Amalgamation-Absorption and External Reconstruction.docx

Business combinations have become common in the corporate world due to globalization, competition, and the need for expansion. When two or more companies combine, the process may take different forms such as amalgamation, absorption, or external reconstruction.
These are undertaken to:
• Achieve economies of scale
• Reduce competition
• Increase market share
• Improve efficiency and profitability
All these processes involve reorganization of capital and ownership.

1. UNIT – I: AMALGAMATION, ABSORPTION AND EXTERNAL
RECONSTRUCTION
1. INTRODUCTION
Business combinations have become common in the corporate world due to
globalization, competition, and the need for expansion. When two or more
companies combine, the process may take different forms such as
amalgamation, absorption, or external reconstruction.
These are undertaken to:
Achieve economies of scale
Reduce competition
Increase market share
Improve efficiency and profitability
All these processes involve reorganization of capital and ownership.
2. AMALGAMATION
Meaning
Amalgamation means the combination of two or more companies to form
a new company, which takes over the business of the existing companies.
The old companies lose their existence.
A new company is formed to take over their assets and liabilities.
Definition (According to AS-14)
“Amalgamation means an amalgamation pursuant to the provisions of the
Companies Act or any other statute which may be applicable to companies.”
Example

2. If A Ltd. and B Ltd. are merged to form a new company C Ltd., it is called
amalgamation.
Features
1.Two or more companies are combined.
2.A new company is formed.
3.All the assets and liabilities of the old companies are taken over by the
new company.
4.Shareholders of the old companies become shareholders of the new
company.
5.The old companies are dissolved.
3. ABSORPTION
Meaning
Absorption means one existing company takes over another existing
company.
Unlike amalgamation, no new company is formed. The absorbed company
loses its existence, while the absorbing company continues.
Example
If A Ltd. takes over B Ltd., A Ltd. is the absorbing company, and B Ltd. is
the absorbed company.
Features
1.One company absorbs another.
2.No new company is formed.
3.The absorbed company is dissolved.
4.The assets and liabilities of the absorbed company are transferred to
the absorbing company.

3. 4. EXTERNAL RECONSTRUCTION
Meaning
External reconstruction means the reorganization of a company’s
financial structure by forming a new company to take over the business of
an existing company.
The purpose is usually to restructure capital and improve financial
stability.
Example
If X Ltd. has heavy losses, it may wind up and form a new company Y Ltd.
to take over its assets and liabilities. This is external reconstruction.
Features
1.An existing company is liquidated.
2.A new company is formed.
3.Assets and liabilities are taken over by the new company.
4.Shareholders of the old company get shares in the new company.
5.The main object is reorganization, not expansion.
5. DISTINCTION BETWEEN AMALGAMATION, ABSORPTION AND
EXTERNAL RECONSTRUCTION
Basis Amalgamation Absorption
External
Reconstruction
Meaning
Two or more
companies
combine to form a
new one
One company
takes over another
existing one
One company is
liquidated and a new
company is formed to
take over its business

4. Basis Amalgamation Absorption
External
Reconstruction
New Company Formed Not formed Formed
Number of
Companies
Involved
Two or more Two One
Purpose
Expansion and
synergy
Expansion Reorganization
Existence
Old companies
dissolve
Absorbed
company dissolves
Old company
dissolves
Shareholders
Become
shareholders in
new company
Absorbed
company’s
shareholders
become
shareholders in
absorbing
company
Old shareholders
become shareholders
in new company
6. PURCHASE CONSIDERATION
Meaning
The term Purchase Consideration refers to the total amount paid by the
purchasing company to the shareholders of the vendor company in
exchange for the business taken over.
Methods of Calculation
(a) Lump Sum Method
A fixed amount is agreed upon between both companies.
Example:
Purchase consideration = ₹10,00,000 (agreed lump sum).

