Demerger and Financial Restructuring Problems for CA Final AFM

Understand Demerger and Financial Restructuring Problems

Key rules to remember

Exchange ratio

Exchange ratio = Value per share of target ÷ Value per share of acquirer

Use the same basis for both (market price, earnings-based or net asset value). The ratio is the number of acquirer shares per one target share.

Shares to be issued in a merger

New shares issued = Target shares held × Exchange ratio

Round per shareholder only if the question says so. Fractions are often settled in cash.

Share entitlement in a demerger

Resulting company shares received = Shares held in demerged company × Entitlement ratio

A ratio of 1:2 means 1 new share for every 2 held, so multiply by 1/2.

Net assets transferred in a demerger

Net assets transferred = Assets of undertaking − Liabilities of undertaking

Include only the liabilities that relate to the undertaking, as the scheme states.

Goodwill or capital reserve (acquisition method)

Goodwill (negative = bargain purchase) = Consideration − Fair value of net identifiable assets acquired

If the result is negative, first reassess the identification and measurement of the assets acquired and liabilities assumed. If a bargain purchase gain still remains, Ind AS 103 recognises it in other comprehensive income and accumulates it in equity as capital reserve where there is clear evidence that the acquisition is a bargain purchase. If there is no clear evidence, it is recognised directly in equity as capital reserve, with no OCI route. Check the question's instruction.

Value neutrality in a demerger

Pre-demerger price per share = Post-demerger price per share + Entitlement ratio × Resulting company price per share

Use this to find the implied price of the new share, or to check the given prices.

Post-merger EPS

Post-merger EPS = (Earnings of acquirer + Earnings of target) ÷ (Acquirer shares + New shares issued)

Add synergy to earnings only when the question gives it.

Balance sheet check

Total assets = Share capital + Reserves + Liabilities

Check this at the end of every restructuring answer.

How to solve Demerger and Financial Restructuring Problems questions

1. 1Read the scheme. Note which undertaking moves, which liabilities go with it, the entitlement ratio or the valuation basis, and whether the combination is under common control.
2. 2Prepare the values. For a demerger, find net assets transferred. For a merger, find the value per share of both companies and the exchange ratio.
3. 3Compute the entitlement. Multiply each holder's shares by the ratio and find the total new shares and their face value.
4. 4Record the consideration. Split it into share capital at face value and securities premium for any amount above face value.
5. 5Fix the difference. Compare the consideration with net assets. Show it as goodwill, capital reserve, or an adjustment against reserves, as the scheme says.
6. 6Prepare the post-restructuring balance sheet for each company. Take the old figures, remove what goes out, add what comes in, and list capital and reserves.
7. 7Check that total assets equal total capital, reserves and liabilities. For a demerger, also check that value before equals value after.
8. 8State the answer clearly: shares issued, entitlement per holder, goodwill or reserve, and the closing totals.

Quickest way: Three-line scan for scheme problems

Common mistakes in Demerger and Financial Restructuring Problems

• Moving the whole liability side of the balance sheet with the undertaking.

  Students forget that only liabilities specified in the scheme are transferred.

  Fix: List the undertaking's assets and its identified liabilities separately. Leave the rest in the demerged company.

• Inverting the entitlement ratio, giving 2 new shares for every 1 held when the scheme says 1 for every 2.

  The notation 1:2 is read in the wrong direction.

  Fix: Write it in words: new shares per old shares. Then multiply. A quick sense check is whether the new shares issued look reasonable against net assets.

• Issuing shares at face value and ignoring securities premium in a merger.

  The exchange ratio is based on market or fair values, but the shares are recorded at face value only.

  Fix: Credit share capital at face value and the rest of the consideration to securities premium.

• Using book values for target assets in an acquisition when fair values are given.

  Students copy the old balance sheet without reading the valuation note.

  Fix: For an acquisition not under common control, use fair values for identifiable assets and liabilities. Use book values only for common-control pooling.

• Balance sheet does not tie, and the student leaves it as it is.

  The reserve adjustment or goodwill is missed, or the transferred loan is not removed.

  Fix: Find the difference between the two sides. It usually equals one missed item, such as goodwill, premium or the reserve write-down.

• Assuming the demerged company's share price stays the same after the demerger.

  Students forget that value moves to the new company.

  Fix: Apply value neutrality. The old price equals the new ex-demerger price plus the ratio times the new company's price.

Worked examples