1.          ACCOUNTING AND AUDITING

1.1       Query

Accounting treatment of revaluation reserve in Amalgamation

1 By an order dated 5.4.1984 of High Court, Delhi, passed u/s 394 of the Companies Act, 1956, the entire assets, liabilities and obligations of ‘X’ Ltd. (Amalgamating Company) stood transferred to ‘Y’ Ltd. (Amalgamated Company) with effect from 1.8.1983 as per the Scheme of Merger placed before the Court and ‘X’ Ltd. stood dissolved without winding up.

 2 The Balance Sheets of the two Companies as on 31^st July, 1983 were as under:

‘X’ Ltd. (AMALGAMATING COMPANY)

‘Y’ Ltd. (AMALGAMATED COMPANY)

Balance Sheet as at 31^st July, 1983

3.According to the Scheme, ‘Y’ Ltd. (Amalgamated Company) allotted shares to the shareholders of ‘X’ Ltd. (Amalgamating Company) in the proportion of 3 equity shares of Rs. 10/- each for every one fully paid equity share held in ‘X’ Ltd. and the new share ranks pari passu with the existing share. ‘X’ Ltd. stood dissolved without winding up on the date on which the last approval was obtained.

 4.The amount of Revaluation Reserve (3,21,76,080/-) appearing in the Balance Sheet of ‘X’ Ltd. represents the appreciation in the value of Land and Hotel Building owned by the said company, which was adjusted in the accounts on 30.7.1983, i.e. a day preceding the merger. This was based on valuation made by an approved valuer. The relevant assets of ‘X’ Ltd. have been taken over by ‘Y’ Ltd. at the revised values i.e. after including the amount of appreciation in the value of Land and Building as determined on the aforesaid revaluation made immediately before the merger. On the basis of the valuation carried out by the approved valuers, both for ‘X’ Ltd. and ‘Y’ Ltd. three shares in ‘Y’ Ltd., of a paid up value of Rs. 10/- each were allotted for every one share in ‘X’ Ltd., of the paid up value of Rs. 10/- each. The basis of allotment of shares to the members of ‘X’ Ltd., was worked out after taking into account the valuation of Land and Building of ‘X’ Ltd. on the basis of the market replacement cost of the said land and building as on 30.7.1983, as duly incorporated in the accounts of ‘X’ Ltd. for the 1982-83. Net value for this works out as under:

5. Two possible alternative accounting treatments have been suggested by the querist for the consideration of the Expert Advisory Committee, which are reproduced below:

(1)        The assets of ‘X’ Ltd. at revalued amounts should be incorporated in the balance sheet of ‘Y’ Ltd. as the amalgamation is in the nature of merger. If this treatment is adopted then, in the Balance Sheet of ‘Y’ Ltd., after amalgamation, the full amount of revaluation reserve of Rs. 3,21,76,080/- which appeared in the books of ‘X’ Ltd. on the basis of the revaluation made at the time of merger would be disclosed on the one hand and, on the other, a corresponding debit to Goodwill Account which works out to Rs. 2,88,00,000/-. It has been mentioned that by giving this treatment the Balance Sheet of ‘Y’ Ltd. will not only show assets at their full revalued figures but in addition to that will also show goodwill of Rs. 2,88,00,000 and correspondingly Revaluation Reserve will also appear in the same Balance Sheet.

(2)        Alternatively, it is apparent that the revaluation of assets of ‘X’ Ltd. was done specifically for the purpose of amalgamation and the assets have been taken over by ‘Y’ Ltd. at revalued figures and the allotment of shares has been worked out on the basis of the revalued figures of these assets. The full value of the net assets including the appreciation on account of revaluation, therefore, is already reflected in the share capital allotted to the members of ‘X’ Ltd., in the ratio of three shares for every one share. Therefore, it is not necessary to carry forward revaluation reserve of ‘X’ Ltd. in the Balance Sheet of ‘Y’ Ltd. Investment Allowance Reserve will be carried forward in order to ensure compliance with the provisions of the Income-tax Act. According to this approach, assets of ‘X’ Ltd., will be included in the Balance Sheet of ‘Y’ Ltd., at their full amount as per revaluation done prior to the amalgamation and there will be no goodwill account raised in the books of ‘X’ Ltd., nor will there be any adjustment in the books of ‘X’ Ltd., for the revaluation reserve which was adjusted in the books of ‘X’ Ltd., at the time of amalgamation. Under this approach, it will also not be necessary to carry forward the debit balance in the profit and loss account which appeared in the Balance Sheet of ‘X’ Ltd. prior to amalgamation since this has also been taken into account while determining the ratio of shares allotted to the members of ‘X’ Ltd. at the time of amalgamation.

6.The opinion of the Expert Advisory Committee has been sought whether the approach mentioned in para 5(1) or that mentioned in para 5(2) above should be adopted. 

Opinion                                                                                                               December 22, 1984

1. The Committee notes that the Guidance Note on Accounting Treatment of Reserves in Amalgamations,[1] covers amalgamations pursuant to a court order under Section 394 of the Companies Act, 1956 [para 9 (a) of the Guidance Note.]

