Sunday 6 March 2016

SCHEME OF MERGER: ACCOUNTING METHODS AND TREATMENT OF RESERVES THEREON

The accounting treatments being followed in the scheme of merger and the treatment to reserves becomes essential because it affects either the reserves of the Company or adds on to the intangible property [goodwill]. While, payments for goodwill can be amortised over a period of years; an addition to reserves may prove difficult to deal with. Under the purchase method of merger, Companies end up having goodwill or capital reserves in exchange of consideration for merger. However, it seems that under the pooling interest method, the said difference could be either debited or credited to any of the reserves as the wordings are as follows [1]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 should be adjusted in reserves.”

The accounting principles (as per AS-14) to be followed while considering the merger of two or more Companies lay down two accounting methods for amalgamations:

·         Amalgamation in the nature of Merger (Pooling of interest method)
·         Amalgamation in the nature of Purchase (Purchase method)

Pooling of interest method is the one where there happens a genuine pooling of not only assets and liabilities but also the stakeholder’s interest and the business wherein certain conditions needs to be followed. Whereas, amalgamation not fulfilling any of the conditions of pooling interest method, falls under the method of purchase.

Key point to be discussed here is the treatment of difference in the consideration paid in the amalgamation and the value of net identifiable assets acquired.       

When this pooling of interest method is applicable, as per the text of AS 14, the difference is required to be transferred to the “Reserves”. However, there being no specific mention about nature of reserves, it is widely interpreted and practiced to be transferred to general reserves or share premium account also; as the said reserves can be akin to the premium on shares.      
In case of Sutlej Industries Ltd it was held by the Rajasthan High Court that in case any reserve arose by amalgamation/arrangement it would be treated as free reserve for distribution to shareholders and since, utilization of arrangement/amalgamation reserve for distribution to shareholders was not objected to by the shareholders and the scheme was approved unanimously in the meeting of the shareholders, there was no reason to exclude that clause from the proposed scheme.

However, in recent past it has been observed that High courts on the basis of objections raised by respective Regional directors have been insisting on transfer of difference to capital reserves only. Opinion of ICAI-Expert Advisory committee also favours transfer to capital reserve as the reserve created out of such transactions (Amalgamation) are of the capital nature. These contentions seem to have supported by the requirement that the amalgamation reserves are not supposed to be free reserves available for distribution of dividend.

In this context, looking at the various schemes of mergers approved by the respective High Courts; it seems that the traditionally transfer to capital reserves is the ideal step to go ahead with. However, wordings of the AS 14 issued by ICAI stating about the transfer of difference to merely “Reserves” remains ambiguous.



[1] Accounting Standard 14 issued by ICAI

No comments:

Post a Comment