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Page 1: Class B.Com. (Hons.) II Year

B.Com (Hons.) 3rd Sem. Subject- Corporate Account

45, Anurag Nagar, Behind Press Complex, Indore (M.P.) Ph.: 4262100, www.rccmindore.com 1

SYLLABUS

Class – B.Com. (Hons.) II Year

Subject – Corporate Account

UNIT – II Valuation of Goodwill and shares.

UNIT – III Accounting for amalgamation of

companies as per Indian Accounting standard 14.

UNIT – IV Consolidated Balance Sheet of holding companies with one subsidiary only.

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B.Com (Hons.) 3rd Sem. Subject- Corporate Account

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Unit II Valuation of Goodwill

Record of Goodwill in accounting is made only when it has a value. When a business is purchased and some additional amount is paid over and above the amount of assets, then this additional amount is paid over and above the amount of assets, then this additional amount is called Goodwill. A person pays Goodwill when he realizes that the amount which he is paying for Goodwill is les than the benefit which he will derive in future. Therefore, he compares the value of Goodwill paid with the value of benefit which he will derive future. Factors Affecting Valuation of Goodwill Internal Factors

1. If expenses are incurred for creation and increase of Goodwill, these expenses affect valuation of Goodwill.

2. Expenses of management: If special type of expenses are incurred on management and after purchase of business, due to ability and capacity of new purchaser these expenses will be reduced, then profits will increase and thus amount of Goodwill also increase. On the contrary, if purchaser feels that after purchase of business he will have to incur more expenses for management than existing ones and profit in comparison to those additional expenses will be more.

3. Use of Patent or Trade Mark: If more capital is to be employed in comparison to profits in order to derive expected profits, then value of Goodwill will be less, but if more profits can be derived by investing comparatively less capital then value of Goodwill be more.

4. Use of patent or Trade Mark: If a firm has established reputation for a patent or Trade-mark, it will have Goodwill due to it. If Goodwill is valued on the basis of patent or Trade-mark, then the period for which patent or Trade-mark can be used in future must be considered. The longer the future period for its use, the more will be Goodwill and vice versa.

5. Relation between employer and employee: The better the relations between employer and employee, more will be Goodwill.

6. Place : Some place are famous for a particular type of trade or business. If a businessman is carried on at these places, the Goodwill is created in addition to other factors, due to that place, e.g., Locks of Aligarh and Bangles of Firozabad, etc.

7. Profits of past years: Past years profits are taken into consideration for determining future profits, therefore past years’ profits play an important role in determination of Goodwill.

8. Other Income : If other incomes are also received in addition to the main incomes of the business, then it must be carefully understood that whether these other incomes will continue to be made in future. If they are to continue, amount of Goodwill will be more.

External Factors

1. Customers View: If customers’ point of view is good about business, Goodwill will be more. 2. Reasonable agreements: If reasonable agreements have been made between concerned

business and outsider and all are properly executed, the amount of Goodwill increases. 3. Competition: If competition increase, the special feature of a business can be noticed and its

amounts to increase in Goodwill. Thus, competition is not always bad for increase of Goodwill. 4. Intangible Asset : Goodwill is not valued like other assets, because value of other assets can be

ascertained from the markets, but goodwill is an intangible asset having no shape and form. It cannot be seen and touched, it can only be felt. It has no market value. Its value is determined on the basis of mutual agreement.

5. Special Contracts: If a businessman is making profits due to special contracts, then it should be seen for what period these contracts would continue. If the period of their continuance is for a short period, Goodwill be less.

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METHODS OF VALUATION OF GOODWILL Following are the methods of valuation of Goodwill: Average Profit Method, (2) Super Profit Method, (3) Capitalization Method, (4) Annuity Method. (1) Average Profit Method: - Under this method profits of last few years are totaled and this total is

divided by concerned number of years and the result after this division is called average profit. This average profit multiplied by certain number of years, say, two or three years and thus the amount of Goodwill is found out.

Method of finding out Average Profit

(i) Total of profits of past 3 to 5 years is found out. If during this period in any year there is loss, this loss is deducted

(ii) If in future years some new expenses are likely to be incurred, they are deducted from this total

(iii) If some items of income are to be made in future, they should be deducted and if some new incomes are to be made in future, they should be added in the above total.

(iv) If some past expenses will not be incurred in future, they are added in above total. (v) Those losses which are not expected to occurred in future are added. (vi) If due to some special circumstances some extraordinary profits have been made and they

are not likely to be made in future such profits are to be deducted. (vii) After making above additions and deduction in the total profits of some past years, i.e.,

three, four or five years, whatever balance is left, this balance is divided by concerned number of years and thus Average Profits is found out.

Years of Purchase: Average Profit is multiplied by certain number of years. Often this profit is multiplied either by two or three years. Whatever number which should be used after approximating it, for multiplying the average profits, e.g., if seven years profit is totalled up, then half of seven is 3-1/2 years, it is approximated 4 years. Thus, average profit should be multiplied by 4 years in this case. Mutual agreement: Though above-mentioned description is general, but really speaking number of years etc. are decided on the basis of mutual agreement between the buyer and seller of business. Therefore, in solving practical question, instructions given in the questions should be complied for valuation of Goodwill.

