Absorption of Company

Absorption of Company is a way of business arrangement in which an existing company takes over the business of the another entity. The entity who gets absorbed goes into the liquidation process. The payment for such absorption to the old entity can be made either in cash or in shares or mixture of both. 

The absorbed company continue to run operations as it was doing before the absorption and staff continue to work under the new management. If any type of fund is being maintained for the employees of the company, it is taken over by the purchasing company. 

There are so many reasons of absorption. One of them is that due to the formation of the new company, it will not get the reputation in the market as the old one. So, that is why, purchasing company absorbs an existing company to using its strength to exploit the opportunities exists in the market.

Example

The balance sheet of Alpha on 31st Dec, 2011 is as follows:

Total assets $1,000,000
Share capital $100 each) 600,000
Profit & Loss account 240,000
Creditors 160,000
   

After detailed discussion, it was decided that the Alpha should be absorbed into Beta . In order to complete the process of absorption, Beta will issue 4 shares of $100 each for three shares held in the Alpha. All liabilities and assets were taken over by the Beta at the book value.

Required:

Pass journal entries in the books of 

a. Alpha, B. Beta

Solution

   
Shares in Beta (8,000 x 100) $800,000
   
If 03 old shares, so new shares = 4  
If 01 old shares, so new shares = 4/3  
If 6,000 old shares, so new shares = 4/3 x 6,000 = 8,000 shares  

 

Alpha Company

Closing Entries

Description Debit Credit
Realization account 1,000,000   
   All assets   1,000,000 
     
Creditors  160,000  
   Realization account   160,000 
     
Receivable from Beta  800,000  
   Realization account   800,000 
     
Shares in Beta  800,000  
   Receivable from Beta   800,000 
     
Share capital 600,000   
Profit & Loss account 240,000   
   Realization account   40,000 
   Shareholders   800,000 
     
Shareholders 800,000   
   Shares in Beta   800,000 

 

 Beta Company

Journal Entries

Description Debit Credit
All assets 1,000,000  
   Capital reserve   40,000
   Creditors   160,000
   Payable to Alpha   800,000
     
Payable to Alpha 800,000  
   Share capital   800,000

Example

The following balance appeared in the balance sheet of YKT as on 30 June 2013:

Assets

Equities

Cash

20,000

Accounts payable

20,000

Accounts receivables

60,000

Bonds payable

100,000

Inventory

160,000

Ordinary Share capital $10 each

600,000

Land & building

240,000

Reserves – general

160,000

Plant & machinery

400,000

Retained earnings

120,000

Goodwill

120,000

   

Total

1,000,000

Total

1,000,000

YKT is absorbed by another company DS on the terms and conditions given below:

  1. Accounts payable is to be cleared by YKT.
  2. All assets will be taken at book values except cash.
  3. The purchase consideration for the absorption deal is as follows:
  4. A cash payment of $ 4 for every share of YKT.
  5. The issue of one share of $ 10 each in DS for every share held in YKT. (The market value of the share is $ 12.5).
  6. 1100 Bonds will be issued at $ 100 each in DS to enable the YKT in discharging its bonds at a premium of 10 %.

Required

  1. Compute the value of purchase consideration.
  2. Pass on necessary entries in the books of YKT and DS.

Solution

Purchase consideration

Shares in DS (60,000 X 12.5) 750,000

Bonds in DS Company (1100 x 100) 110,000

Payment in cash (60,000 x 4) 240,000

Purchase consideration 1100,000

YKT

Journal Entries – For Closing

Description

Debit

Credit

To close all asset accounts, following entry is passed on:

   

Realization account

980,000

 

Accounts receivables

 

60,000

Inventories

 

160,000

Plant & machinery

 

400,000

Land & building

 

240,000

Good will

 

120,000

     

To record the payments of accounts payable, we will pass on this entry:

   

Accounts payable

40,000

 

Cash

 

40,000

     

Now, we will record purchase consideration:

   

Receivable from DS

1100,000

 

Realization account

 

1100,000

     

To record amount received from DS, we will pass this entry:

   

Shares in DS

750,000

 

Cash

240,000

 

10% bonds in DS

110,000

 

Receivable from DS

 

1100,000

     

To record interest on bonds, the following entry is passed on:

   

Realization account

10,000

 

Interest on bonds

 

10,000

     

To record close of bond with interest over it:

   

Interest on bonds

100,000

 

Bonds payable

10,000

 

Bondholders

 

110,000

     

To record distribution of bonds to bondholders

   

Bondholders

110,000

 

10% bonds in DS

 

110,000

     

To record transfer of equities to shareholders

   

Share capital

600,000

 

Retained earnings

120,000

 

General reserve

160,000

 

Realization account

110,000

 

Shareholders

 

990,000

     

To record distribution of cash & shares to shareholders:

   

Shareholders

990,000

 

Cash

 

750,000

Shares in DS

 

240,000

 

DS Company

Journal Entries

Description

Debit

Credit

To record the taking over of the assets of YKT:

   

Accounts receivable

980,000

 

Inventories

 

60,000

Land & building

 

160,000

Plant & machinery

 

400,000

Goodwill

 

240,000

Payable to YKT

 

120,000

     

To record issue of shares, bond and cash payment:

   

Payable to YKT

1100,000

 

Share capital

 

750,000

10% bond payable

 

240,000

Cash

 

110,000