A merger is a strategic decision in the business world where two or more companies combine to form a new entity. Unlike an acquisition, where one company overtakes another, in a merger, all participating entities typically have similar standing and agree to combine as equals.
Examples of Mergers
- Exxon and Mobil (1999): The merger between Exxon and Mobil was one of the largest in history, creating ExxonMobil.
- Glaxo Wellcome and SmithKline Beecham (2000): This merger led to the formation of GlaxoSmithKline, one of the world’s largest pharmaceutical companies.
- United Airlines and Continental Airlines (2010): Combined to form United Continental Holdings, increasing market share and operational scale.
Frequently Asked Questions (FAQs)
What is the primary feature of a merger?
A merger primarily involves the creation of a new business entity where all merging parties combine on relatively equal footing with none obtaining control over the others.
How does a merger differ from an acquisition?
In a merger, two companies combine as equals to form a new company, whereas in an acquisition, one company takes over another, and the acquirer usually retains control.
What are the criteria for identifying a merger according to Financial Reporting Standard 6?
According to the now-discontinued Financial Reporting Standard 6:
- No party should be the acquirer or acquired.
- All parties must participate in establishing the management structure.
- Entities should be relatively equal in size.
- The consideration received by shareholders primarily consists of equity shares in the new entity.
Are mergers common in the contemporary business environment?
True mergers are quite rare today. Many so-called mergers are, in fact, acquisitions in disguise.
Why has merger accounting been limited in contemporary business practice?
Merger accounting has been limited due to its abuse. It’s now mainly restricted to internal reconstructions within existing groups to prevent exploitation.
Related Terms with Definitions
- Acquisition: The process of one company purchasing most or all of another company’s shares to gain control.
- Consolidation: The process of combining the assets, liabilities, and other items of two companies into a single entity.
- Equity Shares: Shares representing ownership interest in a company, entitling the holder to dividends and voting rights.
- Takeover: The acquisition of one company by another.
Online References
Suggested Books for Further Studies
- Mergers and Acquisitions from A to Z by Andrew J. Sherman – An insightful guide into the process and strategies involved in mergers and acquisitions.
- The Art of M&A: A Merger Acquisition Buyout Guide by Stanley Foster Reed and Alexander Reed Lajoux – This book provides a comprehensive look at the practices in the M&A field.
- Mergers, Acquisitions, and Corporate Restructurings by Patrick A. Gaughan – An analytical approach to understanding M&As and restructurings in business.
Accounting Basics: “Merger” Fundamentals Quiz
### What is the key distinguishing feature of a merger?
- [ ] One company overtakes another.
- [x] Two companies form a new entity on equal footing.
- [ ] One company becomes a subsidiary of the other.
- [ ] None of the above.
> **Explanation:** The defining feature of a merger is that two entities combine to form a new entity on an equal footing, with no one party having control over the other.
### Under Financial Reporting Standard 6, what is received by the equity shareholders of each merging party?
- [ ] Cash consideration primarily
- [x] Equity shares in the combined entity primarily
- [ ] Bonds primarily
- [ ] Real estate primarily
> **Explanation:** The equity shareholders of each merging party primarily receive equity shares in the new combined entity as consideration.
### Which of the following is accurate about true mergers in the modern business environment?
- [ ] They are very common.
- [x] They are quite rare.
- [ ] They are exactly the same as acquisitions.
- [ ] They don't exist anymore.
> **Explanation:** True mergers, where both parties combine as equals, are rare in the modern business environment as many mergers are, in reality, acquisitions in disguise.
### What is the main reason merger accounting has been limited?
- [ ] It is too complicated
- [ ] It provides no tax benefits
- [x] It has been widely abused
- [ ] It is not recognized internationally
> **Explanation:** Merger accounting has been limited due to its widespread abuse in practice, and it is now mainly restricted to internal reconstructions within existing groups.
### Which statement is true regarding the management structure in a merger?
- [ ] The acquirer usually controls the new management.
- [ ] Only one company's management remains in place.
- [x] All parties participate in establishing the new management structure.
- [ ] A third-party management team is brought in.
> **Explanation:** All merging entities participate in establishing the new management structure as per the criteria for a true merger.
### Which term is closely related to the concept of merger where one company takes over another?
- [ ] Spin-off
- [ ] Consolidation
- [x] Acquisition
- [ ] Divestiture
> **Explanation:** An acquisition is closely related where one company takes over another, often seen as a key distinction from a merger which combines entities on equal footing.
### In terms of size of the combining entities, what is required for a true merger?
- [ ] One entity must be significantly larger than the other.
- [ ] Both entities must be unrelated in size.
- [x] Combining entities must be relatively equal in size.
- [ ] Size does not matter at all.
> **Explanation:** For a true merger, the combining entities must be relatively equal in size according to the identifying criteria.
### How would you classify an economic activity where combining entities form a new entity but operate under parent companies' dominance?
- [ ] Joint Venture
- [x] Consolidation
- [ ] Mergers
- [ ] Spin-off
> **Explanation:** Such economic activities align with the concept of a consolidation where entities form a new entity but may still retain dominance from parent companies.
### What is a common misconception about most business combinations labeled as mergers?
- [ ] They are always equally beneficial to both parties
- [ ] They create more competition
- [x] They might be acquisitions in reality
- [ ] They need government support
> **Explanation:** Often, combinations labeled as mergers can be acquisitions in reality where one company dominates the combination, despite the label suggesting equality.
### Why might merging entities seek equity shares in the new entity instead of cash?
- [x] To ensure shared ownership and control
- [ ] To avoid taxes
- [ ] Because cash is unavailable
- [ ] For branding purposes
> **Explanation:** Equity shares ensure shared ownership in the new combined entity, aligning interests of merging parties, and maintaining a balance of control without one party dominating.
Thank you for embarking on this journey through our comprehensive accounting lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!