WEIGHTED AVERAGE PROFIT METHOD

This method is an improvement over the simple average profit method. In order to calculate goodwill under this method a weight is assigned to the profit and loss of each financial year. Thereafter each year’s profit is multiplied by the weight assigned to derive the weighted profit. For determining the weighted average profit the total of the weighted profit is divided by the total weight. In order to calculate goodwill the weighted average profit should be multiplied by the years of purchase. This method eliminates the fluctuations in the profits. If the profit in the business is continuously increasing and this change is also in reasonable quantity then calculation of goodwill should be made on weighted average profit method instead of simple average profit method because this method provided more weightage should be provided to current years.

SUPER PROFIT METHOD

The method of super profit calculation of goodwill is more satisfactory than the average profit method. In general term, the concept of super profit is that profit. Which is over & above the profit earned by competitive business unit engaged in the same field of business. For example—Mr. A is engaged in cloth business, he has invested Rs. 50,000 as capital and he has earned a profit of Rs. 5,000 in one year. Another businessman doing the same business by investing the same amount has earned Rs. 5,500 as profit in the same year. Thus the excess of Rs. 500 (5,500-5,000) is treated as super profit. But in the technical sense the experts have a different concept of super profit which may be enumerated as under:

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Meaning of Super Profit When starting the business, every businessman expects a minimum rate of return which is leased on nature of business, amount invested and general rate of interest in the market. If any [businessman earns more than the expected normal profit, the excess is considered as super profit. (According to accounting system the concept of super profit is determined by following formula: Super Profit = Actual Average Profit - Normal Profit Under this method of calculating the goodwill, the following procedures are applied: A) Calculation of Capital Employed in business For knowing the goodwill, at the first step, the amount of capital employed in the business is to be calculated and for that purpose the following considerations are to be kept in mind: (1) Fixed Assets: All the fixed assets at market value are to be added. In case the market value is not available then book value is taken into consideration, and the depreciation on excess value is to be deducted. If the rate of depreciation is not given then estimated amount may be taken into consideration. Alternatively, it can be ignored and a note is given for that purpose. (2) Current Assets: Current assets should be taken on agreed value. In case it is not given I then book value should be taken into consideration. (3) Fictitious Assets: Fictitious assets like—preliminary expenses, discount on shares and debentures, deferred revenue expenditure etc. shown in the balance sheet, should be excluded. (4) Intangible Assets: Intangible assets like trademark, Patent, Copyright etc. should be included at a fair value or book value if they are helpful in running the business. If they are not helpful in business then it should be excluded. If in the question nothing is clear then they should be included. The total of all such assets is to be treated as total assets for the purpose of valuation of goodwill. (5) Investment: The consideration for investment may be as follows: (i) If the investment is internal for the development of the business then it should be | shown at revalued price including profit earned on it. (ii) If the investment is made outside and which is not related to business for earning income, then it should not be included in the capital employed alongwith profit earned on it. (iii) If it is not clear about investment that whether it is internal or external then it should always be treated as external investment. (6) Goodwill: The amount of goodwill shown in the balance sheet should not be included in calculation of capital employed. But if it has been purchased then it may or may not be included. The experts differ in opinion therefore, it is better to exclude because goodwill is to be calculated separately. (7) External Liabilities: Out of total liabilities shown in the balance sheet the amount of external liabilities should be deducted from the total assets. Such liabilities are—debentures, bank loan, general loan, bills payable, creditors, unpaid expenditure etc. But items belonging to shareholders like—Capital gain, reserves and fund, undistributed profit and dividend etc. should not be taken into consideration as they are shareholders' fund. The total of such liabilities should be deducted from the total assets which will result in net assets. (8) Preference share capital: If there is preference share capital in the balance sheet, then it should also be deducted from the net assets, then the balance will be the capital employed in the business. If preference share is in the nature of participating then it should not be deducted as they are also treated as owner of the business sharing profit and loss. This calculation gives us the amount of capital employed in the business. (B) Average Capital Employed On the basis of above calculation the capital employed in the business is arrived. Capital employed in the business is not supposed to be correct as the profit is earned throughout the year. Therefore most of the experts have opinion that for calculating goodwill the amount of average capital employed should be used. Therefore after calculating the capital employed in the business revenue profit of the year should be taken one-half and it should be deducted from the capital employed, then average capital employed is found out.

