Share for share exchange anomaly

Share for share exchange anomaly

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To cut a very long story short, we have taken over from the previous accountants who were involved in a poorly effected share for share exchange to incorporate a holding company into the structure. The relevant bit is that shares in X Ltd of £100,000 £1 shares were swapped for £200,000 £1 shares in Holdings Ltd. So Holdings balance sheet was:

Fixed asset investments      £100,000

Net Assets                           £100,000

Share Capital                       £200,000

Share premium                   -£100,000

Shareholder funds               £100,000

Clearly the negative share premium is incorrect.

We believe the balance sheet should be:

Fixed asset investments       £100,000

Unpaid SC                            £100,000

Net Assets                            £200,000

Share Capital                        £200,000

Shareholder funds                £200,000

However a corporate lawyer has suggested this:

Fixed asset investment         £200,000

Net Assets                             £200,000

Share capital                         £200,000

Shareholder funds                 £200,000

The lawyer believes that this is ok as the shares were issued at par and the carrying value is less than the value of the business.

My issue is that it would now appear the shareholders of Holdings have a base cost of £200,000 rather than £100,000. Is it simply a case that their base cost hasn't changed even though the investment is held at £200,000 in holdings (and the lawyer is correct), or were we correct, or is the answer something else?

Many thanks

Jonathan

Replies (22)

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By Steve Kesby
12th Jun 2014 17:14

Something else

Start with Joe Bloggs. Joe originally had 100 £1 shares in X Ltd, which he'd paid £100 for.

He now has 200 fully paid £1 shares in Holdings Ltd. His base cost for those 200 shares is still £100, irrespective of what happens in Holdings Ltd's balance sheet (which deals with Holdings Ltd, and not Joe et al). He's paid no more or less for them as a result of the exchange.

I think Holdings Ltd's balance sheet should be:

Fixed Asset Investments £X

Net Assets £X

Share Capital £200K

Share Premium £X - £200K (assuming that's a positive figure, which you do suggest).

Shareholders' Funds £X

Where £X is the value of X Ltd (did you see what I did there?) at the time of the aquisition, because fixed assets should be shown at cost, being the fair value of the consideration given. Since X Ltd is worth £X it follows that the shares given to acquire X Ltd at the time of acquisition must also have been worth £X.

EDIT: Damn. I had my share premium formula wrong. When I said £200K - £X, I actually meant £X - £200K. Now corrected

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By johngroganjga
12th Jun 2014 16:09

Firstly, what was the value of X Ltd?  Its issued share capital is irrelevant.

Secondly the base cost of the old shares just rolls into the new shares.  The number of shares makes no difference..

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By Jon220
12th Jun 2014 16:50

Thanks for the quick replies. I'm not sure where you're going with the value of the business, but it's £2.5m. Holdings has paid £200K for it's 100% share in X, and is shown at cost rather than its market value?

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By Steve Kesby
12th Jun 2014 16:56

It hasn't paid only £200K

It's paid £2.5m for its acquisition of X.

It issued new shares worth £2.5m for the acquisition. Since those shares have a nominal value of just £0.2m they have been issued at a premium of £2.3m.

Holdings balance sheet should be:

Investment/Net assets £2.5m

Share capital £0.2m

Share premium £2.3m

Shareholders' funds £2.5m

And that's still not going to have any bearing on Joe Bloggs who has 200 of the shares with a base cost of £100.

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By User deleted
12th Jun 2014 16:59

Holdings hasn't "paid" anything for X

It has issued shares to acquire X, the value of those shares being the value of X. So if you want to insist that it has paid for X then it has paid £X.

So:

Fixed asset investments  £2,500,000

Share capital                       £200,000

Share premium                £2,300,000

 

[EDIT - as usual, crossed with Steve]

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By johngroganjga
12th Jun 2014 17:07

Agree with the above.

And the transaction wasn't "poorly effected" - just misunderstood by the OP.

