” instead of “Capital Reserve A/C” giving an impression that the difference was actually realized in cash.
• Also, where the consideration paid is higher than the Fair Value of the Net Assets acquired, instead of debiting the difference to the Goodwill A/C & amortising the same to income over the years in accordance with AS-14, companies are debiting difference to the brought forward balance in Capital Reserve Account, Securities Premium Account or Revenue Reserve Account thereby avoiding the hit of amortisation of “Goodwill” on current year as well as on future year profitability.

Conclusion:

The standard ,with due respect, instead of achieving the objective of making treatment uniform in all cases of amalgamation ,it is interpreted as if it gives permission to the companies to come out unique and diverse accounting practices which many times go beyond even generally accepted accounting principles. Further, any diversion in treatment needs to be disclosed only for a year hence users of accounting statements will never have a clear idea about the performance of the entity. Further, unless the standard is amended/revised, the proposed convergence of Indian AS with the IFRS will not be possible.

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