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The concept of half revenue profit of the year is that out of total profit the income on external investment, interest on long term loan, interest on debentures, remuneration of owners and directors and taxes are to be deducted. It will give half of the profit earned during the year. For calculating goodwill either capital employed or average capital employed may treated as basis but most of the accountants take average capital employed for this purpose. Other methods : Capital employed in the business can be calculated by other methods which are as follows : (i) Average capital employed in the business can be calculated by adding the opening capital of the business and the closing capital of the business and the total is divided by It will give average capital employed. (ii) Second method is to add half of the profit of the year in opening capital of the year. (iii) Third method is that from closing capital of the year deduct half of the profit, it will give average capital employed in the business. For the purpose of calculating half of the profit of the year it should be considered that in the balance sheet on the liabilities side proposed dividend has been given then it should added with the net profit of the year. After that half of this amount should be added to opening capital or deducted from closing capital. (C) Average Profit The meaning of average profit is the total of profit earned during certain year is divided I by the number of years. It has already been explained in detail while discussing the first method of calculating goodwill, that is, Average Profit Method. (D) Actual Average Profit After calculating the average profit further the amount of actual average profit is to be determined. For this purpose the following considerations are required (i) If the items like—income from external investment, interest on debentures, interest on long term loans, and remuneration of owners and directors are included in the profit then it should be deducted from average profit. (ii) If in any year due to certain unexpected events, additional profit is earned and it is expected not to continue during future years then this additional profit should also be deducted _ from the average profit. (iii) If the assets have been valued at increased price for calculating capital employed then' the depreciation on this excess value should also be deducted. (iv) If any risk capital has appeared in balance sheet then it should also be deducted. (v) In case income tax has not been deducted then it should also be deducted from average profit. (vi) The dividend on preferential shares should also be deducted if the preferential shares are not participating share. (vii) If in any year due to unexpected events additional loss is incurred and it is not likely to continue in the future then it should be added in the average profit. After making above adjustment in the average profit the actual average profit is determined. Certain businessmen think to apply certain weight for calculating actual average profit, then a justified weight may be given. (E) Normal profit Normal profit is that profit which a businessman generally expects from the investments It is calculated on the basis of expected rate of interest (known as normal rate) multiplied by average capital employed. (F) Super Profit Super profit is that profit which is arrived by deducting the normal profit from the actual average profit.

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B.Com (Hons.) 3rd Sem. Subject- Corporate Account

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(G) Goodwill After calculating the super profit on the basis of above mentioned considerations the goodwill is calculated by multiplying the super profit by certain number of years. The resulting amount is goodwill. The difficult point here is the number of years with which super profit is to be multiplied. Following description is useful in this respect: 1. Number of years should be more if super profit is more and number of years should be less if super

profit is less. 2. Correct determination of number of years depends on : (i) nature of business, (ii) condition of

securities, (iii) Govt. policies, (iv) circumstances of the business, etc. 3. If such business is being purchased in which for earning profit credit mainly goes to management

and after purchase of this business management will be changed, then super profit should be multiplied either by one or two years only.

4. How many years a new business will take to earn so much profit as is the profit of an existing business at present. Super profit should be multiplied by same number of years.

5. Ordinarily three to five years period is treated as ideal for this purpose.

VALUATION OF SHARES Shares:- Under section 2(46) of companies Act 1956 “share means share in the share capital of a company and includes stock except where a distinction between share and stock is expressed or implied. Valuation of shares means the computation of the value of a share on which it can be bought or sold, transferred or assessed under tax cows. Types of the value of shares:-

(i) Face value or value at par (ii) Market value (iii) Purchase value (iv) Book Value (v) Intrinsic value (vi) fair value

Necessity for valuation of shares:- Value of a shares depends on the purpose of valuation. All the persons or institutions, having interest in company, make valuation of these shares on different occasions and for different purposes. Sometimes the company itself makes the valuation of its share or get them valued by an outside expert. Generally under the following cases the valuation of shares becomes essential

(i) To know the financial position of finance comp (ii) To value unquoted shares (iii) At the time of conversion of shares (iv) Shares as security of loan (v) To get contract.

Method of valuation of shares:- It is obvious that there may be only two basis for the valuation of shares financial base and income or profit or yield base. Though no specific method of valuation at shares is mentioned in Comp. Act 1956 the following methods are most popular and widely used.

METHODS OF VALUATION OF SHARES

No method of valuation of shares is given in the Companies Act, though provision may be made in the Articles of Association of the company for it. Ordinarily following methods of valuation of shares are adopted: 1. Asset valuation method, 2. Yield or Income valuation method

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45, Anurag Nagar, Behind Press Complex, Indore (M.P.) Ph.: 4262100, www.rccmindore.com 7

3. Fair value method 4. Earning per share method.

1. Asset valuation method

Following procedure is adopted for finding out value of shares according to this method: (1) To find out realisable value of real assets of the company. (2) To find out total of external liabilities (3) To find out the value of net assets:- After calculating realisable value of assets and liabilities the

value of net assets may be found out by deducting the value of external liabilities from the value of real assets. The amount of net assets should be divided by number of shares which will give the value of one share.

In the form of formula, it may be as follows: (i) Value of net assets = Total of realisable assets – Total of external liabilities

(ii) Value of one share = 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑛𝑒𝑡 𝑎𝑠𝑠𝑒𝑡𝑠

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠𝑕𝑎𝑟𝑒𝑠

While calculating net assets, the following points should be considered carefully

(i) The fictitious assets should be left (ii) Revalued figure of the real assets should be considered (iii) If there is any asset which is being used in the business but not recorded in the book so for

then it should be taken in the list of real assets at a proper value. (iv) Goodwill is also taken in the list of real assets

About liabilities:- Only external liabilities considered for calculating net asset external liabilities are those liabilities, the payment of which is to be made to a person or institution other than the owner of the business. 4. Equity share capital – It should not be deducted because these are the internal liabilities. 5. Reserve & Surplus :- Reserve & surplus should not be taken in the list of external liabilities. But provisions are treated or external liabilities and should be deducted from assets.

