Practice Questions: Amalgamation of Firms

(b) Answer in one sentence each: (5)

1. In which ratio is the profit on realisation shared?
2. Where does the general reserve of an old firm go?
3. What arises where the net assets taken over exceed the purchase consideration?
4. At what values do assets enter the realisation account?
5. What check proves that an old firm's working is correct?

---

Answers

Answer 1

Step one: the goodwill.

Cash is absent from both columns, because neither firm's cash was taken over.

Step two: the realisation accounts.

In the books of X & Co

Two things to notice. The bank loan is credited to realisation as a liability transferred and then debited when it is paid out of cash, so it nets to nil and the profit is unaffected. And the cash never enters as an asset transferred, because it was not transferred.

In the books of Y & Co

Step three: the partners' capital accounts.

X & Co, reserves and realisation profit in 3:2

P plus Q is Rs 3,10,000, the consideration for X & Co, so both are closed by a debit "To Capital in XY & Co" of those amounts. X & Co's cash went entirely on the bank loan, so nothing is paid to the partners.

Y & Co, reserves and realisation profit equally

Here the total is Rs 2,40,000 against a consideration of Rs 2,30,000, and the difference of Rs 10,000 is exactly the cash that was not taken over. Each partner receives Rs 5,000 in cash and the balance as capital in the new firm:

Step four: the balance sheet.

Balance Sheet of XY & Co as at 1 April 2027

There is no cash, because neither firm's cash was taken over. A candidate who has cash on this balance sheet has taken over something the question expressly kept back.

Answer 2

(a) The five conditions are that all the assets and liabilities of the transferor pass to the transferee; that holders of not less than 90 per cent of the face value of the equity shares of the transferor become equity shareholders of the transferee; that their consideration is discharged wholly by the issue of equity shares, apart from cash for fractions; that the business is intended to be carried on; and that no adjustment is made to book values except to make accounting policies uniform. They are cumulative: failing any one makes it an amalgamation in the nature of purchase.

Applied to firms, the second and third cannot be satisfied as written, because a firm has neither shares nor shareholders. They are read as requiring that all or substantially all the partners of the old firms become partners of the new firm, and that their consideration is credited to them as capital in the new firm rather than paid out. Say in the answer that you are translating, and add that AS 14 states of itself that it is directed principally to companies, so it supplies the vocabulary and the test but does not govern the transaction.

(b) The purchase method applies. Condition (v) has failed, because the book values were adjusted, and the conditions are cumulative; the fact that everything and everybody came across does not save it. Revaluation alone makes it a purchase.

The difference to the balance sheet is that the buildings appear Rs 50,000 higher, and the new firm's total is correspondingly larger. Because the partners were credited with capital equal to their old capitals rather than with the higher net assets, the consideration falls short of the net assets by Rs 50,000 and a capital reserve of that amount arises on the liabilities side.

The difference to later profits is that depreciation is charged on the higher figure, so reported profit is lower for as long as the buildings are held. Under pooling the same buildings would have carried their old value and a lower charge. The choice of method is therefore not presentational; it changes reported profit for years.

Answer 3

(a) Short notes

1. Purchase consideration and its two methods. It is the aggregate of everything the new firm gives to the partners of the old firm, in capital, cash or other assets. Under the net assets method it is the agreed value of the assets taken over less the agreed value of the liabilities taken over, counting only what actually passes and never deducting the partners' own capitals or reserves. Under the net payment method it is the capital credited plus the cash and anything else given to the partners, ignoring the individual asset values. The question's data decide which applies; where both can be computed, the excess of the payment over the net assets is goodwill and the shortfall a capital reserve.

2. Treatment of goodwill. It arises only under the purchase method, as the excess of the consideration over the net assets taken over, computed firm by firm. It may be retained, written down to a stated figure, or written off entirely, and the default is to retain it. Where it is written off, the partners' capital accounts are debited in the new profit-sharing ratio. Because it reached them through their old firms in the old ratio, the write-off transfers value between the partners, the gains and losses summing to nil.

3. The realisation account. It is opened in each old firm's own books to close that firm. It is debited with every asset transferred at book value, with cash paid on any liability not taken over, and with realisation expenses the firm bears; it is credited with the liabilities transferred at book value, with the purchase consideration, and with the proceeds of any asset sold. The partners' capitals, the reserves and the new firm's goodwill never enter it. The balancing figure is the profit or loss on realisation, shared in the old ratio.

(b) Answers in one sentence

1. In the old profit-sharing ratio, because it was earned by the old firm before the new one existed.

2. Straight to the partners' capital accounts in the old ratio; it never enters the realisation account.

3. A capital reserve, the new firm having acquired more than it gave.

4. At their book values in the old firm's balance sheet, the agreed values belonging to the new firm's books.

5. That the partners' closing capital balances added together equal the purchase consideration, adjusted for anything settled in cash.

Marking yourself