Topic 7 and 8

TOPIC 7:

REFER TEXTBOOK company and group financial reporting

Changes in Business Structure

LEARNING OUTCOME

Student will be able to understand:

1. Conversion of a business entity into a company.2. Business combination3. Determination of the consideration transferable

(purchase price)4. Purchase consideration 5. Accounting entries6. Amalgamation of companies7. Absorption8. Acquisition of control (take over)9. Pre-incorporation profits and losses

INTRODUCTION Business combination and ‘merger’ refers to situations

where businesess combine. Business combination can be in various ways:-

a) 1 entity acquire the net assets of another entity & incorporating these assets into their operations.b) Involve acquiring control over the operations of the other entity by acquiring the issued voting share capital of that entity.

Business combinations can be horizontal and/or vertical integration.

Horizontal integration involves entities in the same line of business combining.

Vertical integration involves combining of businesses in different lines but within the same ‘stream’ of activity.

CONVERSION OF A BUSINESS ENTITY INTO A COMPANY

Owners of sole proprietorship and partnership may want to convert their business into a company.

This process is not called a business combination but the accounting treatment is similar to most forms of business combinations.

In order to convert the business into a co., the owners will form a co. specifically to acquire their own business as a going concern.

The co. formed will acquire the assets & liabilities of the old business.

For taking over the assets & liabilities of the old business, the new co. will incur a cost which is the consideration transferable or purchase price, agreed upon by both the purchaser & the seller (vendor)

The purchase price could be settled by cash, shares in the co, or a combination of cash & shares or other securities. If the sellers are give shares in the new co. then they become shareholders of the new co. & in most cases directors of the new co. The sole trader or partners may wish to sell their business to a limited liability co. with no desire to participate in the running of the co. Whether there is a conversion of a business into a co. or a sale of business, there is a seller and a buyer.

BUSINESS COMBINATION

Amalgamation

Absorption

Takeovers

Amalgamation of Limited Liability Companies

Amalgamation takes place when 2 or more companies combine their businesses together by selling their businesses as going concerns to a newly formed co.

A new co. is formed to acquire the assets & liabilities of the old companies & these old companies are wound up.

The consideration given may consist of cash, shares and/or debentures in the new co.

Depending on the consideration given, the shareholders of the old companies may become shareholders of the new & bigger co.

L Sdn Bhd + M Sdn Bhd = LM Sdn Bhd

Absorption

Absorption takes place when 1 dominant co. acquires the assets & liabilities of another co. and the co. being acquired is wound up.

The purchase consideration given may be in cash, shares and/or debentures in the purchaser co.

X Sdn Bhd + Z Sdn Bhd = X Sdn Bhd

Takeovers (Acquisition)

In a takeover, the investor acquires control in another co (investee).

Usually, investors will acquire the majority of the voting shares of the acquired co.

Co. that controls another co. is referred to as the holding or parent co. and the acquired co. becomes a subsidiary of the co.

The major shareholder in the parent co. will elect the majority of the members of the BOD of the subsidiary, thereby controlling the financial & operating policies of the subsidiary.

TAKEOVER describe the process of acquiring the majority of the issued share capital of a co. In takeover, the purchasing co. may acquire the issued share capital of the investee co, OR the investee co. may issue sufficient new shares to the purchasing co. for them to have a majority shareholding. Alternatively, the purchasing co. may make a direct offer to the shareholders to acquire their shares, which is referred to as a takeover bid. This form of takeover may have the approval of the directors or may be opposed by the directors. If the takeover attempt is not favoured by the directors of the co. being acquired, it is referred to as a hostile takeover.

Another ways of acquiring shares is to purchase them in the open market. This technique is applicable to acquiring the shares of public companies only. If the entity has not acquired more than 50% of the voting shares, the acquirer (the buyer) has to make a general offer to all the holders of voting shares not held by it to acquire the offeree’s shares. The acquired co. referred to as a subsidiary, retains its legal entity status, maintaining its own set of books of accounts and preparing its own financial statements. Normally after the takeover, there may be changes in the structure, plans and operations, management and etc of the subsidiary.

From the year of acquisition of a subsidiary, the acquiring co. (holding or parent co) has to prepare a set of financial statements incorporating the results of operation, financial position & cash flow of its subsidiaries. This set of accounts is called consolidated financial statements. Associate co –where acquiring co. own 20% or more but less than 50% of the voting shares of the investee co. An associate co. is one which is not subsidiary, but in which the investors holds substantial (min. 20%) amount of voting shares, the investor is able to exercise significant influence over its financial & operating policies, though not control it.

DETERMINATION OF THE CONSIDERATION TRANSFERABLE (PURCHASE PRICE)

The purchase price or consideration may comprise:a) Cash and cash equivalents payable b) Fair value of other consideration (other than cash)

given by the buyer. Factors that determine the consideration transferred:

a) The net assets taken over by the buyer (recognition of assets & fair value of assets)

b) Goodwillc) Liabilities taken overd) Liquidation expenses

PURCHASE CONSIDERATION

Purchase consideration could consist of any or a combination of the following:a) Cashb) Shares in the purchasing co.c) Liabilities in the purchasing co.d) Other assets

The purchase consideration should equal the consideration transferred.