S.No. Reserves & Surplus Provisions 1 Workmen’s accident compensation

fund Workmen’s Provident Fund

2 Workmen’s Insurance Fund Employee’s State Insurance Fund (E.S.I.) 3 Reserve Fund Workmen or Employee’s Profit Sharing Fund. 4 Dividend Equalisation Fund Workmen or Employee’s or Staff Security

Deposits 5 Contingency Fund. Staff Pension Fund 6 General Reserve Workmen’s Saving Bank Account 7 Debenture Sinking Fund Super Annuation Fund 8 Capital Redemption Reserve Investment Fluctuation Fund. 9 Security Premium Provision for Depreciation. 10 Development Rebate Reserve Provision for Bad and Doubtful Debts. 11 Project Allowance Reserve 12 Forfeited Shares Account 13 Capital Reserve The above list is not complete but sufficient.

Note-Some reserves in the balance sheet are related with assets. Such as provision for bad and Doubtful Debts is related to debtors. Investment fluctuation fund is related to investments, provision for depreciation is related to fixed assets. These, reserves are actually provisions. These are shown on

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the liabilities side or as a deduction from respective fixed asset on assets side. Now if a particular asset is not revalued, the net value of that asset (after deducting provision) is included in the list of assets. Alternatively the gross value (before deducting provision) is taken in the list of assets and the provision should be included in the list of external liabilities. We can easily understand that the net effect of both the treatments will be same. But if the asset is revalued, its revalued amount only is included in the list of assets and the provision should not be considered at all. (1) If according to Articles of Association preference shares have priority only for capital.

Value of one equity share =𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑠𝑠𝑒𝑡𝑠 −𝑃𝑟𝑒𝑓 .𝑆𝑕𝑎𝑟𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

𝑇𝑜𝑡𝑎𝑙 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑒𝑞𝑢𝑡𝑖𝑦 𝑆𝑕𝑎𝑟𝑒𝑠

(2) On the above basis value of preference share can be calculated by the following formula:

Value of one pref. share = 𝑃𝑟𝑒𝑓 . 𝑆𝑕𝑎𝑟𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

𝑇𝑜𝑡𝑎𝑙 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑃𝑟𝑓 . 𝑆𝑕𝑎𝑟𝑒𝑠

(3) If according to Articles of Association of the company, preference shares have priority only for dividend, then

The formula is as follows:

Value of one share = =𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑛𝑒𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 −𝐷𝑖𝑣𝑖𝑑𝑛𝑒𝑑 𝑜𝑛 𝑃𝑟𝑒𝑓 .𝑆𝑕𝑎𝑟𝑒

𝑇𝑜𝑡𝑎𝑙 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑟𝑒𝑓 . 𝑎𝑛𝑑 𝑒𝑞𝑢𝑖𝑡𝑦 𝑆𝑕𝑎𝑟𝑒𝑠

(4) On the above condition if the value of preference share is to be found, then the following formula can be applied :

Value of pref. share = 𝑃𝑟𝑜𝑓 .𝑆𝑕𝑎𝑟𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 +𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑜𝑛 𝑃𝑟𝑓 . 𝑆𝑕𝑎𝑟𝑒𝑠

𝑇𝑜𝑡𝑎𝑙 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑟𝑒𝑓 . 𝑎𝑛𝑑 𝑒𝑞𝑢𝑖𝑡𝑦 𝑆𝑕𝑎𝑟𝑒𝑠

(5) If preference share have priority of payment capital and dividend, then the value of equity share can be calculated as follows:

Value of one equity share = 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑛𝑒𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 (𝑃𝑟𝑒𝑓 .𝑆𝑕𝑎𝑟𝑒 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 +𝐷𝑖𝑣𝑖 . 𝑜𝑛 𝑃𝑟𝑒𝑓 .𝑆𝑕𝑎𝑟𝑒

𝑇𝑜𝑡𝑎𝑙 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠𝑕𝑎𝑟𝑒

(6) If according to Articles of Association and Memorandum of Association of the company preference shares have no priority of payment of capital and dividend, which means both have equal rights then the value of one share can be calculated dividing the value of net assets by total number of equity and preference shares. In the form of formula:

Value of one share = 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑛𝑒𝑡 𝑎𝑠𝑠𝑒𝑡𝑠

𝑇𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑎𝑛𝑑 𝑝𝑟𝑒𝑓 .𝑠𝑕𝑎𝑟𝑒𝑠

Income or yield valuation method:-

(i) On the basis of dividend Rate:- Under this method the points of concentration is how much a company distributes as dividend to its shareholders and what the other company do. This can be explained by the following formula

Value per share = 𝐴𝑐𝑡𝑢𝑎𝑙 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑑𝑖𝑣𝑖𝑑𝑛𝑒𝑑

𝑁𝑜𝑟𝑚𝑎𝑙 𝑅𝑎𝑡𝑒 𝑜𝑓 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 × 𝑝𝑎𝑖𝑑 𝑢𝑝 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠𝑕𝑎𝑟𝑒

