Accounting for Amalgamations
The provisions of Accounting Standard (AS-14) on Accounting for Amalgamations issued by the Institute of Chartered accountants of India need to be referred to in this context.
The two main methods of financing an acquisition are cash and share exchange:
Cash: This method is generally considered suitable for relatively small acquisitions. It has two advantages:
(i) The buyer retains total control as the shareholders in the selling company are completely bought out.
(ii) The value of the bid is known and the process is simple.
Let us consider 2 Companies A & B whose figures are stated below:
Assume Company A intends to pay Rs.12,00,000/- cash for Company B.
If the share price does not anticipate a merger:
The share price in the market is expected to accurately reflect the true value of the company.
The cost to the bidder Company A = Payment – The market value of Company B
= Rs.12 lakhs – Rs.9 lakhs
= Rs.3 lakhs.
Company A is paying Rs.3 lakhs for the identified benefits of the merger.
If the share price includes a speculation element of Rs.2/- per share:
The cost to Company A = Rs.3,00,000 + (60,000 x Rs.2)
= Rs. 3,00,000 + Rs. 1,20,000
= Rs. 4,20,000/-
Worth of Company B = (Rs. 15 – Rs. 2) × 60,000
= Rs. 13 × 60,000
= Rs. 7,80,000/-
This can also be expressed as: Rs. 12,00,000 – Rs. 4,20,000 = Rs. 7,80,000/-
Share exchange: The method of payment in large transactions is predominantly stock for stock.
The advantage of this method is that the acquirer does not part with cash and does not increase the financial risk by raising new debt. The disadvantage is that the acquirer’s shareholders will have to share future prosperity with those of the acquired company.
Suppose Company A wished to offer shares in Company A to the shareholders of Company B instead of cash:
Amount to be paid to shareholders of Company B = Rs. 12,00,000
Market price of shares of Company A = Rs. 75/-
No. of shares to be offered = Rs. 12,00,000 / Rs. 75 = 16,000
Now, shareholders of Company B will own part of Company A, and will benefit from any future gains of the merged enterprise.
Their share in the merged enterprise = 16,000 / (1,00,000 + 16,000) = 13.8%
Further, now suppose that the benefits of the merger has been identified by Company A to have a present value of Rs. 4,00,000/-,
The value of the merged entity = Rs. 75,00,000 + (Rs. 9,00,000 + Rs. 4,00,000) = Rs. 88,00,000/-
True cost of merger to the shareholders of Company A: