Mergers Acquisition
Mergers and acquisitions involve complex accounting treatment a merger, defined as amalgamation in India, involves the absorption of the target company by the acquiring company which results in the uniting of the interests of the two companies the merger should be structured as pooling of interest. In the case of acquisition, where the acquiring company purchases the shares of the target company, the acquisition should be structured as a purchase.
Pooling of interests method
In the pooling of interest method of accounting the balance sheet items and the profit and loss items of the merged firms are combined without recording the effects of merger. This implies that asset, liabilities and other items of the acquiring and the acquired firms are simply added at the book values without making any adjustments. Thus there is no revaluation of assets or creation of goodwill.
Purchase method
Under the purchase method, the assets and liabilities of the acquiring firm after the acquisition of the target firm may be stated at their exiting carrying amounts or at the amounts adjusted for the purchases price paid to the target company. The assets and liabilities after merger are generally revalued under the purchase method. If the acquirer pays a price greater than the fair market value of assets and liabilities, the excess amount is shown as goodwill in the acquiring company’s books.
Leveraged buy-outs
A leveraged buy-out (LBO) is an acquisition of a company n which the acquisition is substantially financed through debt when the managers buy their company from its owners employing debt, the leveraged buy-out is called management buy-out (MBO). Debt typically forms 70-90 per cent of the purchase price and it may have a low credit rating. In the USA, the LBO shares are not bought and sold in the stock market, and the equity is concentrated in the hands of a few investors. Debt is obtained on the basis of the company’s future earnings potential; LBOs generally involve payment by cash to the seller.
LBO are very popular in the USA. It has been found there that in LBOs, the sellers require very high premium, ranging from 50 to 100 per cent, and the main motivation in LBOs is to increase wealth rapidly in a short span of time. A buyer would typically go public after four or five years, and make substantial capital gains.