Actual Rate of dividend:- 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑

𝑇𝑜𝑡𝑎𝑙 𝑃𝑎𝑖𝑑 𝑢𝑝 𝑉𝑎𝑙𝑢𝑒× 100

If the different Rates of dividend of the previous years are given in the questions the average Rate of dividend will be taken as actual Rate of dividend if normal Rate is not given:-

Dividend Received × 100 / Market Value of Share (ii) On the basis of expected Rate of Return:-

Under their method we should consider the available Profit instead of profit distributed as dividend

Value per share = 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛

𝑁𝑜𝑟𝑚𝑎𝑙 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 × 𝑃𝑎𝑖𝑑 𝑢𝑝 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠𝑕𝑎𝑟𝑒

Expected Rate of Return = 𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑣𝑎𝑖𝑎𝑙𝑏𝑒 𝑓𝑜𝑟 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠𝑕𝑎𝑟𝑒 𝑕𝑜𝑙𝑑𝑒𝑟

𝑃𝑎𝑖𝑑 𝑢𝑝 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠𝑕𝑎𝑟𝑒 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 × 100

Profit available for equity share = N.P. – IT – Transfer to – Reserve – Pref. dividend (iii) On the basis of earning capacity:- This method adopted by those person or companies

who wants to buy a running business or acquire control over a running business.

Value per share = 𝐴𝑐𝑡𝑢𝑎𝑙 𝑅𝑎𝑡𝑒 𝑜𝑓 𝐸𝑎𝑟𝑛𝑖𝑛𝑔

𝑁𝑜𝑟𝑚𝑎𝑙 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 × 𝑝𝑎𝑖𝑑 𝑢𝑝 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠𝑕𝑎𝑟𝑒

Actual Rate of earning = 𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 ×100

𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑

Capital employed = Net Assets – Pre. Share Capital

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Or Capital employed = all assets – C.L. – debentures, Long term liabilities and pre. Capital Average capital: - Closing capital employed – half of current year profit As regard capitals employed, the instruction given in the question must be followed in the absence

of any instruction average capital employed should be considered. Fair value Method:- This is the average of the two values of a share as per net assets and the income

valuation method (earning capacity). This is calculated by the following formula.

Fair value:- 𝐼𝑛𝑡𝑒𝑟𝑖𝑛𝑠𝑖𝑐 𝑣𝑎𝑙𝑢𝑒 +𝑉𝑎𝑙𝑢 𝑒 𝑎𝑠 𝑝𝑒𝑟 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝑐𝑎𝑝𝑎𝑐𝑖𝑡𝑦

2

Right shares:- (1) The market value of one existing share

𝑁𝑒𝑤 𝑆𝑕𝑎𝑟𝑒

𝑇𝑜𝑡𝑎𝑙 𝑆𝑕𝑎𝑟𝑒× (𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑜𝑙𝑑 𝑠𝑕𝑎𝑟𝑒 − 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑛𝑒𝑤 𝑠𝑕𝑎𝑟𝑒𝑠)

Total share = New (Right Share + Old Share)

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Unit – III ACCOUNTING FOR AMALGAMATION OF COMPANIES

(i) Amalgamation : Amalgamation means an Amalgamation pursuant to the provisions of the

Companies Act 1956, or any other statute which may be applicable to companies, in which two or more companies amalgamation with each other and maintain their identity.

(ii) Transferor Company : Transferor company means the company which is amalgamated into another company. It was known as vendor company prior to this standard.

(i) Transferee Company : Transferee company mean the company into which a transferee company is amalgamated. It was know as purchase company prior to this standard.

TYPE OF AMALGAMATION

According to AS 14 there are two types of amalgamation : (1) Amalgamation in the nature of merger. (2) Amalgamation in the nature of purchase.

1. Amalgamation in the nature of merger : amalgamation in the nature of merger is an amalgamation which satisfies all the following five conditions : (i) All the assets and liabilities of the transferee company. (ii) Shareholders holding not less than 90% of the face value of the equity shares of the transferor

company become equity shareholders of the transferee company by virtue of the amalgamation, other than the equity shares already held therein, immediately before the amalgamation, by the transferee company or its subsidiaries or their nominees :

(iii) The consideration for the amalgamation receivable by those equity shareholders of the transferor company who agrees to become equity shareholders of the transferee company is discharged by the transferee company wholly by the issue of equity shares in the transferee company, except that cash may be paid in respect of any fractional share.

(iv) The business of the transferor company is intended to be carried on after the amalgamation, by the transferee company.

(v) 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 financial statements of the transferee company except to ensure uniformity of accounting policies.

2. Amalgamation in the nature of purchase : amalgamation in the nature of purchase is an amalgamation which does not satisfy any one or more of the conditions which have been discussed in amalgamation in the nature of merger.

Journal entries in the books of Transferee Company

as per pooling of interests method (Merger) Items Entries Dr. Cr. 1. For purchase consideration

Business Purchase A/c Dr. To Liquidator of transferor company Company (Being record of purchase consideration)

P.C.* P.C.*

2. For the transfer of assets and liabilities

Sundry assets A/c Dr. Fictitious assets A/c Dr. General reserve A/c Dr. To Sundry liabilities A/c To Sundry reserves A/c To Profit and loss a/c To Business Purchase A/c To General reserve A/c (Being Sundry Assets, Liabilities and

Balance sheet values

(Balancing fig.)

