What is Merger Accounting?
Merger accounting is a method of accounting that treats two or more businesses as combining on an equal footing. It is typically applied without any restatement of net assets to their fair value and includes the results of each of the combined entities for the entire accounting period as if they had always been combined. In this method, the issue of shares is not viewed as an application of resources at their fair value. The resulting difference on consolidation is not considered goodwill but is deducted from, or added to, reserves.
In the past, merger accounting was often used to avoid recognizing goodwill in combinations that were fundamentally takeovers rather than true mergers. However, current accounting standards like the Financial Reporting Standard applicable in the UK and Republic of Ireland permit merger accounting only in cases of group reconstruction. Conversely, the International Financial Reporting Standard (IFRS) 3, Business Combinations, prohibits merger accounting for all business combinations within its scope.
Examples of Merger Accounting
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Group Restructuring within a Conglomerate: When a conglomerate restructures and combines its subsidiaries under a single umbrella, it might use merger accounting to present the financials of the subsidiaries as if they were always part of the consolidated group.
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Non-Profit Organizations: When two non-profit organizations with similar missions merge to form a single entity, merger accounting might be preferred to present a unified financial picture without the complexities of fair value adjustments.
Frequently Asked Questions (FAQs)
What is the main difference between merger accounting and acquisition accounting?
Merger accounting treats the merging entities as combining on equal terms without revaluing net assets, while acquisition accounting involves revaluing the acquired entity’s net assets to fair value and possibly recognizing goodwill.
Why is merger accounting not commonly used under IFRS?
IFRS 3, Business Combinations, prohibits merger accounting for all business combinations within its scope, advocating for acquisition accounting instead to provide more transparent reporting.
When is merger accounting still applicable?
Merger accounting is applicable in scenarios of group reconstruction where the financial interests of shareholders in the combining entities are substantially unchanged.
What happens to goodwill in merger accounting?
In merger accounting, any difference arising on consolidation does not represent goodwill but is adjusted against reserves.
Why was merger accounting historically used in takeovers?
Merger accounting was used in takeovers to avoid recognizing goodwill, thus potentially enhancing the perceived value of the combined entity.
Related Terms
- Acquisition Accounting: An accounting method that involves revaluing the acquired entity’s net assets to fair value and potentially recognizing goodwill.
- Goodwill: An intangible asset that represents the excess of purchase price over the fair value of an acquired company’s net identifiable assets.
- Net Assets: Total assets minus total liabilities, representing the equity value of a company.
- Financial Reporting Standard: Standards issued to ensure consistent financial reporting across organizations.
- Consolidation: The process of combining the financial statements of multiple entities into one.
Online References
- IFRS 3 - Business Combinations
- Financial Reporting Standard applicable in the UK and Republic of Ireland
Suggested Books for Further Studies
- “International Financial Reporting Standards (IFRS) Explained” by BPP Learning Media
- “Advanced Accounting” by Patrick Hopkins and D. Michael Stewart
- “Financial Accounting: An Introduction to Concepts, Methods and Uses” by Roman L. Weil, Katherine Schipper, and Jennifer Francis
Accounting Basics: “Merger Accounting” Fundamentals Quiz
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