Consideration transferred = fair value of the separately identifiable net assets taken over

EXAMPLE 1 (297) REFER TEXTBOOK company and group financial reporting

The partners of AB Partnership wish to convert the partnership

into a limited liability co. On 1.1.x9, AB Sdn Bhd was

incorporated with authorised capital of 600,000 OS of RM 1

each to purchase all the assets, (except cash) and liabilities of

AB Partnership. AB Sdn Bhd was to discharge the purchase

price by issuing 400,000 OS.

The following is the SOFP of AB Partnership as at 1.1.x9: RM RMLand and building 200,000Plant and machinery 100,000Inventories 30,000Trade receivables 40,000Bank 4,000

374,000Capital:En. A 200,000En. B 150,000 350,000Trade payables 24,000

374,000

The following are the fair values of the assets taken over: RM

Land and building 220,000Plant and machinery 110,000Inventories 25,000Trade receivables 30,000

The partners share profits and losses equally. En A agreed to accept any cash remaining as part settlement of the amount due to him on liquidation of the firm.Required:a) The consideration transferredb) The goodwillAnswera) The consideration transferred is equal to the

purchase consideration.

The purchase consideration = 400,000 (400,000 OS of RM

1 each)

Net identifiable assets taken over: RMLand and building 220,000Plant and machinery 110,000Inventories 25,000Trade receivables 30,000

385,000Trade payables (24,000)

361,000Consideration transferred 400,000Goodwill 39,000

b) In the question, payment for goodwill is not given. Goodwill is the excess of the consideration transferred over the fair value of the net identifiable assets taken over.

If the consideration transferred were to be only RM 350,000, then there is a bargain purchase of RM 11,000. The buyer will record this as reserve initially & recognise as gain in the SOCI immediately.

ACCOUNTING ENTRIES

There were 2 aspects to the accounting treatment, a) the winding up the affairs of the selling entityb) opening up the relevant books of the buyer.

Closing the Books of the Seller/Vendor

Realisation acc. need to be open and into this account is

transferred the book value of the assets and liabilities which

are transferred to the buyer.

RM RMa) To record the consideration transferred

Dr.Purchasing co's account xxCr. Realisation account xx

b) Assets taken overDr.Realisation acc xx

Cr. Relevant assets at carrying value xx

c) Liabilities taken overDr.Relevant liabilities xx

Cr. Realisation acc xx

d) Liquidation expenses paid by sellerDr.Realisation acc xx

Cr. Bank xx

e) Write-off assets that have no valueDr.Capital account xx

Cr. Assets of no value - at carrying value xx

f) Profit on realisationDr.Realisation acc xx

Cr. Capital acc xx

g) Purchase consideration received from buyerDr.Cash, shares etc. received/ receivables xx

Cr. Purchase xx

h) Close off the capital accountDr.Capital acc xx

Cr. Purchase consideration and all remaining assets xx

Assets and Liabilities not Taken over Some assets may not be taken over by the purchaser of the business. In that case, the assets are sold separately and the profit or loss on sale is transferred to the realisation account.

Debentures outstanding

RM RMa) Transfer of debentures to debenture holders account

Dr.Debentures xxCr. Debenture holders' account xx

b) Premium paid to the debenture holdersDr.Realisation acc xx

Cr. Debenture holders' account xx

Shareholders’ EquityRM RM

a) Transfer of preference share capitalDr.Preference share capital xx

Cr. Sundry members' acc xx

b) Premium payable to the preference shareholdersDr.Realisation acc xx


c) Transfer of ordinary shares capital and reserveDr.OSC xxDr.Reserve xx


d) Purchase consideration receivedDr.Assets (received/ receivable) xx

Cr. Buyer xx

e) Discharging the amount owing to the debenture holdersDr.Debenture holders' acc xx

Cr. Relevant assets xx

f) Setting the amount due to the preference shareholdersDr.Sundry members' acc xx

Cr. Assets xx

g) Distribution of remaining assets to the ordinary shareholdersDr.Sundry members' acc xx

Cr. Remaining assets xx

EXAMPLE 2 (302)

You are required to close the books of AB Partnership RM RM

a) To record the considertion transferredDr. AB Sdn Bhd 400,000

Cr.Realisation acc. 400,000

b) Assets taken overDr. Realisation acc 370,000

Cr.Land and building 200,000Plant and machinery 100,000Inventories 30,000Trade receivables 40,000

c) Liabilities taken overDr. Trade payables 24,000

Cr.Realisation acc 24,000

d) Purchase consideration receivedDr. OS in AB Sdn Bhd 400,000

Cr.AB Sdn Bhd 400,000

e) Profit on realisation, shared between the partners equallyDr. Realisation acc 54,000