Balance sheet values** P.C.* (Bal. figure)

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reserves taken over from transferor company and balancing figure as General Reserve)

3. Payment of Purchase consideration

Liquidator of vendor Co. A/c Dr. Discount on issues of shares A/c Dr. To Equity share Capital A/c To Pref. Share capital a/c To Bank A/c (Being payment of purchase consideration)

P.C.*

Shares given by

transferee co.

4. Conversion of debentures

Debentures of Vendor Co. A/c Dr. To Debentures A/c (Being conversion of debentures)

B/S value **

B/S value **

5. Liquidation exps. (if paid by transferee

General Reserve A/c Dr. To Bank A/c (Being liquidation expenses of transferor company paid by transferee company)

Liqui. Exps. Liqui. Exps.

6. Preliminary exps. Of transferee Company

Preliminary expenses A/c Dr. To Bank A/c (Being preliminary expenses paid)

Preli. Exp. Preli. Exp.

Journal entries in the books of transferee company in case of purchase method

Items Particulars Dr. Cr. 1. For purchase consideration

Business purchase A/c Dr. To Liquidator of transferor Co. A/c (Being Business Purchases)

P.C.* P.C.*

2. For transfer of Assets & liabilities

Sundry Assets A/c Dr. Goodwill A/c Dr. To Sundry external liabilities A/c To Business Purchase a/c To Capital Reserve A/c (Being various assets and liabilities taken over and balancing figure debited to Goodwill A/c)

Agreed Values** Bal. figure

Agreed Values** P.C. (Bal. figure)

3. Payment of purchase price

Liquidator of transferor Co. A/c Dr. To Equity Share Capital A/c To Preference Share Capital A/c To Debentures A/c To Bank A/c (Being payment of purchase consideration)

P.C.** Issued shares Issued shares Issued deben. Cash Payment

4. Liquidation & preliminary exps.

Preliminary expenses A/c Dr. Goodwill A/c Dr. To Bank A/c (Being Payment of Preliminary Expenses and liquidation expenses paid)

Prel. Exps. Of transferee co. Liq. exps.of transferor co.

Paid amount

5. Conversion of Debenture

Debentures of Transferor Co. A/c Dr. To Debentures A/c (of Transferee Company)

Value of debenture Value of debentures

6. Statutory reserves Amalgamation Adjustment A/c Dr. Amount of Statu. Res.

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of transferor company To Various Statutory Reserves A/c (Being incorporation of statutory reserves of Transferor Company)

Amount of Statu. Res.

Journal entries in the books of Transferor Company

Either amalgamation in the nature of merger or in the nature of purchase, in both the cases the following journal entries in the books of Transferor company:-

Realisation A/c Dr. To Sundry Assets A/c (at Balance Sheet value) (Being sundry assets transferred to Realisation A/c) (2) Transfer of fictitious assets to equity shareholders A/c- Equity shareholders A/c Dr. To Discount on share and debentures a/c To Preliminary Expenses A/c (formation expenses) To Underwriting Commission A/c To Expenses on issue of share and debentures To Development expenses A/c To Profit and Loss A/c (Dr. balance) (Being fictitious assets accounts transferred to equity shareholders a/c) (3). Transfer of liabilities to realisation a/c Sundry liabilities A/c (at B/S value) Dr. To Realisation A/c (Being sundry liabilities accounts transferred to Realisation A/c) Note:- All the external liabilities, whether or not taken over by transferee company, are transferred to realisation account.) (4) Transfer of equity share capital, reserves, and credit balance of profit and loss account to equity shareholders a/c- Equity share capital A/c Dr. Sundry reserve and funds A/c Dr. Securities premium A/c Dr. To Equity shareholders A/c (Being transfer to equity shareholders A/c) (5) Purchase consideration- P.C. Transferee Company Dr. To Realisation A/c (Being Purchase consideration due) (6) On receipt of purchase consideration- Shares in Transferee Company A/c Dr. Debentures in Transferee Company Dr. Bank A/c Dr. To Transferee Company (Being Purchase consideration received) (7) In case of amalgamation in nature of purchase, the entry for the sale of the assets not taken over by the transferee company will be as under- Bank A/c Dr. To Realisation A/c (Being sale of assets) (8) In case of amalgamation in nature of purchase, the entry for the payment of external liabilities not taken over by the transferee company- Realisation A/c Dr. To Bank A/c (Being payment of liability)

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(9) Transfer of preference share capital account to preference shareholders account- Preference share Capital A/c Dr. To Preference Shareholders A/c (Being balance of Pref. Share capital transferred to Pref. Shareholders A/c) (10) On payment to preference shareholder- Preference shareholders A/c Dr. Realisation (Premium) A/c Dr. To Bank A/c To Realisation (discount) A/c (Being payment made to Pref. Shareholders) (11) Transfer of realisation profit to equity shareholders account- Realisation A/c Dr. To Equity Shareholder A/c (Being realisation profit transferred to equity shareholders A/c) (12) Transfer of realisation loss to equity shareholder account- Equity Shareholders A/c Dr. To Realisation A/c (Being realisation loss transferred to equity shareholders A/c) (13) On payment of liquidation expenses by transferor company- Realisation A/c Dr. To Bank A/c (Being liquidation expenses paid) (14) On payment to equity shareholders- Equity Shareholders A/c Dr. To Equity Shares in Transferee Company A/c To Debentures in Transferee Company A/c To Bank A/c (Being payment of equity shareholders)

Necessary Ledger accounts

Realisation A/c Step No.

