KARATINA UNIVERSITY COLLEGE

BBM 301: ADVANCED ACCOUNTING 1

Chapter 1
AMALGAMATION AND EXTERNAL RECONSTRUCTION
Introduction
Amalgamation is combining two or more existing businesses/companies into one business/company, the
shareholders of each company becoming substantially the shareholders in the company which is to carry on
the combined business. There may be amalgamation either by transfer of two or more businesses to a new
company or by transfer of one or more businesses to an existing company. Companies come
together/combine in order to enjoy the economies of scale and to reduce or eliminate competition. This
may be done either by one of the existing companies taking over the other combining company or
companies, the later being dissolved or by starting a new company which takes over all the combining
companies.
Types of Amalgamation
Amalgamation may be in the nature of Merger or acquisition (purchase).
Merger
 For an amalgamation in the nature of merger, there is a genuine pooling of the assets and liabilities
of the amalgamating companies and also of the shareholders‟ interest and of the business of these
companies.
 The accounting treatment of such an amalgamation should ensure the resultant figures of assets,
liabilities, capital and reserves more or less represent the sum of the relevant figures of
amalgamating companies.
 Merger can be likened to a marriage where two come together with all their strengths, weakness,
assets (in form of human capital) etc. in this kind of a union the two parties come together and
become one and none loses identity. Companies in Kenya that have merged are ICEA Lion,
KenolKobil, PWC and CFC Stanbic.
Acquisition
 An amalgamation in the nature of acquisition is where one company acquires another company. As
a consequence, the shareholders of the transferor company normally do not continue to have a
proportionate share in the equity of the transferor company. Actually it may not be intended to
continue the business of the transferor company. The acquired business loses identity.

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 Accounting for amalgamations.
There are two methods of accounting for amalgamating depending on the nature of amalgamation.
i. The pooling of interest method.
a) This method is used in case of an amalgamation in the nature of merger.
b) Under this method the assets, liabilities and reserve of the transferor company are recorded by
the transferee company at their existing carrying amounts and in the same form as at the date of
the amalgamation i.e. the way they are recoded in the books of account.
c) The balance of the Profit and Loss Account of the transferor company is aggregated with the
balance of the Profit and Loss account of the transferee company or transferred to the General
Reserve.
d) The difference between the amount recorded as share capital issued plus any additional
consideration in the form of cash or other assets on the one hand and the amount of share capital
of the transferor company on the other hand is adjusted in reserves.
e) When the transferor and transferee companies have conflict accounting policies, a uniform set
of accounting policies is adopted following the amalgamation.
ii. The Acquisition method.
a) The method is followed in case of an amalgamation in the nature of acquisition.
b) The transferee company accounts for the amalgamation either by incorporating the assets and
liabilities of the transferor company 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. Just as when buying a piece of land you
just value what can be clearly identified like farm house, trees in the land, and crops.
c) Where assets and liabilities are restated on the basis of their fair values, the determination of fair
values may be influenced by the intentions of the transferee company may intend to effect
changes in the activities of the transferor company which may necessitate the creation of
specific provisions for the expected cost, for example, planned employee termination and plant
relocation costs.
The excess of the amount of the consideration, if any, over the value of the net assets of the transferor
company acquired by the transferee company is recognized in the transferee company‟s books of account
as goodwill arising on amalgamation and if the amount of the consideration is lower than the value of
assets acquired, the difference is credited to capital reserve.

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The goodwill arising in amalgamation, as per Accounting Standards 14, should be amortized to income on
a systematic basis over its useful life. The factors which may be considered in estimating the useful life of
goodwill arising on amalgamation include:
a. The effects of product obsolescence, changes in demand and other economic factors;
b. The service life expectancies of key individuals or group of employees;
c. The foreseeable life of the business or industry;
d. Expected actions by competitors or potential competitors; and
e. Legal, regulatory or contractual provision affecting the useful life.

Distinction between the two methods

The main points of distinction between the two methods of accounting for amalgamation are:
i. The pooling of interest method is applied in case of an amalgamation in the nature of merger
whereas the acquisition method is applied in case of an amalgamation in the nature of purchase.
ii. In the pooling of interest method, the assets and liabilities and also the reserves of the transferor
company are recorded in the transferee company in its books. For the acquisition method, only the
assets and liabilities are taken over; the reserves, except the statutory reserves, of the transferor
company are not aggregated with those of the transferee company. Kindly not this is a major
departure between the two methods: merger add everything in the books of Account, Acquisition:
Only assets and liabilities are taken over.
iii. Under the pooling of interests method, the difference between the consideration paid and the share
capital of the transferor company is adjusted in general reserve or other reserves of the transferee
company. For the acquisition, the difference between the consideration paid and the net assets taken
over is treated by the transferee company as goodwill or capital reverse, bas the case may demand.
iv. When for legal compliance, statutory reserve such workmen compensation fund of the transferor
company are incorporated in the books of the transferee company, in pooling of interests method
the statutory reserves are recorded like all other reserves and no amalgamation adjustment account
is required to be opened. In the acquisition method, while incorporating the statutory reserves the
transferee company has to open amalgamation adjustment account debiting it with the amount of
the statutory reserves being incorporated.

