Accounting Treatment and Disclosure of Debit Balance of Capital Reserve arising on Merger
Facts of the case:
A public limited company (applying Ind AS) engaged in manufacturing of steel tubes and pipes, decided to merge its wholly owned subsidiary, S Ltd., and its step-down subsidiary, T Ltd., effective from April 1, 2021. Both S Ltd. and T Ltd. were acquired subsidiaries. The company has recorded goodwill of Rs. 23 crores for S Ltd. and Rs. 114 crores for T Ltd., totaling Rs. 137 crores in the consolidated financial statement prior to the merger.
Query posed before EAC:
Should the pre-merger consolidated goodwill of Rs. 137 crores remain in the post-merger standalone and consolidated financial statement, with only the balance amount of Rs. 145 crores (generated on merger of S Ltd. And T Ltd.) shown as debit balance of capital reserve? or
Should the entire amount of Rs. 282 crores be shown as a debit balance of capital reserve?
Company’s Contention:
The management is of the view that difference between consideration/ investment and net assets aggregating Rs. 282 crores should be shown as debit balance in negative side of capital reserve, citing guidance from Paragraph 12 of Appendix C of Ind AS 103, and Question 45 of Educational Material on Ind AS 103 issued by former Ind As implementation group under AS Board of ICAI.
EAC Response:
Referring to paragraphs 8-12 of Appendix C of Ind AS 103, ‘Business Combinations,’ EAC stated that Business Combinations Under Common Control (BCUCC) should be accounted for using the ‘pooling of interests’ method. This involves reflecting the assets and liabilities of the combining entities at their carrying amounts, with anydifference between amount recorded as share capital issued plus additional consideration and the amount of transferor’s share capital transferred to capital reserve, presented separately, and disclosed in the notes regarding its nature and purpose.
The Committee noted that in paragraph 2 of the Appendix C, ‘transferor’ and ‘transferee’ are defined separately. Further, Paragraph 11 of Appendix C does not require recognition of balance of retained earnings in consolidated financial statements. Following paragraphs 11 and 12, the EAC emphasized preserving the identity of reserves in the transferee’s financial statements in the same form as they appeared in the transferor’s financial statements.
Paragraph 9 (ii) of the Appendix implies that adjustments to assets and liabilities should only be made to align accounting policies. Thus, it suggests recognizing amounts from separate financial statements rather than consolidated financial statements. Carrying values from the subsidiary’s separate financial statements should be used. If no goodwill is recognized in their pre-merger financial statements, it shouldn’t be recognized in the post-merger financial statements of the Company.
According to the Educational Material on Ind AS 103 and Issue 2 of ITFG Bulletin 9, the Committee notes that the merger of a subsidiary at the consolidated group level doesn’t entail a substantive change. The assets, liabilities, and reserves of the subsidiary previously in the consolidated financial statements will now be part of the parent company’s separate financial statements. Thus, it may be appropriate to recognize these values from the pre-merger consolidated financial statements of the parent company in the post-merger financial statements, as per Question 43 of the Education Material on Ind AS 103.
Conclusion:
Goodwill pertaining to the business represented by the wholly owned subsidiary and step-down subsidiary as appearing in the pre-merger consolidated financial statement should continue to be recognized in the post-merger financial statement of the company.
The treatment accorded by the company to not recognize goodwill appearing in the pre-merger consolidated financial statements of the company in the post-merger financial statement of the company is also correct.
SW Point of view: Accounting treatment for common control business combination is complex, lacking clear guidance from IFRS. However now the EAC suggest both approaches to accounting are acceptable, this will lead to diversity in accounting practice.