Particulars Amount Step No.

Particulars Amount

1 To Sundry Assets A/c Book Values 2. By Sundry Liabilities A/c Book value 5. To Bank A/c 3. By Transferee Co. A/c 6. To Pref. Shareholder A/c 4. By Bank A/c 7. To Bank A/c 8. By Pref. Equity Shareholders A/c 8. To Equity Shareholders A/c 8. To Equity Shareholders A/c

Transferee Company 1. To Realisation A/c (Purchase consideration due)

2. By Equity Shares in transferee company By Pref. shares in transferee company By Debenture in transferee Company By Bank A/c

P.C

. received

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Preference Shareholders A/c 2 To Realisation A/c (Discount) 3 To Bank or pref. Share in transferee co. A/c

1.By Equity Shares Capital A/c 2. By Realisation A/c (Premium)

Equity Shareholders A/c

2 To Fictitious Assets A/c To Profit & Loss A/c (Loss) 3 To Realisation A/c (Loss) 4 To Equity shares in transferee company To Bank A/c To Debentures in transferee Co.

1 By Equity Share capital A/c 2 By General Reserve A/c By Profit and Loss A/c (Profit) 3 By Realisation A/c (Profit)

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Unit IV Holding Company (with one subsidiary company)

Holding Company 2(19) :- clause 4(4) of the said section defines a holding company as:- The company shall be deemed to be the holding company of another, it but only if that other is its subsidiary. Meaning of holding company can not be understood well without understanding the meaning of subsidiary company. Subsidiary Company:- Section 4

(i) Sub Company is that in which other comp. control the composition of its Board of direct (ii) More than half of total voting rights are under the control of another company. (iii) Another company holds more than half of the nominal value of its equity share capital (iv) It subsidiary company is a holding company o another subsidiary company the original

holding company is also holding company of that other subsidiary company. Preparation of consolidated Balance Sheet:- Through it is not compulsory under companies act it is preferable to give the balance sheet of both the companies in a consolidated form.

Procedure for preparing consolidated

Balance Sheet (i) Calculation of goodwill or capital reserve:- When the price paid by holding company is

more than the holding company share in sum of subsidiary company’s share capital reserve and surplus up to the date of purchase and P & L arising on revaluation of assets, the excess is capital loss and it is called goodwill as cost of control. If the position is Reverse that is the price paid is lower, than the difference is capital profit and it will be transferred to capital reserve A/c.

The goodwill or capital reserve is calculated as under- Share of holding company in share capital subsidiary company - + Share in pre acquisition profits - - Share in pre acquisition loss - + Share in pre acquisition reserve - + Share in revaluation profit on assets - - Share in revaluation loss on assets - - - Cost of Share (Purchase consideration) Ans. (+ ) Capital Reserve - Ans. (-) Goodwill - (2) Calculation of the amount of consolidated profit and loss account- Consolidated profit or loss means the amount which comes by adding the share of .holding company in the post acquisition profit of subsidiary company, to the balance in the profit and loss account of holding company. Consolidated profit or loss is calculated as under is-

Balance in the P & L A/c of holding company ……… + Share of holding company in the post acquisition

Profits of subsidiary company +………. - . Consolidate profit to be shown in balance sheet (3) Consolidated Reserves-This is calculated as under- Balance in the Reserve account of holding company .........

+ Share of holding company in the post acquisition

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Reserves of subsidiary company +…….. Consolidate reserve to be shown in balance sheet --------

(4) Calculation of minority Interest-The remaining shareholders in the subsidiary company are called minority shareholders and their share in the net assets of subsidiary company is called minority interest. This is calculated as under-

Share in equity share capital of subsidiary company — + Share in total profit of subsidiary company — - Share in total losses of subsidiary company — + Share in reserves of subsidiary company — + Share in revaluation profit on assets of subsidiary company — - Share in revaluation loss on assets of subsidiary company — - Share in fictitious assets written off —

Minority Interest — — (5) Inter company transaction-The transactions between holding company and

subsidiary company are called inter company transaction. In consolidated balance sheet these transactions are eliminated. Inter company transactions are as under-

(i) Bills receivable and Bills payable-The amount of mutual bills drawn on each other by holding and subsidiary company is deducted from the total amount of bills receivable and bills payable in the consolidated balance sheet. But the discounted bills receivable will be mentioned in consolidated balance sheet.

