When corporate mergers occur, they consolidate everything that pertains to them. Their financial records and banking accounts are consolidated as well. Just as the legal entities of both companies are combined into one, the financial documents and accounts have to be duly prepared.
Merger accounting refers to a way of accounting for a business merger by following a set of laid down principles and policies used in accounting for mergers. Under Financial Accounting Standards, FRS 6 deals with accounting for mergers and acquisitions. This financial accounting standard provides a framework which serves as the guide to follow when preparing accounts for mergers.
What does it entail?
Not all business consolidations are considered as mergers. A combination of two businesses will be considered as a merger when they meet the provisions or definition of a business merger as stated in the Companies Acts. The generally accepted accounting principles must permit the use of merger accounting for that kind of business combination – per FRS 6.
Under the Companies Acts, the combination of two businesses can be regarded as a merger only if it involves a direct exchange of equity shares for the other company’s equity shares.
According to FRS 6, merger accounting principles and policies will be applied to a business combination only if the combination satisfies all of the following conditions:
- None of the parties is depicted as the buyer or the target
- All the parties are involved in the process of management selection and the decisions are agreed upon by consensus rather than by reference to their voting rights.
- The parties to the business combination are of relatively equal size.
- All of the equity shareholders of the combining businesses shall acquire full rights and interests in the performance of the combined entity.
There are many complexities associated with accounting for qualified mergers. The transformation of the two businesses into one unit involves many transactions and can take many forms, but the most important of all is the shareholder value creation and preservation.
During the negotiation process, transactions must be undertaken only after rigor analysis has been conducted in order to fully appreciate the financial reporting implications. Some kinds of transaction structures may have pre-acquisition impacts or post-acquisition impacts on income.
For example, complex capital structures, calls, puts, and other conditional provisions, may require classification of ownership interests outside of equity. These can create valuation complexities which may delay or even disrupt transactions if they are not identified earlier.
Who carries out Merger Accounting
The complexities in these transactions are numerous and there are special provisions and guidelines in the Generally Accepted Accounting Principles to follow. These complexities include but are not limited to consolidation assessments, potential new basis issues, identification and accounting for financial instruments and derivatives, accounting for new stock compensation plans etc.
It takes highly skilled accountants and experts in the field to identify and fully understand all the possible or potential issues involved in it. Since most companies may not have the requisite expertise in-house, it is prudent to seek experts’ assistance during the early days of the negotiation process.