 2.For the purpose of accounting treatment of reserves in amalgamations, the said Guidance Note distinguishes between ‘amalgamation in the nature of merger and ‘amalgamation in the nature of purchase’. According to para 9(e) of the Note an “amalgamation is called an ‘amalgamation in the nature of merger’ when all the following conditions are satisfied:

(i)         All the property and liabilities of the transferor company become, after amalgamation, the property and liabilities of the transferee company.

(ii)        The business of the transferor company is intended to be carried on, after the amalgamation, by the transferee company in substantially the same form in which it was carried on by the transferor company before its amalgamation.

(iii)       The consideration for the amalgamation receivable by the equity shareholders of the transferor company is discharged by the transferee company to the extent of not less then 75% of such consideration by the issue of equity shares in the transferee company.

(iv)       No adjustment is intended to be made to the book values of the assets and liabilities of the Transferor Company when they are incorporated in the books of transferee company except to ensure uniformity of accounting policies.”

At per para 9(f) of the Guidance Note, an “amalgamation is called an ‘amalgamation in the nature of purchase’ when all or any of the conditions listed in sub-paragraph (e) above are not satisfied.”

 3.The Committee is of the view that though the conditions specified in para 9 (e) of the said Guidance Note reproduced above appear to have been fulfilled, yet, the last condition [9 (e) (iv)] is met only in form and not in substance since the assets of ‘X’ Ltd. have been revalued just one day before the transfer date and the purchase consideration has been based on revalued figures. Thus, for all practical purposes, the amalgamation should be treated as an amalgamation in the nature of purchase.

 4.The Committee notes that paras 13, 17 and 20 of the said Guidance Note recommend treatment of profit and loss account balance and reserves in amalgamations in the nature of purchase. The said paragraphs are reproduced below:

“13       If the amalgamation is an ‘amalgamation in the nature of purchase’ the identity of the reserves, other than the reserves referred to in paragraph 11*, is not preserved. Therefore, the aggregate of the consideration and the amount of reserves referred to in paragraph 11 would be deducted from the book value of the net assets of the transferor company (or in the case of revaluation, the revalued amounts). If the result of the computation is positive, the same is credited to a Capital Reserve. If the result of the computation is negative, the same is debited to Goodwill.”

“17       In the case of an ‘amalgamation in the nature of purchase,’ the balance of the Profit and Loss Account in the books of the transferor company, whether debit or credit, will lose its identity and will be treated like any other reserve (other than a reserve referred to in paragraph 11*). If, as explained in paragraph 13, there is a resultant Goodwill, it is permissible for the debit balance of the Profit and Loss Account, if any, to be shown as such and Goodwill reduced to that extent. The resultant debit balance of the Profit and Loss Account can, however, be adjusted against the General Reserve, if any, appearing in the transferee company’s books.”

“20       In the case of an ‘amalgamation in the nature of purchase,’ the Revaluation Reserve of the transferor company will lose its identity and its treatment will be similar to that of any other reserve (other than a reserve referred to in paragraph 11*).”

5.On the basis of the above, the identity of the Revaluation Reserve, the Profit and Loss Account (Debit Balance) of ‘X’ Ltd. will not be preserved since the amalgamation is in the nature of purchase. The identity of Investment Allowance Reserve can be preserved for Income-tax Act purposes, provided it fulfills the requirements of that Act.

 6.The Committee is of the view that the above treatment will give a ‘true and fair view’ of the state of affairs of ‘Y’ Ltd., after amalgamation.

 7.The Committee is of the view that the accounting treatment indicated by the querist in para 5(1) is based on the assumption that the amalgamation is in the nature of merger. Even, if this assumption is considered correct on technical grounds, the Committee is of the view that the balance sheet of ‘Y’ Ltd., prepared on this basis, after amalgamation, will not reflect a true and fair view of the state of affairs on the following grounds:

(i)         Goodwill of Rs. 2,88,00,000 does not, in fact, arise since the increase in the value of fixed assets on revaluation, has already been paid and disclosed as a higher amount of share capital;

(ii)        The balance sheet would show a very unrealistic position as Goodwill, debit balance of profit and loss account and Miscellaneous Expenditure of ‘X’ Ltd., and Revaluation Reserve of ‘X’ Ltd., will be shown side by side.

8. The Committee is therefore of the view that even if the amalgamation is considered to be in the nature of merger, Goodwill should be adjusted against the Revaluation Reserve of ‘X’ Ltd., with appropriate disclosure since Goodwill has arisen only by making book entries and in fact it is non-existent.

 9.On the basis of the above, the Committee is of the opinion that the alternative indicated by the querist in para 5(2) above should be adopted. In case, the alternative at para 5(1) is adopted Goodwill should be adjusted against the Revaluation Reserve of ‘X’ Ltd., with appropriate disclosure.

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[1] Issued by the Research Committee of the Institute of Chartered Accountants of India.

* Reserves created in the books of amalgamating company in terms of requirement of other statutes such as Investment Allowance Reserve.

*  Reserves created in the books of amalgamating company in terms of requirement of other statutes such as Investment Allowance Reserve.