Apart from the inter-company indebtedness, we may also come across inter-company investments in shares or debentures.
This situation is studied in the following situations:-
1. Shares may be held by the Transferee (Purchasing) company in the Transferor (Selling) company, or
2. Shares may be held by the Transferor (Selling) company in the Transferee (Purchasing) company, or
3. Shares may be held by both companies in each other. (Cross Holdings)
When the purchasing company holds shares in the vendor company, the purchasing company is required to pay only that portion of the total purchase consideration which is payable to outside shareholders. For instance, if purchasing company holds 25% shares in the vendor company and the total amount payable as purchase consideration is Rs 2,00,000, the purchasing company will have to pay 75% of Rs 2,00,000 only i.e., Rs 1,50,000. This is because the absorbing company buys only the net assets, belonging to outside shareholders; they are the owners of the vendor company to the extent of 25% of the shares for which they need not pay anything.
Treatment in the Books of Vendor Company:
Debit the purchasing Company Account and credit Realisation Account with the full amount of purchase consideration. When the purchase consideration (amount payable to outside shareholders) is received, debit Cash, Shares or Debentures Account, as the case may be and credit the Purchasing Company Account.
Shareholders Account is debited with the cash, shares or debentures etc. Now the balance in the Purchasing Company Account represents the amount receivable by the Vendor Company from Purchasing Company; and the balance of Shareholders Account represents the amount payable to Purchasing Company because of their holding in Vendor Company. Carefully note that the debit balance of Purchasing Company is equal to credit balance of shareholders Account: and this amount is neither receivable by Vendor Company nor payable by Purchasing Company. Therefore, the two Accounts will be set off by debiting Shareholders Account and crediting Purchasing Company Account.
Alternatively, the Selling Company debit the Purchasing Company with the purchase consideration for outside shareholders and credit the Realisation Account. The paid up value of the shares held by the Purchasing Company is credited to the Realisation Account by debiting the Share Capital/Shareholders Account. This is because the Vendor need not pay towards the amount of share capital, which is held by the Purchasing Company.
Treatment in the Books of Purchasing Company:
Credit the liquidator of Vendor Company with the full amount of purchase consideration and debit in the Business Purchase Account. On payment of purchase consideration for outside shareholders, debit the liquidator of Vendor Company and credit cash, shares or debentures account.
Now the balance in the liquidator of Vendor Company represents amount not payable which is set off against the Investment Account (in shares in Vendor Company). Any balance in the Shares in Vendor Company Account will be transferred to Goodwill Account or Capital Reserve Account.
Illustration 1 (Inter-Company Owings):
The following is the Balance Sheet of Selling Company as on 31st December 2006:
The debentures held by Purchasing Company Ltd. who also hold 20,000 shares acquired during the past two years at a total cost of Rs 1, 45,000.
Negotiations between the two Companies resulted in an agreement for absorption of selling company upon the following terms:
1. That Selling Company takes over the assets and liabilities of Selling Company as at 31st December at their book figures, subject to revaluation of the Plant and Machinery at Rs 4, 50,000.
2. That the amount due in respect of Debentures be set off against the purchase consideration and that they be cancelled on the completion of the transactions.
3. That the outside shareholders in Selling Company be given Rs 10 shares issued at par by Purchasing Company on the basis of such shares being worth Rs 15 each and the shares in Selling Company being worth Rs 5 each.
The arrangement was approved by the necessary resolution of the shareholders in Selling Company.
Show journal entries required to close the books of Selling Company and to record the transaction in the books of Purchasing Company including the transfers required to close the accounts therein relating to the shares and debentures in Selling Company.
If the selling company already holds shares of the purchasing company, these shares cannot be taken over with other assets, but they will remain in the hands of the liquidator, as a company cannot purchase its own shares.
In other words, investments of the Company representing shares in purchasing company must not be taken over by the purchasing company as it is illegal on the part of a company to purchase its own shares.
If the purchase consideration is determined on the basis of net assets taken over, investment account representing shares in purchasing company in calculating net assets. The shares in hand plus new shares are distributed to shareholders.
If the purchase consideration is calculated on the basis of net payment method, deduct the number of shares already held by the vendor company from the shares agreed to be issued. When the books of the vendor company is closed, the investment account representing shares already held in purchasing company should not be transferred to Realisation Account.
The new shares received as purchase consideration will be debited to this investment. At the same time, the existing shares held are revalued and brought to the same values at which the new shares have been issued. The profit or loss on such revaluation is transferred to Realisation Account or Shareholders Account.
Illustration 2 (Inter-Company Owings):
The following is the Balance Sheet of A Limited as at 31st December 2006.
The Company is absorbed by B Ltd. on 1st January 2007. For this purpose the fixed assets are valued at Rs 25,000 and the current assets at Rs 28,000. The purchase consideration is discharged by the issue of shares of Rs 10 each in B Ltd. at an agreed value of Rs 12 per share.
You are required to close the books of A Ltd.
There may also be cases of cross-holdings. That is purchasing company having shares of selling company and selling company also having shares in purchasing company in their investments. In case of such cross holding the purchase consideration is to be calculated on the basis of net asset method or intrinsic value.
Under net payment method, calculate the number of shares to be issued to outside shareholders in the absorbed company plus calculate the number of shares due to purchasing company. This step gives us the total number of shares to be issued. From this total, deduct the number of shares already held by the absorbed company. This gives us the number of shares. This number of shares is multiplied with the issue price to get purchase consideration.
Under net asset method, the calculation involves algebraic process because the value of net assets of each company is influenced by the value of net assets of other.
This will be clear from the following illustrations:
Illustration 3 (Cross-Holdings):
Following are the Balance Sheets of X Ltd. and Y Ltd.
Y Limited is absorbed by X Ltd. X Ltd. issue two shares of Rs 10 each at a premium of Rs 2 per share for every one share of Y Ltd. Pass necessary journal entries in the books of X Ltd. and open necessary accounts in the books of Y Ltd.
The value of existing shares = 2,500/200 = Rs 12.50 but the present value is at Rs 12.00 per share. Therefore, there is a loss of Rs 200 x 0.50 = Rs 100.