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By Jon220
12th Jun 2014 18:35

In a roundabout way, this discussion has helped. The previous accountants have used merger relief, therefore that was where my confusion lay with your comments. You know what they say about assumptions... So your answers confirm the advice given by the lawyer. And the shareholders have a base cost of £100,000 for £200,000 £1 shares. AND Holdings has not paid anything, only issued shares, which is where my terminology has not helped.

John- I struggle with your comment given that the FA investment was incorrect, together with a negative share premium. The real issue is the lack of paperwork, filing at CH, retention of records etc etc...

Many thanks for the discussion.

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By johngroganjga
12th Jun 2014 18:39

You said that the share for share exchange had been "poorly effected".  If you had said that the preparation of the accounts to record it had been poorly carried out and thought through I would have agreed with you.

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By Jon220
12th Jun 2014 19:23

Well that is true, but from what I posted, you couldn't argue it wasn't poorly effected, enacted, transacted or whatever verb you want to use. Plus there was no misunderstanding of what had happened, as there wasn't much to go on; just some incorrect accounting entries. A lack of understanding of how to correct the transaction was the key. I have also never come across a share for share exchange where merger relief wasn't applied. Anyway genuine thanks for your input.

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By User deleted
12th Jun 2014 19:53

Can you explain

Why you consider that it was poorly effected (or what you would have done differently)?

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By Jon220
12th Jun 2014 20:43

Well to execute a share for share exchange, there are many stages including agreeing the correct shareholding to be exchanged, applying for clearance, producing the statutory forms & meeting minutes, submitting the statutory forms, creating the correct accounting entries and retaining the relevant paperwork. None of the above was done. Essentially the transaction does not exist other than on a pretty poor excuse for financial statements.

The accountants who did this were also the cause of many other accounting errors in other financial statements.

We've taken other clients off this firm and errors include dividends out of non-distributable profits, dividends in unequal measures with 50/50 shareholders and an array of other quite disturbing advice.

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By User deleted
12th Jun 2014 20:58

Sorry, but you've lost me

From what you've posted there's nothing to indicate that the exchange was poorly effected. As John has said, the accounting entries may have been incorrect but the accounting entries merely reflect the transaction, they don't form any part of the transaction.

Perhaps it's just the terminology that's confusing me. Is it that you are trying to tell us that insufficient documentation has been kept in order to evidence the fact that the transaction did take place? In that case I think "handled" would be more appropriate than "effected".

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By Jon220
12th Jun 2014 21:19

It must be! My first post could have been written 'accountants who didn't complete a share for share exchange correctly. The main area of concern for me are the accounting transactions.'  Effected is often used in a legal context and it's a word I use. Maybe I should be careful with it.

Thinking about it though, there isn't confusion over affect and effect is there!?

To me, effected means the execution of a process to achieve an aim:

verb (used with object)

10.to produce as an effect; bring about; accomplish; make happen: The new machines finally effected the transition to computerized accounting last spring.  

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By Jon220
12th Jun 2014 21:34

Yes rereading the thread, it would explain the confusion if the posters are getting confused with affect and effect!

 

http://www.future-perfect.co.uk/grammar-tip/is-it-effect-or-affect/

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Stepurhan
By stepurhan
13th Jun 2014 09:24

Not sure you're right

If the share for share exchange has happened, surely that means it has been properly effected. The share for share exchange has been brought about/accomplished/made happen. Whether there is paperwork sufficient to show how this effective transaction has taken place is a separate issue.

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By Jon220
13th Jun 2014 12:01

That's bordering on philosophy I would suggest. Either way, it hasn't been properly transacted/effected. It could be made up for all I know.

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Stepurhan
By stepurhan
13th Jun 2014 12:27

Then why only worried about accounts treatment

If you really think the transfer could be made up, why is your OP only worrying about the accounts treatment? The correct accounting treatment for transactions that have not happened is not to make any entries at all. The fact that you are making entries means that the share transaction must have been effected (you even have a lawyer telling you shares have actually been issued at par). Whether it was a good idea to structure the transaction that way is irrelevant. Whether the accounting entries originally made were wrong is irrelevant. If the share for share exchange has actually happened, it has been effected. It is you that is using the word incorrectly.