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Example 1
The following are the balance sheet of Hexagon Hexagon Ltd and S Pentagon Ltd as on 31st Dec 2011.
Hexagon Ltd Pentagon Ltd
Liabilities Kes 000 Kes 000
Equity Share Capital, Kes 10 each, fully paid 108,000 45,000
11% Preference Share Capital Kes 100 each fully paid 25,500
General Reserve 12,000 6,750
Export Profit Reserve 3,000
Profit and Loss account 11,250 6,000
9% Debentures, Kes 100 each, fully paid 7,500
Creditors 17,250 5,250
148,500 99,000
Assets
Land and Buildings 37,500
Plant and Machinery 48,750 43,500
Furniture and Fittings 8,625 14,115
Stock 32,250 26,085
Debtors 10,875 7,800
Cash at Bank 10,500 7,500
148,500 99,000
Hexagon Ltd takes over Pentagon Ltd on 1st Jan , 2012 and discharges consideration for the business as
follows:
i.) Issued 35 000 fully paid equity shares of Kes 10 each at par to the equity share holders of Pentagon
Ltd.
ii.) Issued fully paid 12% preference shares of Kes 100 each to discharge the preference share holders
of Pentagon Ltd at a premium of 10%.
It is agreed that the debentures of Pentagon Ltd will be converted into equal number and amount of 10%
debentures of Hexagon Ltd. The statutory Reserve of Pentagon Ltd is to be maintained for two more years.
You are required to show the balance sheet of Hexagon Ltd assuming that
a) The Amalgamation is the nature of merge, and

b) The amalgamation is the nature of acquisition

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 Solution: (a) In case the amalgamation is the nature of merger
Balance Sheet of Hexagon Ltd as on 1st Jan 2012
Liabilities Kes 000 Assets Kes 000
Share Capital ? Fixed assets
Authorized Land and Building 37,500
Issued and Subscribed: Plant and Machinery 92,250
16,050, 000 Equity Shares of Kes Furniture and Fitting 22,740
100 each, fully paid –up 160,500 Current Assets, Loans and
280,500 12% preference shares Advances
(Of the above shares, all the 28,050
preferences shares and 35 000 A)Current Assets
equity shares are allotted as fully Stock 58,335
paid- up pursuant to a contract Debtors 18,675
without payments being received in Cash at Bank 18,000
cash.) B) Loan and advances. Nil
Reserves and Surplus
General Reserve(as per working 14,700
note)
Export profit reserve 3,000
Profit and loss account Secure 11,250
loans
10% Debentures of Kes 100 each
fully paid-up 7,500
Current liabilities and provisions
A)Current Liabilities
Creditors 22,50
B)Provisions Nil
247,500 247,500

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 i) Working Notes Kes 000 Kes 000
Hexagon Ltd.‟s General reserve 12,000
Add :Pentagon Ltd ‟s general reserve 6,750
Pentagon Ltd .‟s [profit and loss account 6,000
24,750
Less: Consideration for equity shares 52,500
Consideration for preference share 28, 050
80,550
Less: Pentagon Ltd .‟ Shares capital
Kes .(45,000+25,500)thousand 70,500 10,050
General reserve as appearing in Hexagon Ltd.‟s balance sheet 14,700

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(b) In case the amalgamation in the nature of Acquisition:
Balance Sheet of Hexagon Ltd. As on 1st Jan 2012
Liabilities Kes 000 Assets Kes 000
Share Capital ? Fixed Assets
Authorized Land and Building 37,500
Plant and Machinery 92,250
Issued and Subscribed: Furniture and Fittings 22,740
16,050, 000 Equity shares of 160,500 Current assets, Loans and
Kes 10 each, fully paid-up Advances
280,500 12% preference shares of 28,050 A)Current Assets
Kes 100 each fully paid-up (of the Stock 58,335
above shares all, the preferences Debtors 18,675
shares and 35 000 equity shares are Cash at Bank 18,000
allotted as fully paid-up pursuant to a B)Loans and advances
contract without payments being Miscellaneous Expenditure
received in cash.) Amalgamation Adjustment 3,000
Reserves and surplus Account
Capital reserve and working note 5,700
General reserve 12,000
Export profit reserve 3,000
Profit and loss account 11,250
Secured Loans
10% Debentures of Kes 7,500
Each fully paid up
Current liabilities and provisions
A)Current liabilities
Creditors 22,500
B) Provisions

