Business combination: Combining
two separate enterprises into a single economic entity as a result of one
enterprise uniting with or obtaining control over the net assets and operations
of another enterprise. The combination can result in a single legal entity or
two separate legal entities.
Acquisition: A business combination in which one of the enterprises, the
acquirer, obtains control over the net assets and operations of another
enterprise, the acquiree, in exchange for the transfer of assets, incurrence of
a liability or issue of equity.
following
are the main differences between amalgamation and absorption:1. Liquidation
Two or more companies are liquidated in the process of amalgamation. One or more companies are liquidated in absorption.
2. Formation
In amalgamation, a new company is formed to take over the business of vendor companies. In absorption, no new company is formed, only purchasing or absorbing company take over the business of liquidated company
Consolidation or amalgamation is the act of merging many things into one. In business, it often refers to the mergers and acquisitions of many smaller companies into much larger ones. In the context of financial accounting, consolidation refers to the aggregation of financial statements of a group company as consolidated financial statements. The taxation term of consolidation refers to the treatment of a group of companies and other entities as one entity for tax purposes. Under the Halsbury's Laws of England, 'amalgamation' is defined as "a blending together of two or more undertakings into one undertaking, the shareholders of each blending company, becoming, substantially, the shareholders of the blended undertakings. There may be amalgamations, either by transfer of two or more undertakings to a new company, or to the transfer of one or more companies to an existing company". Thus, the two concepts are, substantially, the same. However, the term amalgamation is more common when the organizations being merged are private schools or regiments.
Types of business amalgamations
There are three forms of business
combinations:
- Statutory Merger: a business combination that results
in the liquidation of the acquired company’s assets and the survival of
the purchasing company.
- Statutory Consolidation: a business combination that
creates a new company in which none of the previous companies survive.
- Stock Acquisition: a business combination in which the
purchasing company acquires the majority, more than 50%, of the Common
stock of the acquired company and both companies survive.
- Amalgamation: Means an existing Company (Vendor
Company) which is taken over by another existing company. In such course
of amalgamation, the consideration may be paid in "cash" or in
"kind", and the purchasing company survives in this process... Terminology
- Parent-subsidiary relationship: the result of a stock
acquisition where the parent is the acquiring company and the subsidiary
is the acquired company.
- Controlling Interest: When the parent company owns a
majority of the common stock.
- Non-Controlling Interest or Minority Interest:
the rest of the common stock that the other shareholders own.
- Wholly owned subsidiary: when the parent owns all the outstanding common stock
of the subsidiary.
Company is formed when in the process of the amalgamation, the
combined company is formed out of the transaction. The amalgamated company is
otherwise called the transferee company. The company or companies, which merge
into the new company, are called the transferor companies and, the company,
into which the transferor companies merge, is known as the transferee company.
"Amalgamating
company" : The company or companies, which are merged, are called the
"amalgamating companies". The amalgamating company or companies are
also called the "transferor company/companies." dsd Date.
Accounting treatment (US GAAP)
A parent company can acquire another
company in two ways:
- By purchasing the net assets.
- By purchasing the common stock of another company.
Regardless of the method of
acquisition; direct costs, costs of issuing securities and indirect costs are
treated as follows:
- Direct costs, Indirect and general costs: the acquiring
company expenses all acquisition related costs as they are incurred.
- Costs of issuing securities: these costs reduce the
issuing price of the stock.
Purchase of Net Assets
Treatment to the acquiring company: When purchasing the net assets the acquiring company
records in its books the receipt of the net assets and the disbursement of
cash, the creation of a liability or the issuance of stock as a form of payment
for the transfer.
Treatment to the acquired company: The acquired company records in its books the elimination
of its net assets and the receipt of cash, receivables or investment in the
acquiring company (if what was received from the transfer included common stock
from the purchasing company). If the acquired company is liquidated then the
company needs an additional entry to distribute the remaining assets to its
shareholders.
Purchase
of Common Stock
Treatment to the purchasing company: When the purchasing company acquires the subsidiary through
the purchase of its common stock, it records in its books the investment in the
acquired company and the disbursement of the payment for the stock acquired.
Treatment to the acquired company: The acquired company records in its books the receipt of
the payment from the acquiring company and the issuance of stock.
FASB 141 Disclosure Requirements: FASB 141 requires disclosures in the notes of the financial
statements when business combinations occur. Such disclosures are:
- The name and description of the acquired entity and the
percentage of the voting equity interest acquired.
- The primary reasons for acquisition and descriptions of
factors that contributed to recognition of goodwill.