Cr.Capital acc - A 27,000Cr.Capital acc - B 27,000

f) Settlement of amount due to ADr. Capital acc - A 227,000

Cr.OS in AB Sdn Bhd 223,000Cr.Cash 4,000

g) Settlement of amount due to BDr. Capital acc - B 177,000

Cr.OS in AB Sdn Bhd 177,000

Opening the Books of the Buyer

RM RMa) To record the agreed consideration

Dr.Business purchase acc. xxCr. Seller/ Liquidator xx

b) To record the assets acquired at fair valueDr.Assets received xx

Cr. Business purchase acc. xx

c) To record the liabilities taken overDr.Business purchase acc. xx

Cr. Liabilities taken over xx

d) To record goodwill or premium paidDr.Goodwill xx

Cr. Business purchase account xx

e) Payment of considerationDr.Seller/ Liquidator xx

Cr. Share capital xxCr. Share premium xxCr. Cash xx

Example 3 (pg 305)

The facts are the same as Example 1.

Required:

a) To record the transactions in the books of the buyer; and

b) To prepare the SOFP of the co. immediately after the business acquisition.

RM RMa) Agreed consideration

Dr. Business purchase acc. 400,000Cr. AB Partnership 400,000

b) Assets acquired at fair valueDr. Land and building 220,000Dr. Plant and machinery 110,000Dr. Inventories 25,000Dr. Trade receivables 40,000Dr. Goodwill 39,000

Cr. Provision for doubtful debts 10,000Cr. Business purchase acc. 424,000

c) Liabilities taken overDr. Business purchase acc. 24,000

Cr. Trade payables 24,000

d) Issue of shares in settlement of consideration transferredDr. AB Partnership 400,000

Cr. Share capital 400,000

RM RMLand and building (cost) 220,000Plant and machinery (cost) 110,000Goodwill 39,000Current assetsInventories 25,000Trade receivables(Less provision for doubtful debts RM 10,000) 30,000 55,000

424,000Authorised capital600,000 OS of RM1 each 600,000Issued and paid-up capital400,000 OS 400,000Current liabilitiesTrade payables 24,000

424,000

AB Sdn BhdStatement of Financial Position as at 1 January x9

AMALGAMATION OF COMPANIESExample 4 (pg 307)

ABSORPTION Example 5 (pg 313)

ACQUISITION OF CONTROL - TAKEOVERS

The acquirer purchases the share capital and gains control of the acquired co.

The acquirer becomes a parent and the acquired the subsidiary. (Parent and subsidiary form a group)

In a takeover bid, the price paid will be based on a number of factors such as the degree of desirability to acquire control, expansion plans, acquiring production or marketing facilities, etc.

The price paid for shares of private & non-listed co. will depend on various factors such as the value of assets, net asset value of the shares, present and future earnings of the co, goodwill, etc.

The consideration given can be in cash, shares and/or debentures of the acquiring co, or a combination of cash, shares and debentures.

Accounting Entries

Parent company Holding an interest in the shares of another entity is

referred to as investment in shares. On acquisition of shares the buyer will:

Dr. Investment in shares xx

Cr. Cash/shares/debentures xx

Consolidated accounts The parent co. is required to prepare the consolidated

financial statements incorporating the results of operation, financial position and changes in financial position of its subsidiaries and its associated companies into that of its financial statements.

Investee Company No entries are made in the books of the investee co.

PRE-INCORPORATION PROFITS AND LOSSES

A co. may be incorporated to acquire a business from a date prior to its incorporation.

This may occur when there is a delay in incorporating the co. but the sale and purchase agreement requires the co. to take over the business on a specified date.

The actg problem will be the calculation & treatment of the pre-incorporation profits or losses.

If the pre-incorporation profits accrue to the buyer, then these profits or losses are not available for distribution.

As the profits were earned before the co. was formed, these profits are to be treated as capital even though they were earned through normal trading activities.

Illustration (pg 326)


Treatment of Pre-Incorporation Profit & Loss – Example 8 (pg 327)


TOPIC 8:


Business Combinations

LEARNING OUTCOME

Student will be able to understand:

1. Parent and subsidiary2. Identifying the acquirer3. Non-controlling interest

PARENT AND SUBSIDIARY

Parent – an entity that has one or more subsidiaries

Subsidiary – an entity including an unincorporated entity such as partnership that is controlled by another entity (known as a parent)

Control – the power to govern the financial & operating policies of an entity so as to obtain benefits from its activities.a) Share ownership and Potential Sharesb) Control without Holding the Majority Voting Shares

IDENTIFYING THE ACQUIRERExample 3 (pg 354)

NON-CONTROLLING INTEREST

Non-controlling interest (minority interest) is the term used for the group of shareholders who do not control an entity.

Eg : an entity XX has in issue 1 million equity shares and entity AB had acquired 70% of the issued share capital of XX and has control over XX. The holders of the shares not held by AB are collectively called non-controlling interest.

Topic 7 and 8

Business

Transcript of Topic 7 and 8