250,500 250,500

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Working Notes Kes 000 Kes 000
Calculation of capital reserve arising on amalgamation
Total Assets of Pentagon Ltd . taken over 99,000
Less:10% Debentures taken over 7,500
Creditors taken over 5,250 12,750
Net Assets Taken Over 86,250
Less: Consideration to equity share holders 52,500
Consideration to preference share holders 28,050 80,550
Capital Reserve arising Amalgamation 5,700

CONSIDERATION
Consideration‟s is the aggregate of the shares and other securities issues and the payment made in form of
cash or other assets by the transferee company to the share holders of the transferors company. This is what
is paid for by the buying company to the selling company.
a) Consideration implies the valued agreed upon the net assets taken over. The amount depends on the
term of the contract between the transferor company and the transferee company.
b) The consideration for amalgamation may consist of shares and other securities, cash and other
assets and the amount of consideration depends upon the fair value of its elements.
c) Where there are issues of securities, the value fixed by the statutory authorities may be taken to be
fair value. In case of other assets, their value may be determined by reference to the market value of
the assets given up.
d) Where the market value of the assets cannot be given up reliably assessed such assets are valued at
their respective net book value.
e) Where the schemes of amalgamation provides for an adjustment to the consideration contingent
one or more future events, the amount of the additional payment it included in the consideration if
payment is probable and reasonable estimate of the amount can be made. In all other cases, the
adjustment is recognized as soon as the amount is determined.

There are three different methods in which consideration may be calculated

(1) Lump sum Method- This is the simplest method where the consideration is stated as Lump sum.
For example, it may be stated as that Hexagon Ltd. Takes over the business of Pentagon Ltd for Kes
.100, 00,000. In this case, the sum of Kes. 100, 00,000 is the consideration.

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 (2) Net Asset Method
a) Under this method, the consideration is arrived at by adding the agreed values of all the
assets taken over by the transferee company and deducting therefore the agreed value s of
the liabilities taken over by the transferee company. It is from the fact that the buying
company will pay the liabilities and thus deducted to determine the consideration.
b) The agreed value means the amount at which the transferor company has agreed to sell the
transferee company has agreed to take over a particular asset or liability. In the absence of
any statement to the contrary regarding the agreed value of an asset or liability, the amount
at which the asset or liability appears in the book of the transferor company is considered to
be the agreed value.
c) Fictitious assets such as Preliminary Expenses, Underwriting Commission, Discount on
Issue of shares of debentures, Expenses on Issue of Debentures, debit balance of profit &
loss Account etc. are not taken over.

The following is the balance sheet of Kobia Ltd:

Liabilities Kes Assets Kes
Share capital 12,000 Equity Share Good will 140,000
Of Kes 100 each, fully paid 1,200,000 Plant and Machinery 920,000
General Reserve 500,000 Furniture and Fittings 204,000
Profit &loss Appropriation A/C 160,000 Stock 872,000
Bills Payable 140,000 Debtors 268,000
Sundry Creditors 490,000 Cash at Bank 46,000
Preliminary Expenses 40,000

2,490,000 2,490,000

Suppose (i) Hurt Ltd Purchases the business of Kobia ltd (ii) Goodwill is valued at Kes 400,000 stock is
valued at Kes 832,000. Other assets are considered worth their book values.(iii)Hurt Ltd does not take over
Cash at Bank(iv)Consideration is to be discharged in the form of 180,000 fully paid equity shares of Kes
10 each valued at par and the balance in cash
In the above mentioned case the consideration will be calculated as follows.

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Agreed value of assets taken over by Hurt Ltd:
Kes
Goodwill 4 00,000
Plant and Machinery 920,000
Furniture and Fitting 204,000
Stock 832,000
Debtors 268,000
Less: Liabilities taken over Kes 2,624,000
Bills payable 140,000
Sundry Creditors 490,000 630,000
Consideration 1,994,000

