Under a company reconstruction a new holding company was created with shares of a nominal value of £1,000,000 which were exchanged for shares in the acquired subsidiary with a nominal value of £10,000. So we have a debit balance merger reserve of £990,000 on consolidation. Subsequently, the subsidiary transferred a fixed asset to the new holding company and this asset was then sold giving a profit of £1,000,000 to the holding company. The proceeds of this was used to repay £990,000 of the share capital, so it now equates to the share capital of the subsidiary. Do we have to adjust the merger reserve for this? What can it be used for in general, or does it have to stay on the balance sheet for ever?
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Merger reserve?
Can you explain how the merger reserve arises? It doesn't appear that the structure you describe occurred due to a merger or demerger and was simply a share for share exercise.
Therefore what you actually have is a £1m investment in the holding company against £1m share capital. On consolidation this becomes (£x) goodwill depending on Proceeds £1m – Fair Value of Net Assets Acquired (£y).
It then appears that you have then done a share buyback (more info needed) using the £990k from the £1m proceeds from asset sale.
If that’s the case then the double entry is DR share cap £990k, CR cash £990k, DR P&L Reserve £990k and CR Capital Redemption Reserve £990k.
A capital redemption reserve stays until the company is liquidated. A much better arrangement would have been a 1:1 share for share exchange rather than 100:1.
In simple terms a merger reserve arises when the consideration (if any) and nominal value of the shares issued during a merger or demerger and the fair value of the assets transferred differ.
Agreed. You are stuck with the merger reserve, if you follow the FRS, but why not account for it as an acquisition and avoid the issue? The capital reduction will create a P&L reserve from which you could vote a dividend and no redemption reserve is necessary.