- The period for which results of operations of acquired
entity are included in the income statement of the combining entity.
- The cost of the acquired entity and if it applies the
number of shares of equity interest issued, the value assigned to those
interests and the basis for determining that value.
- Any contingent payments, options or commitments.
- The purchase and development assets acquired and
written off.
Treatment of goodwill impairments:
- If Non-Controlling Interest (NCI) based on fair
value of identifiable assets: impairment taken against parent's income
& R/E
- If NCI based on fair value of purchase price:
impairment taken against subsidiary's income & R/E
Reporting intercorporate interest — investments in common stock
20%
ownership or less
When a company purchases 20% or less
of the outstanding common stock, the purchasing company’s influence over
the acquired company is not significant. (APB 18 specifies conditions where
ownership is less than 20% but there is significant influence).
The purchasing company uses the cost
method to account for this type of investment. Under the cost method, the
investment is recorded at cost at the time of purchase. The company does not
need any entries to adjust this account balance unless the investment is
considered impaired or there are liquidating dividends, both of which reduce
the investment account.
Liquidating
dividends :
Liquidating dividends occur when
there is an excess of dividends declared over earnings of the acquired company
since the date of acquisition. Regular dividends are recorded as dividend
income whenever they are declared.
Impairment
loss : An impairment loss occurs
when there is a decline in the value of the investment other than temporary.
20%
to 50% ownership — Associate company
When the amount of stock purchased
is between 20% and 50% of the common stock outstanding, the purchasing
company’s influence over the acquired company is often significant. The
deciding factor, however, is significant influence. If other factors exist that
reduce the influence or if significant influence is gained at an ownership of
less than 20%, the equity method may be appropriate (FASB interpretation 35
(FIN 35) underlines the circumstances where the investor is unable to exercise
significant influence).
To account for this type of
investment, the purchasing company uses the equity method. Under the
equity method, the purchaser records its investment at original cost. This
balance increases with income and decreases for dividends from the subsidiary
that accrue to the purchaser.
Treatment of Purchase
Differentials: At the time of purchase, purchase differentials arise from
the difference between the cost of the investment and the book value of the
underlying assets.
Purchase differentials have two
components:
- The difference between the fair market value of the
underlying assets and their book value.
- Goodwill:
the difference between the cost of the investment and the fair market
value of the underlying assets.
Purchase differentials need to be
amortized over their useful life; however, new accounting guidance states that
goodwill is not amortized or reduced until it is permanently impaired, or the
underlying asset is sold.
More
than 50% ownership — Subsidiary
When the amount of stock purchased
is more than 50% of the outstanding common stock, the purchasing company has
control over the acquired company. Control in this context is defined as
ability to direct policies and management. In this type of relationship the
controlling company is the parent and the controlled company is the subsidiary.
The parent company needs to issue consolidated financial statements at the end
of the year to reflect this relationship.
Consolidated financial statements show the parent and the subsidiary as one single entity.
During the year, the parent company can use the equity or the cost method to
account for its investment in the subsidiary. Each company keeps separate
books. However, at the end of the year, a consolidation working paper is
prepared to combine the separate balances and to eliminatethe intercompany
transactions, the subsidiary’s stockholder equity and the parent’s investment
account. The result is one set of financial statements that reflect the
financial results of the consolidated entity there are three forms of
combination: 1. horizontal integration:is the combination of firms in the same
business lines and markets. 2. vertical integration: is the combination of
firms with operations in different but successive stages of production or
distribution or both. 3. Conglomeration: is the combination of firms with
unrelated and diverse products or services functions, or both.
Business combination: Combining two separate enterprises into a single economic
entity as a result of one enterprise uniting with or obtaining control over the
net assets and operations of another enterprise. The combination can result in
a single legal entity or two separate legal entities.
Acquisition: A business combination in which one of the enterprises, the
acquirer, obtains control over the net assets and operations of another
enterprise, the acquiree, in exchange for the transfer of assets, incurrence of
a liability or issue of equity.
Uniting of interests: A business combination in which the shareholders of the
combining enterprises combine control over the whole, or effectively the whole,
of their net assets and operations to achieve a continuing mutual sharing in
the risks and benefits attaching to the combined entity such that neither party
can be identified as the acquirer. Also called a pooling of interests.
Control: The power to govern the financial and operating policies of
an enterprise so as to obtain benefits from its activities. If one enterprise
controls another, the controlling enterprise is called the parent and
the controlled enterprise is called the subsidiary.