Hurt Ltd will discharge the consideration as under

180,000 equity shares of Kes 10 each fully paid at par 1,800,000
Cash (balancing figure) 194,000
Total 1,994,000
The following should be noted:
a) To add value of the assets taken over by the transferee company, Goodwill is invariably taken over
by the transferee company and also prepaid expenses should be added.
b) Not to add the assets not taken over.(e.g. cash in the banking the above example) and the fictitious
assets a and the expenses not written off. All items which appear in the above balance sheet under
the heading ‟Miscellaneous Expenditure‟ like Primary Expenses, Discount or commission on issue
of shares or Debentures etc and the debit balance of profit and loss account if any should never be
added.
c) Not to deduct the liabilities not taken over by the transferee company but to deduct the agreed value
of the liabilities taken over.
(a) Not to deduct such balances and Capital reserves, Capital Redemption, Share Premium Account,
General Reserves, Debentures Redemption Reserves, and Credit Balances of profit and Loss
Account etc i.e. any account which denotes undistributed profits. This also includes all such items
appear under the heading Reserves and Surplus. However if any reserve or a fund or a portion of
any reserve and funds denotes liability to third party, the same must be included in liabilities, for
example Workmen Compensation Fund and insurance reserve. A company may credit regularly a

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 certain amount to Workmen Compensation Fund so that at any time a liability arises to pay
compensation to worker or workers, this fund may be used.
(b) That the expression „all assets‟ includes cash and “the business” standing alone means assets
including cash and all the liabilities to outsiders. Both the expression exclude expenses and loss
written off.

(3) Net payment Method.

In this method, consideration is ascertained by adding up the cash paid, agreed values of assets
given and the agreed values of the securities allotted by the transferee company to the transferor
company is discharged of consideration.
Suppose Hexagon Ltd for business taken over from Pentagon Ltd agrees to pay Kes 2,500,000 in
cash and allot to Pentagon Ltd 2,000,000 equity shares of Kes 10 Each fully paid at an agreed
value of Kes 15 Per share. In this case, the consideration will be ascertained as follows:
Kes
Cash 2,500,000
2,000,000 equity shares of Kes 10 each fully paid at Kes 15 per share
(2,000,000 x Kes. 15) 30,000,000
Consideration 32, 500,000
Another method of indicating consideration is to say how much a share holder will get per share on the
transfer of the company‟s business to the transferee company.

Consider the following balance sheet of Pentagon Ltd .

Liabilities Kes Kes Kes

Share Capital : Sundry Assets 63,000,000
60,000 11% Preference shares
of Kes. 100 each, fully paid up 6,000,000
2,400,000 Equity share of Kes
10 each fully paid up 24,000,000
Reserves 15,000,000
Sundry Liabilities 18,000,000
63,000,000 63,000,000

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Suppose Hexagon Ltd. takes over the business of Pentagon Ltd, and agrees to give for each 11% preference
share in Pentagon Ltd, ten 12% preference shares of Kes 10 fully paid up at per and for each equity share
in Pentagon Ltd. Kes. 1 in cash and 1 fully paid equity share in Hexagon Ltd. of Kes 10 valued at Kes 15.
The consideration will be computed as follows:

12% preference shares to be allotted by P Ltd Kes

= Kes 10 x 60,000 x 10 6,000,000

Equity shares to be allotted by Hexagon Ltd.

= Kes 15 x 2,400,000 36,000,000

Cash to be paid by Hexagon Ltd.

= Kes 1 x 2,400,000 2,400,000

44,400,000

4. Intrinsic Worth Method.

a) Consideration may have to be calculated on the basics of the agreed value of shares of the
transferor company.
b) Shares are ownership securities; if the transferee pays for all the shares of the transferor
company, it can be said to have paid the entire business of the transferor company.

c) Suppose the subscriber capital of Pentagon Ltd. consists of 600,000 equity shares of Kes 10
each fully paid and there are no preference shares. Suppose, Hexagon Ltd. takes over the
business of Pentagon Ltd and it is agreed between Pentagon Ltd and Hexagon Ltd. that the
value of one share of Pentagon Ltd. is Kes 13; then the consideration will be Kes 13 x
600,000=Kes 7,800,000.
d) If the transferee company is to discharge the consideration in the form of its own equity
shares, the agreed value of a share of Transferee Company also becomes relevant. The
consideration, divided by the agreed value of one share of Transferee Company will give the
number of shares to be allotted by the transferee company to transferor to discharge
consideration.
e) In the above mentioned case, if Hexagon Ltd. is to discharge the consideration in the form
of its own shares and if its agreed between Hexagon Ltd. and Pentagon Ltd. that the value of
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 one share of Hexagon Ltd. of the paid up value of Kes 10 is Kes 25 Hexagon Ltd. will
allot 7,800,000/25=312,000 shares to Pentagon Ltd. to discharge the consideration.
f) At the time of the allotment, Hexagon Ltd will debit liquidator in Pentagon Ltd. with Kes
7,800,000 (amount of consideration) and credit equity share capital with Kes 3,120,000
(Paid up value of the shares allotted) and securities premium account with Kes 4, 680,000
(the amount of securities premium charged @ Kes 15 per share). The transferor company
will debit shares in transferee company account and credit transferee company with the
agreed value of shares received from transferee Company.

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