A merger is a very special event in the life of business entities. In this context, one or more companies are taken over by another based on an owner decision. In practice it means that the companies taken over (legal predecessors) cease to exist, while the acquiring company becomes their legal successor, continuing the operations as a going concern. This is a form of mergers in which the participating companies have specific reporting obligations along with several special accounting tasks.
When is a merger not possible?
As with all other types of transformation, companies in liquidation, bankruptcy or under voluntary liquidation cannot opt for a merger. This is also the case if the company is subject to criminal proceedings.
General rules for transformation balance sheets and inventories of assets and liabilities in Hungary
To be able to determine the assets (equity) of the business entities participating in the transformation, a transformation balance sheet has to be prepared. The rows of the transformation balance sheet must be supported by an inventory of assets and liabilities which contains an itemised list of the assets and liabilities of the legal predecessors and the legal successor business entity. The Hungarian Act on Accounting details the requirements regarding the preparation of these documents in a separate chapter.
In the case of business entities that prepare IFRS financial statements, the necessary documents have to be compiled along the lines of the IFRS valuation principles. However, if the business entities participating in the merger include companies that prepare their annual accounts in accordance with the Hungarian Act on Accounting, along with companies that prepare their annual accounts in accordance with IFRS, these requirements need to be harmonised. In the case of a merger, the reporting rules applied by the acquiring business entity apply since it will continue as the going concern. When compiling their transformation balance sheet, the business entities being discontinued and taken over, and applying different rules, must switch to these rules.
In Hungary, the above documents have to be prepared twice during the merger. First, for the decision on the transformation and for the registration procedure as of the balance sheet date specified by the company’s supreme body (transformation balance sheet and draft inventory of assets and liabilities). Secondly, as of the date of the merger (final transformation balance sheet, final inventory of assets and liabilities).
When preparing the draft transformation balance sheet and draft inventory of assets and liabilities, the rules applicable for the preparation of interim balance sheets apply, thus the accounting close is only a technical issue for the business entities participating in the transformation. This means the sub-ledger and general ledger records do not have to be closed, they are kept on a continuous basis. If the legal entity does not apply revaluation, the latest financial statements may be taken into account to support equity for six months after the balance sheet date. Thus, no separate close is needed.
When preparing the final transformation balance sheet and final inventory of assets and liabilities, the entities being discontinued (taken over) prepare financial statements as of the date of the merger as the reporting date, and they close their sub-ledgers and general ledgers (termination with a legal successor). The financial statements are published and must be filed (within 90 days of the merger date). In their case, the financial year commences on the day following the balance sheet date of the previous financial year, and ends on the date of the merger – as the balance sheet date. For the business entity carrying on as a going concern this close is only a technical issue, its financial year and reporting date will not change due to the transformation. The final transformation balance sheet is prepared based on the data of the ongoing bookkeeping, and the assets and liabilities taken over from the legal predecessors will be added to the books as of the day after the merger (including provisions and accruals and deferrals).
Form of transformation balance sheet for the business entities taken over
The transformation balance sheet shall be prepared with three columns, which contain the following:
- book value of the assets, liabilities and equity of the business entities taken over,
- revaluation difference (if applied), and
- value as per asset valuation, as the sum of the two.
Rules for preparing transformation balance sheets for business entities taken over in Hungary
The business entity undergoing the transformation may revalue the assets and liabilities (including provisions and accruals and deferrals) recorded in its books, while those not recorded by value and the business entity’s liabilities may be entered into the transformation balance sheet. This is the asset revaluation (market valuation), whose impact is shown in the revaluation difference column.
If the company opts for revaluations, the equity must be adjusted with the aggregate value of the revaluation differences. For upwards differences the capital reserve is adjusted, while for downwards differences first the capital reserve is adjusted (up to the positive amount), then retained earnings.
Rules for equity
An additional important rule is that under equity in the third column of the transformation balance sheet of a business entity being transformed (taken over) only registered capital, the capital reserve, retained earnings (latter also may be negative) and the allocated reserve may be included. To this end, several adjustments and technical transfers have to be performed. The profit after tax has to be transferred to the retained earnings, the valuation reserve has to be eliminated, while the allocated reserve may also have some adjustments.
Form of transformation balance sheet for the acquiring business association
The transformation balance sheet of the acquiring business entity includes the following:
- assets of the legal predecessor business entities at the value specified by the asset valuation,
- the assets of the legal successor business entity as the sum of the above.
Content of the “differences” column
- settlements due to new owner
- settlements due to capital increase of existing owners
- settlements due to exiting owner
- derecognition of mutual shares
- waiver by owner of a claim arising from a supplementary payment made to a legal predecessor
- derecognition of mutual receivables, liabilities, accruals and deferrals
- other items not specified by law, etc.
One important rule in Hungary is that in the case of a merger, the acquiring business entity may not revalue the assets and liabilities, so a revaluation of assets may not take place.
Date of share derecognition for transformations
When determining the equity of the legal successor business entity, the value of the shares held in the business entities taken over must be eliminated, and recognised as a decrease in assets and equity. The registered capital within equity is reduced by the nominal value of the shares, while the portion in excess of the nominal value is eliminated through retained earnings.
The share terminated in the legal predecessor must be derecognised at the acquiring company as of the day following the date of merger.
Content of “settlement” column
- allocated reserve in the transformation balance sheet due to an expected loss
- allocated reserve for a tax liability arising directly in connection with the transformation (if the tax liability is payable by the legal successor and no other reserve was allocated for it)
- any adjustment of allocated reserve
- settlement of negative retained earnings, etc.
The “settlement” column contains the rearranged elements of equity if specified by the owners in the deed of foundation or required by law. During the rearrangement, the requirements for the maximum amount of registered capital must be taken into consideration.
Only (positive amounts of) registered capital, the capital reserve, retained earnings and the allocated reserve may be shown under equity in the column showing the assets of the legal successor business entity in the draft transformation balance sheet of a business entity established by way of transformation.
Accounting for goodwill
Subject to certain conditions, goodwill can already be recognised in the transformation balance sheet of the acquiring business entity during the merger if the book value of its shares in the company/companies taken over exceeds the amount of equity in the draft transformation balance sheet of the company/companies taken over.
Audit of a merger in Hungary
If any of the transformed companies (legal predecessors and legal successor) is subject to an audit under the Hungarian Act on Accounting, this obligation shall prevail for all draft transformation balance sheets and draft inventories of assets and liabilities. However, an audit of the final transformation balance sheet and final inventory of assets and liabilities shall always be mandatory.
The permanent auditor of the companies participating in the transformation or the auditor performing either an audit or a contribution-in-kind review in the two financial years preceding the date of the draft transformation balance sheet may not audit the transformation. The auditor of the transformation may not be appointed as the auditor of the legal successor within three financial years of the registration of the company in Hungary.
Should the Court of Registration reject the registration of the merger or cancel the registration procedure due to the application for registration being withdrawn, from an accounting point of view it shall be deemed as if nothing happened. The business entities seeking transformation will continue to operate as going concerns and keep their books without the need to prepare a final transformation balance sheet and a final inventory of assets and liabilities.
In this article we only detailed the accounting tasks related to a merger, but tax implications may also arise during a transformation, in the case of corporate tax or property acquisition duty for example. It is worth examining the advantages of a preferential transformation too. Additionally, there are a number of legal tasks and deadlines to meet, which must be strictly complied with to make the transformation a success. Therefore, a merger definitely requires preliminary planning, consultations and the involvement of experts to enable the owners to make the best decisions possible. Please do not hesitate to contact us if you need the advice of experienced professionals.