Incidentally, I really don't see your argument that everyone else must be getting confused with affected. Their comments make less sense, not more, if they think you mean the transaction has been influenced or simulated poorly.

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Replying to ireallyshouldknowthisbut:
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By Jon220
13th Jun 2014 12:55

To finish

stepurhan wrote:

If you really think the transfer could be made up, why is your OP only worrying about the accounts treatment? The correct accounting treatment for transactions that have not happened is not to make any entries at all. The fact that you are making entries means that the share transaction must have been effected (you even have a lawyer telling you shares have actually been issued at par). Whether it was a good idea to structure the transaction that way is irrelevant. Whether the accounting entries originally made were wrong is irrelevant. If the share for share exchange has actually happened, it has been effected. It is you that is using the word incorrectly.

Incidentally, I really don't see your argument that everyone else must be getting confused with affected. Their comments make less sense, not more, if they think you mean the transaction has been influenced or simulated poorly.

 

I don't think it's made up, I was making the point that it could be given the evidence. Without evidence you cannot say the transaction was effected at all, let alone good or bad. I won't answer anything else, no one else cares, and we've all got better things to do with our time.

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Replying to leshoward:
Stepurhan
By stepurhan
15th Jun 2014 09:51

A whole different question

Jon220 wrote:
I don't think it's made up, I was making the point that it could be given the evidence. Without evidence you cannot say the transaction was effected at all, let alone good or bad. I won't answer anything else, no one else cares, and we've all got better things to do with our time.
You were the one that said everyone was misunderstanding your use of effected. If you couldn't face being challenged on that then you shouldn't have made such a big thing of it.

Since you say you won't answer anything else, this question is probably pointless but, if you the evidence is not enough to know the transaction has happened, why did you say this in your OP?

Jon220 wrote:
The relevant bit is that shares in X Ltd of £100,000 £1 shares were swapped for £200,000 £1 shares in Holdings Ltd.

This unequivocally states that the transaction has happened, that it has been effected. If you are now saying you have doubts that it has happened, then you have an entirely different problem to the one you asked about. There was a lawyer involved apparently (as you've spoken to them and they have confirmed shares were issued) so is it possible that you have simply not seen the evidence, rather than it not existing? Have you considered asking them to see the paperwork? That they may not understand enough about accountants to give the correct accounting treatment is largely moot.

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By User deleted
13th Jun 2014 12:32

Schrodinger's share exchange?

Based on the information supplied, it seems that the transaction both occurred and did not occur.

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Replying to ireallyshouldknowthisbut:
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By Jon220
13th Jun 2014 12:56

Agreed!

BKD wrote:

Based on the information supplied, it seems that the transaction both occurred and did not occur.

Agreed!

 

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By Jon220
15th Jun 2014 15:25

I didn't make a 'big thing' of it. There was confusion, so I tried to work out why. It appears there was a misunderstanding over the word and its use.

Of course I'll answer your question, I only said it was final as why argue over the point, I needed an accountancy question answered and I got it. For which I am grateful.

The transaction hasn't happened legally on paper (and evidentially) and incorrectly in accounting terms. Therefore the transaction has and hasn't happened. Ultimately it has, but it must be documented legally. Once that is done, it must be recorded correctly in the accounts (the reason why I asked the question).

My sentence simply tells of what needs to be recorded, it's not a summary of what has happened. We only have the accounts that suggest this is what should have happened.

Your point about the lawyer makes a lot of assumptions. There was no lawyer involved in the original transaction, only the accountant. So we (in agreement with a Legal 500 lawyer) need to perform the transaction from start to finish and 'effect' the transaction retrospectively.

Effected- 'brought into existence'. You may argue unequivocally that it has been brought into existence, but I and the lawyer do not believe so.

 

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