Premiums and Pre‐Acquisition Profits: The Legal and Accountancy Professions and Business Combinations
| DOI | http://doi.org/10.1111/j.1468-2230.1991.tb01852.x |
| Author | Christopher Napier,Christopher Noke |
| Published date | 01 November 1991 |
| Date | 01 November 1991 |
Premiums and Pre-Acquisition Profits: The
Legal
and
Accountancy Professions and Business Combinations
Christopher Napier and Christopher Noke
*
‘Accounts are
the
one subject of which lawyers are supposed
to
know nothing.”
In
both statute and case law, this view has
until
quite recently been evidenced by a
reluctance
to
set detailed rules for company accounts, and a willingness to leave
mattcrs of accounting to accountants and ‘men of business.’2 Where accountants
and men of business agree, such a
luissezfuire
attitude
is
attractive to accountants;
any profession seeks
to
establish its own domain of regulation. The problems start
when accountants and men of business disagree.
In
these circumstances, accountants
seeking to enforce their views may find the regulatory power of the accountancy
profession weaker than they would wish.
A
stronger and more effective domain
must be entered, that
of
law. But
in
appealing
to
law
in
order
to
enforce their views,
accountants risk sacrificing autonomy. This inevitably creates tension, and the
relationship of accounting and law can therefore be an uneasy 0ne.j
These regulatory tensions are explored here
in
an historical analysis of accounting
for business combinations. The problems of accounting for business combinations
are representative of those arising where accounting and law interface. These
problems do not arise
in
a vacuum; they are the consequences of the interaction
of
accounting and law over several decades.
In
the first section, we outline the
alternative methods of accounting for business combinations. We then examine the
historical process whereby accounting for business combinations has come
to
be
regulated. This historical examination is
in
three sections, divided by the major
changes
in
the relevant statute law
in
the Companies Act (CA) 1948 and CA
1981.
The final section of the article draws conclusions from the historical analysis.
Accounting for Business Combinations
Virtually all large commercial organisations
in
the United Kingdom are structured
as groups
of
companies, whereby one company (the ‘parent’ or ‘holding company’)
owns controlling interests
in
the other companies (‘subsidiaries’). The group structure
emerged towards the end of the 19th century, as a byproduct
of
business combinations
in
industries such as textiles, iron and steel, brewing and toba~co.~
It
was exploited
in
the early 20th century for both positive and negative reasons. The group structure
often brought
with
it
operating convenience, as different aspects of an organisation
could be legally separated into individual subsidiaries. But the
use
of subsidiaries
allowed for secrecy about the performance
of
major parts of the group, as subsidiaries
could be incorporated as private companies, which at that time were under no
*Department of Accounting and Finance, London School
of
Economics and Political Scicncc.
I
Lord Halsbury LC in
The
Accuitritanr,
24
July
1897,
p
730.
2
Lee
v
Neirc/wre/
Aspkalte
Co
Lfd
(1889)
41
Ch
I,
21
(per
Lindley LJ).
3
Napier and Noke. ‘Accounting and Law: An Historical Overview
of
an Uneasy Relationship’
in
Broiiiwich and Hopwood (eds),
Accuioifirig
mc/
r/re
Lrov
(London: ICAEW/Prentice Hull, forthcotiiing
1992).
4
Hannah,
77ie
Riw
of
rlie
Corporore
Ecunomy
(2nd ed, London: Methuen,
1983).
8
10
?%r
Mdcni
hiv
Rcvicw
54:6
November
1991 0026-7961
November
199
11
The
Legal
arid
Aecouirtaircy Professiotts
awd
Birsirrcss Cortrbiiiatiotrs
obligation to publish their accounts.5 The demand for statements to explain the
financial position and performance of the group as a whole began to be expressed
in
the
1920s.
Some leading companies were to provide such statements (‘group
accounts’)
in
advance of a general legal requirement introduced
in
CA
194tla6
The most common ways of combining the businesses of two or more companies
are for one company to acquire a majority of the share capital of the other companies
or for a new holding company to be set up to acquire the shares of all the companies
in
the combination. The combination process gives rise to two classes of accounting
problems. First, it is necessary to record the shares acquired
in
the accounts of the
acquiring company, by attributing a ‘cost’ to the shares. Where the shares are acquired
for cash,
the
cost
of
the shares is simply the cash paid (including any incidental
costs of acquisition). But
if
the acquirer pays for the shares by allotting its own
securities, two different approaches suggest themselves. The cost could be taken
as the nominal (par) value of the securities issued.
In
a share-for-share exchange,
however, the shareholders of the company being acquired
will
assess the shares
they receive not at their nominal value but at
their
current market value.
So
the
cost of the shares acquired could be taken as the current value of the shares issued,
which will
in
general be greater than the nominal value of those shares. When shares
are issued for cash amounts greater than nominal value, the excess is regarded as
a
share premium;
is this also the case when shares worth more than their nominal
value are issued
in
exchange for other shares?
The second class of accounting problems stems from the requirement to prepare
group accounts, reflecting not just the acquiring company but also its subsidiaries.’
The general principle of group accounts is that they should comply
so
far as is
practicable
with
the accounting provisions of
CA
1985
as
if
the undertakings
in
the group were a single The almost universal method of preparing
group accounts is ‘consolidation.’ When a company acquires the shares
of
another
company, the consolidated balance sheet does not include these shares as an asset
of the group, but
in
their place includes the individual assets and liabilities of the
company acquired.
There are two methods of consolidation. Under ‘acquisition accounting,
’
any shares
issued as part of the consideration for the shares acquired are recorded at their fair
value
in
the parent company’s accounts, while on consolidation the identifiable assets
and liabilities of the companies acquired are included
in
the consolidated balance
sheet at their fair value at the date
of
acquisition. The difference between the fair
value of the net identifiable assets acquired and the fair value of the purchase
consideration is goodwill. For many companies, neither of the current permitted
alternatives for accounting for goodwill” is attractive, as these either reduce
reported shareholders’ equity immediately or diminish reported profits over a longer
term.
A
further problem arises under acquisition accounting. The results of the acquired
companies are brought into the group accounts only from the date of acquisition.
However,
it
is likely that an acquired company has accumulated reserves. Such ‘prc-
~ ~~~~~~ ~~
5
CA
1907,
ss
21.
37.
6
Bircher,
‘The
Adoption
of
Consolidatcd
Accounting
in
Great
Britain’
(Wintcr
1988),
Accorortirrg
cord
Bitsitless
Resecirclr
3.
7
CA
1985,
s
227,
IS
inscrtcd
by
CA
1989,
s
5(1).
8
CA
1985,
Schcd
4A.
para
I(I),
as
inserted
by
CA
1989,
Sched
2.
9
Wrik
off
iinniediatcly
against rcscrves
or
rccognise
as
tin
assct
and
aniortise
through
the
profit
mid
loss
account
-
Accounting
Standards
Committee,
SSAP
22
(Revised):
Accnrtrrririg
for
Gcioc/wi//
(London:
ASC.
1989)
puras
39-41.
81
I
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