5. (b) Net Assets Method
Purchase consideration = Total agreed value of assets taken over – Total
agreed value of liabilities taken over
(c) Net Payment Method
Purchase consideration = Total of payments made to shareholders (cash,
shares, debentures, etc.)
(d) Intrinsic Value / Share Exchange Method
Based on the ratio in which shares of the new company are exchanged with
those of the old company.
Example 1: Calculation of Purchase Consideration
Company A Ltd. agrees to purchase Company B Ltd.
Assets taken over: ₹12,00,000
Liabilities taken over: ₹2,00,000
Purchase consideration is settled by issuing 80,000 shares of ₹10
each fully paid.
Solution:
Purchase consideration = 80,000 × ₹10 = ₹8,00,000
Net assets = ₹12,00,000 – ₹2,00,000 = ₹10,00,000
Profit on purchase = ₹10,00,000 – ₹8,00,000 = ₹2,00,000
7. ACCOUNTING TREATMENT
The accounting treatment differs based on whether the amalgamation is in
the nature of merger or purchase, as per AS-14 (Accounting for
Amalgamations).

6. (A) Amalgamation in the Nature of Merger
Conditions (as per AS-14):
1.All assets and liabilities of the transferor company become those of the
transferee company.
2.Shareholders holding at least 90% of equity shares become
shareholders of the transferee company.
3.The consideration is discharged only by the issue of equity shares.
4.The business of the transferor company is intended to be continued.
5.Assets and liabilities are recorded at existing book values.
Method of Accounting:
Pooling of Interest Method is used.
Features:
Assets and liabilities are recorded at existing book values.
Reserves of the transferor company are preserved.
No goodwill or capital reserve arises.
(B) Amalgamation in the Nature of Purchase
Characteristics:
Not all conditions of merger are satisfied.
Purchase consideration may be partly in cash.
The transferee company does not take over reserves.
Goodwill or capital reserve may arise.
Method of Accounting:
Purchase Method is used.

7. Treatment:
Assets and liabilities are recorded at fair values.
Reserves (except statutory reserves) are not taken over.
Difference between purchase consideration and net assets = Goodwill
or Capital Reserve.
Journal Entries in the Books of Transferee Company
1. For purchase consideration due:
Dr. Business Purchase A/c
 
 To Liquidator of Vendor Company A/c
2. For recording assets and liabilities taken over:
Dr. Assets A/c
 
 To Liabilities A/c
 
 To Business Purchase A/c
3. For payment of purchase consideration:
Dr. Liquidator of Vendor Company A/c
 
 To Equity Share Capital / Cash / Debentures A/c
4. For recording goodwill or capital reserve:
If debit balance → Dr. Goodwill A/c
If credit balance → To Capital Reserve A/c
8. EXTERNAL RECONSTRUCTION ACCOUNTING ENTRIES
1.For transfer of assets and liabilities to Realisation Account
 
Dr. Realisation A/c
 
 To Assets A/c
 
 To Liabilities A/c

8. 2.For recording purchase consideration
 
Dr. New Company A/c
 
 To Realisation A/c
3.For settlement of purchase consideration
 
Dr. New Company A/c
 
 To Shareholders A/c
4.For closure of Realisation Account
 
Profit/Loss transferred to Shareholders A/c
9. DISTINCTION BETWEEN INTERNAL AND EXTERNAL
RECONSTRUCTION
Basis Internal ReconstructionExternal Reconstruction
Meaning
Reorganization of capital
within the same company
Formation of a new company
to take over old company’s
business
Company Same company continues New company formed
Legal Process Alteration of share capital
Liquidation of old and
formation of new
Reserves/Losses
Adjusted through capital
reduction
Not carried forward
Purpose Eliminate losses
Rebuild business and
structure
10. ADVANTAGES OF AMALGAMATION / ABSORPTION
Economies of scale
Elimination of competition
Better utilization of resources

9. Improved financial strength
Market expansion
Tax benefits
11. DISADVANTAGES
Monopoly tendencies
Cultural and employee issues
Complexity in valuation
Legal formalities and high costs
Risk of inefficiency if management is large
12. SUMMARY
Concept Meaning
Company
Formed
Accounting
Method
Amalgamation
Two or more
companies unite
New company
Pooling /
Purchase
Absorption
One company takes
over another
No new
company
Purchase
External
Reconstruction
New company takes
over old one
New companyPurchase