Distinguishing between acquisitions and
unitings of interests
Under IAS 22, "virtually
all" business combinations are acquisitions. [IAS 22.10]
Indications of an acquisition are:
[IAS 22.10]
- One enterprise acquires more than one half of the
voting rights of the other combining enterprise.
- One enterprise has the power over more than one half of
the voting rights of the other enterprise as a result of an agreement with
other investors.
- One enterprise has the power to govern the financial
and operating policies of the other enterprise as a result of a statute.
- One enterprise has the power to appoint or remove the
majority of the members of the board of directors or equivalent governing
body of the other enterprise.
- One enterprise has power to cast the majority of votes
at meetings of the board of directors of the other enterprise.
SIC 9 explains that the overriding criterion to distinguish an
acquisition from a uniting of interests is whether an acquirer can be
identified, that is to day, whether the shareholders of one of the combining
enterprises obtain control over the combined enterprise.
In an acquisition, therefore, the
acquiring company must be identified. Usually, that is evident. If it is not
evident, IAS 22.11 provides some guidance:
- The fair value of one of the combining enterprises is
significantly more than that of the other.
- In an exchange of voting common shares for cash, the
enterprise paying the cash is the acquirer.
- After the business combination, the management of one
enterprise dominates the selection of the management team of the combined
enterprise.
Indications of a uniting of
interests are: [IAS 22.13]
- An acquirer cannot be identified.
- The shareholders of both combining enterprises share
control over the combined enterprise substantially equally.
- The managements of both of the combining enterprises
share in the management of the combined entity.
A business combination should be
classified as an acquisition unless the all of the following three
characteristics are present. Even if all three are present, the combination
should be presented as a uniting of interests only if the enterprise can
demonstrate that an acquirer cannot be identified. [IAS 22.15]
- The substantial majority of the voting common shares of
the combining enterprises are exchanged or pooled.
- The fair value of one enterprise is not significantly
different from that of the other enterprise.
- Shareholders of each enterprise maintain substantially
the same voting rights and interests in the combined entity, relative to
each other, after the combination as before.
The following suggest that a
business combination is not a uniting of interests: [IAS 22.16]
- Financial arrangements provide a relative advantage to
one group of shareholders.
- One party's share of the equity in the combined entity
depends on the performance, subsequent to the business combination, of the
business which it previously controlled.
Unitings
of interests – accounting procedures
A uniting of interests should be
accounted for using the pooling of interests method. [IAS 22.77] Under this
method:
- Financial statement items of uniting entities should be
combined, in both the current and prior periods, as if they had been
united from the beginning of the earliest period presented. [IAS 22.78]
- Any difference between the amount recorded as share
capital issued plus any additional consideration in the form of cash or
other assets and the amount recorded for the share capital acquired should
be adjusted against equity. [IAS 22.79]
- The costs of the combination should be expensed when
incurred. [IAS 22.82]
Acquisitions
– accounting procedures
An acquisition should be accounted
for using the purchase method of accounting. Under this method: [IAS 22.19]
- The income statement should incorporate the results of
the acquiree from the date of acquisition; and
- The balance sheet should include the identifiable
assets and liabilities of the acquiree and any goodwill or negative
goodwill arising.
Date
of acquisition
The date of acquisition is the date
on which control of the net assets and operations of the acquiree is
effectively transferred to the acquirer. Goodwill is the difference between the
cost of the acquisition and the acquiring enterprise's share of the fair values
of the identifiable assets acquired less liabilities assumed. [IAS 22.20]
Cost
of acquisition
The cost of the acquisition is the
amount of cash paid and the fair value of the other consideration given by the
acquirer, plus any costs directly attributable to the acquisition. Contingent
consideration should be included in the cost of the acquisition at the date of
the acquisition if payment of the amount is probable and it can be measured
reliably. The cost of acquisition should be adjusted when a relevant
contingency is resolved. When settlement of the consideration is deferred, the
cost is the present value of such consideration and not the nominal amount.
[IAS 22.21]
Identifiable
assets and liabilities
The identifiable assets and
liabilities acquired that are recognised should be those of the acquiree that
existed at the date of acquisition (some of which may not have been recognised
by the acquiree), together with any permitted provisions for restructuring
costs (see below). They should be recognised separately if it is probable that
any associated future economic benefits will flow to or from the acquirer, and
their cost/fair value can be measured reliably. Other than permitted provisions
for restructuring costs (see below), liabilities should not be recognised at
the date of acquisition if they result from either:
- the acquirer's intentions or actions; or
- future losses or other costs expected to be incurred an
a result of the acquisition.
Restructuring
provisions
Liabilities should not be recognised
at the date of acquisition based on the acquirer's stated intentions.
