Mergers of Trading Companies Under the Accounting Act Part 1

Leszek WOZIŃSKI
Audit Manager at RSM Poland

Trading companies with similar business profiles often decide to merge in order to grow faster. Mergers are used as a solution to enhance the effectiveness of companies and reduce operating costs, thus achieving synergies.

Apart from the Code of Commercial Companies, mergers of trading companies are regulated by the Act of 29 September 1994 on Accounting (Accounting Act – uniform text Journal of Laws of 2021, item 217, hereinafter the AA).

In line with the AA, different aspects of mergers are regulated in Chapter 4a, and a merger by takeover or incorporation of a new company may take place in accordance with Article 44a of the AA by way of:

1. Acquisition method, by aggregating the acquirer’s assets and liabilities at their book value, with corresponding assets and liabilities of the acquiree at their fair values determined at the merger date; 
2. Proportionate consolidation method, by aggregating corresponding assets and liabilities as well as revenues and costs of merged companies at the merger date, after adjusting their values to uniform valuation methods and making required eliminations.

Mergers by takeover

The legislator has treated a merger by takeover as a sale and purchase transaction, where the buyer is the acquirer and the seller is the acquiree. Accordingly, the acquiring company undertakes to pay a certain price for the acquired assets. Thus, the person accounting for the merger of companies does not rely on values included in the books, but rather on amounts considered to be the fair value of the assets concerned. The fair value is assumed to be the amount for which an asset could be exchanged between the interested parties in an arm’s length transaction, provided that both parties to the transaction are well informed. The methods for determining the fair value of assets or liabilities are presented in Article 44b par. 4 of the AA.

Given the fact that the acquisition method is a sale and purchase transaction in nature, it should be emphasised that the valuation of assets and liabilities is made only in the acquiree, whereas all the elements of the balance sheet of the acquirer stay unchanged in the books. If companies merge through an acquisition method, pursuant to Article 12 par. 2 of the AA, the acquiree shall close its books at the takeover date, i.e. on the date of registering this merger (takeover). The acquirer does not close its books at that time.

Please note that the assets and liabilities of the acquiree at the merger date also include assets or liabilities that have not been accounted for before in the books and the financial statements of the acquiree, if the merger results in their disclosure and they meet the definition of assets and liabilities. This is extremely important, because it is often the case that these parts of the assets make up the bulk of the purchase price of the acquiree.

The equity of the acquiree (determined at the merger date as net assets at fair value) is eliminated. Any mutual receivables and liabilities as well as other similar settlements between merging companies are also eliminated.

The surplus of the takeover price, referred to in Article 44b par. 5 of the AA, over the fair value of net assets of the acquiree is recognised as goodwill in the assets of the company to which the assets of the merged companies were transferred or the company incorporated following the merger.

Example 1

Takeover price PLN 5 million

Data of acquiree expressed in PLN million:

Goodwill: PLN 3 million (PLN 5 million – (minus) PLN 2 million).

Please note that if the merger is a result of a couple of successive transactions, the takeover price, the fair value of net assets of the acquiree in a percentage reflecting the percentage of net assets acquired and the difference in the takeover price of the fair value of net assets of the acquiree are all determined separately at the date of each significant transaction, assuming that the first significant transaction was carried out no later than on the date on which the acquirer obtained control of the acquiree. The final takeover price, the fair value of net assets of the acquiree and the difference in the takeover price over the fair value of net assets of the acquiree at the merger date represent a total of corresponding amounts at the dates of individual significant transactions. The carrying amounts of assets and liabilities determined at the merger date shall be adjusted in subsequent reporting periods, if the fair value determined at the merger date is found to be incorrect following events or upon learning new information. In such cases, an appropriate adjustment of goodwill or negative goodwill shall be made, provided that the entity expects to recover the value of the adjustment from future economic benefits and such an adjustment is made during the financial year in which the merger took place. Otherwise, such an adjustment shall be included in other operating income or expenses, as appropriate.

When the terms and conditions of the merger provide for the possibility of adjusting the takeover price as a result of certain future events, such an adjustment should be taken into account when determining the takeover price at the merger date, provided that the occurrence of such future price-adjusting events is probable, and the amount of the price adjustment can be reliably measured. If, in subsequent reporting periods, there are no events that would require the takeover price to change, or the actual change of the price differs from the estimated value, then the takeover price and goodwill or negative goodwill should be adjusted accordingly.

IFRS 3 offers a different approach to the measurement period, namely, if the initial accounting for a business combination can be determined only provisionally by the end of the reporting period in which the combination took place, the acquirer’s financial statements present provisional amounts for those items that were accounted for only provisionally. During the measurement period, the acquirer makes retrospective adjustments to provisional amounts recognised at the acquisition date to reflect new information obtained about facts and circumstances that were in existence at the acquisition date and, if known, would have affected the measurement of amounts recognised at that date. During the measurement period, the acquirer recognises additional assets and liabilities, if new information was obtained about facts and circumstances that were in existence at the acquisition date and, if known, would have affected the recognition of these assets and liabilities at that date. The measurement period ends once the acquirer receives information they were looking for about facts and circumstances that were in existence at the acquisition date or finds that no more information can be obtained. However, the measurement period cannot exceed one year from the acquisition date.

The entity amortises goodwill over its useful economic life. If the useful economic life cannot be reliably estimated, the period over which goodwill is amortised cannot be longer than 5 years. Amortisation write-offs are made with a straight line method and are included in other operating costs.

Negative goodwill, being the surplus of the fair value of net assets of the acquiree over the takeover price up to the amount not exceeding the fair value of acquired fixed assets and excluding long-term financial assets quoted on regulated markets, is included in accrued income over a period being a weighted average of the useful economic life of the acquired assets subject to amortisation. Negative goodwill in the amount exceeding the fair value of fixed assets, excluding long-term financial assets quoted on regulated markets, is included in revenue at the business combination date.

Example 2

Takeover price PLN 1 million;

Data of acquiree expressed in PLN million:

Negative goodwill: PLN 1 million (PLN 1 million – (minus) PLN 2 million).

Please note that negative goodwill is written off against other operating income up to the amount reflecting reliably measured future losses and expenses determined by the acquirer at the acquisition date, yet not being a liability. This write down is made in the reporting period in which losses and costs affect the financial result. If these losses and costs have not been incurred in reporting periods as previously anticipated, the negative goodwill associated with them is written off as defined above.

IFRS 3 presents different rules for accounting for negative goodwill. It does not provide for accounting for negative goodwill over time, but requires it to be immediately recognised in profit or loss.

In accordance with the AA, any costs incurred directly in connection with the merger increase the takeover price. The organisational costs incurred when setting up a new joint-stock company or the costs of increasing the share capital for merger purposes decrease the reserve capital of the acquirer or the company incorporated as a result of the merger, up to the amount of share premium, and the reminder is classified as financial costs.

IFRS 3 precludes the option of including direct costs of the merger transaction in the takeover price; instead, such costs must be expensed in other operating expenses.

The financial statement prepared at the end of the reporting period in which the merger took place should include comparative data for the preceding financial year. Comparative data for the previous financial year are data from the acquirer’s financial statement.

If you want to learn about the correct accounting treatment of mergers made with proportionate consolidation method, I encourage you to follow upcoming posts on our blog.