(ii) Debtors and creditors-The amount of common debtors and creditors between holding company and subsidiary company will be deducted from total debtors as well as from total creditors in consolidated balance sheet. (iii) Unpaid dividend-The dividend receivable from subsidiary company by the holding company is mentioned in the assets side of holding company and in liability side of subsidiary company. This is eliminated in consolidated balance sheet. Only the dividend payable to minorities will be shown in the liability side of the consolidated balance sheet.

(iv) Proposed dividend-When a subsidiary company proposes dividend, it is debited to profit and loss account and mentioned in the liabilities side of subsidiary company. But the holding company does not show this in its balance sheet. At the time of making consolidated balance sheet this amount is added to profit & loss account. The portion of proposed dividend related to minority shareholders is either shown separately or added to the minority interest in consolidated balance sheet.

(v) Inter-company debentures-When holding and subsidiary company have bought the debentures in each other, these are called mutual debentures. The aggregate amount of mutual debentures is deducted from total debentures in the liability side as well as total investments in the assets side of consolidated balance sheet.

(vi) Loans and advances-If there is mutual borrowings these are also eliminated in consolidated balance sheet.

(vii) Unrealised profits and stock reserve-There are frequent purchase and sale transactions between holding and subsidiary company. The portion of the mutual purchase which is unsold at the end of year includes profits charged by the selling company. This is called unrealised profit. The holding company's share is unrealised profit is called stock reserve. This amount of stock reserve is deducted from the total stock of both the companies on the assets side and amount of consolidated profit and loss account on the liabilities side in consolidated balance sheet.

(6) Goodwill already appearing in balance sheet-If goodwill appears in the balance sheets of both the companies this is also aggregated in consolidated balance sheet. If capital reserve arises as a result of acquisition of shares it is deducted from goodwill in consolidated balance sheet and if goodwill arises it is added to the goodwill in consolidated balance sheet.

(7) Preference shares-If none of the preference shares in subsidiary company is purchased by holding company, the total amount of preference shares is added to the minority interest. If the holding company has purchased the preference shares also in subsidiary company, it is used only for the

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calculation of goodwill or capital reserve and not used for the distribution of profit between the two companies. For this purpose the ratio of equity shares only between holding company and minority interest is used.

(8) Interim dividend-If a subsidiary company has paid any interim dividend it will be out of pre or post acquisition profit. If it is out of pre-acquisition profits it will be deducted from pre-acquisition profits. So the cost of acquisition of shares will be reduced. Now the goodwill or capital reserve will be calculated. If interim dividend is paid out of post-acquisition profits it is deducted there from and the remaining post acquisition profit will be divided in holding company and minority shareholders. The holding company will add its portion in interim dividend to its profits in the balance sheet.

(9) Issue of Bonus Shares-If Bonus shares are issued after the acquisition of shares by holding company in subsidiary company, it will increase the number of shares held by holding company and minorities. But the ratio of holding between them will not be changed. It is important to note that whether the Bonus shares are issued out of pre or post acquisition profits, the treatment in both the cases will be as under- (i) Issue of Bonus shares out of pre acquisition profits- In this case the amount of goodwill or

capital reserve on the acquisition will not be changes because the prior profit is converted into capital.

(ii) Issue of Bonus share out of post acquisition profits- In such a case the goodwill or capital reserve will be affected because the revenue profit (Post acquisition profits) is converted in a capital profit(i.e. share capital) If the issue of bonus shares is not accounted for in the books of subsidiary company the calculation of capital reserve or goodwill should be made after the issue of bonus share. The value of goods will reduced because of increase in the paid up value of share capital. (10) Revaluation of assets of subsidiary company- To calculate the amount of goodwill or

capital reserve arising due to the acquisition of shares by holding company in subsidiary company, it is necessary to revalue the assets of the subsidiary company on the date of acquisition of shares. The effect of revaluation will be as follows-

(i) The profit on revaluation is added and loss on revaluation is deducted for the calculation of goodwill or capital reserve.

(ii) The assets are mentioned at revalued figures in balance sheet. (iii) Additional depreciation must be charged on asset in case of profit on revaluation and

excess depreciation must be written back in case of loss on revolution.

PROFIT OR LOSS PRIOR TO I OF SUBSEQUENT TO INCORPORATION A Company acquires the right to enter into the contract only after it receives the certificate of incorporation. The promoters perform certain works before the incorporation of the company. Some new companies come into existence only for purchasing certain running businesses, but these companies cannot wait for purchase of business till the date of incorporation. There are many reasons for it and one of the main reason is the payment of purchase consideration. Determination of purchase consideration becomes much easier when the vendor prepares his Balance Sheet because the assets and liabilities are currently valued at that time. This is the reason why an incorporated company generally purchases the continuing business of other company at the end of the financial year and received the certificate of incorporation from the registrar after few days. However, the business of vendor company continues from the date of purchase upto the date of incorporation of the company; if profit is made during this period, it is called profit prior to incorporation, if loss is made during this period, it is called loss prior to incorporation. Purchased business also continues after incorporation hence the profit or loss made from the date of incorporation upto the date of closing of accounts at the end of the first financial year is known as profit or loss subsequent to incorporation. The above discussion no doubt is academic but in fact in the absence of contrary information, profit to prior or subsequent to incorporation in both private and public companies means the profit prior to or subsequent to incorporation and not to commencement of business.