Liabilities should also not be recognised for future losses or other costs
expected to be incurred as a result of the acquisition, whether they relate to
the acquirer or the acquiree. [IAS 22.29]
Restructuring provisions are
recognised at acquisition only if the restructuring is an integral part of the
acquirer's plan for the acquisition and, among other things, the main features
of the restructuring plan were announced at, or before, the date of
acquisition. The restructuring must involve terminating or reducing the
acquired company's activities. Furthermore, even if the main features of a
restructuring plan were announced prior to the acquisition, a provision for the
restructuring sill should not be accrued unless, by the earlier of three months
after the date of acquisition and the date when the annual financial statements
are authorised for issue, the restructuring plan has been further developed
into a detailed formal plan (specifics set out in IAS 22.31].
Measuring
acquired assets and liabilities
Individual assets and liabilities
should be recognised separately as at the date of acquisition when it is
probable that any associated future economic benefits will flow to or from the
acquirer, and their cost/fair value can be measured reliably. [IAS 22.26]
IAS 22 provides for benchmark and an
allowed alternative treatments for measuring the acquired assets and
liabilities:
- Under the benchmark treatment, the assets and
liabilities are measured at the aggregate of the fair value of the
identifiable assets and liabilities acquired to the extent of the
acquirer's interest obtained, and the minority's proportion of the
pre-acquisition carrying amounts of the assets and liabilities. [IAS
22.32]
- Under the allowed alternative treatment, the assets and
liabilities should be measured at their fair values as at the date of
acquisition with the minority's interest being stated at its proportion of
the fair value of the assets and liabilities. [IAS 22.34]
The fair values of assets and
liabilities should be determined by reference to their intended use by the
acquirer. Guidelines are provided for the determining fair values for specific
categories of assets and liabilities. When an asset or business segment of the
acquiree is to be disposed of, this is taken into consideration in determining
fair value. [IAS 22.39]
Step acquisitions (successive share
purchases)
Where the acquisition is achieved by
successive share purchases, each significant transaction is treated separately
for the purpose of determining the fair values of the assets/liabilities
acquired and for determining the amount of goodwill arising on that transaction
– comparing each individual investment with the percentage interest in the fair
values of the assets and liabilities acquired at each significant step. If all
of the assets and liabilities are restated to fair values at the time of each
purchase, adjustments relating to the previously held interests are accounted
for as revaluations. [IAS 22.36]
Subsequent
adjustments to original measurements of acquired assets and liabilities
The carrying amounts of assets and
liabilities should be adjusted when additional evidence becomes available to
assist with the estimation of the fair value of assets and liabilities at the
date of acquisition. Goodwill should also be adjusted if the adjustment is made
by the end of the first annual accounting period commencing after the
acquisition (providing that it is probable that the amount of the adjustment
will be recovered from the expected future economic benefits). Otherwise, the
adjustment should be treated as income or expense.
Goodwill
Goodwill arising on the acquisition
should be recognised as an asset and amortised over its useful life. There is a
rebuttable presumption that the useful life of goodwill will exceed 20 years.
[IAS 22.44] IAS 22 indicates that the 20-year maximum presumption can be
overcome "in rare cases" — for instance if the goodwill is so clearly
related to an identifiable asset or group of identifiable assets that it can
reasonably be expected to provide benefits over the entire life of those
related assets. Amortisation will normally be on a straight-line basis. [IAS
22.50]
Goodwill is subject to the general
impairment requirements of IAS 36. [IAS 22.55] If the amortisation
period exceeds 20 years, recoverable amount must be calculated annually, even
if there is no indication that it is impaired. [IAS 22.56] Non-amortisation of
goodwill based on an argument that it has an infinite life is not permitted by
IAS 22.
Negative goodwill
Negative goodwill must always be
measured and initially recognised as the full difference between the acquirer's
interest in the fair values of the identifiable assets and liabilities acquired
less the cost of acquisition. [IAS 22.59]
- To the extent that it relates to expected future losses
and expenses that are identified in the acquirer's acquisition plan, the
negative goodwill is recognised as income when the future losses and
expenses are recognised. [IAS 22.61]
- An excess of negative goodwill to the extent of the
fair values of acquired identifiable nonmonetary assets is recognised in
income over the average live of those nonmonetary assets. [IAS 22.62(a)]
- Any remaining excess is recognised as income
immediately. [IAS 22.62(b)]
- Negative goodwill is presented as a deduction from the
assets of the enterprise, in the same balance sheet classification as
(positive) goodwill. [IAS 22.64]
