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38. Question and Answer

Small Ltd. and Little Ltd., two companies in the field of speciality chemicals, decided to go in for a follow on Public Offer after completion of an amalgamation of their businesses. As per agreed terms initially a new company Big Ltd. will be incorporated on 1st January, 2012 with an authorized capital of Rs 2 crore comprised of 20 lakh equity shares of Rs 10 each. The holding company would acquire the entire shareholding of Small Ltd. & Little Ltd. and in turn would issue its shares to the outside holders of these shares. It is also agreed that the consideration would be a multiple of the average P/E ratio for the period 1st January, 2011 to 31st March, 2011 times the rectified profits of each company, subject to necessary adjustments for complying with the terms of the share issue.


The following information is supplied to you:

Small Ltd. Little Ltd.
Ordinary Shares of Rs 10 each (Nos.) 40 lakhs 20 lakhs
10% Preference shares of Rs 100 each (Nos.) 2 lakh Nil
10% Preference shares of Rs 10 each (Nos.) Nil 2 lakh
5% debentures of Rs 10 each (Nos.) 4 lakh 4 lakh
Investments Held
(a) 4 lakh ordinary shares in Small Ltd. Rs 40 lakhs
(b) 2 lakh ordinary shares in Little Ltd. Rs 20 lakhs
Profit before Interest & Tax (PBIT) after considering impact of Rs 50 lakhs Rs 25 lakhs
Inter-company Transactions and Holdings.
Average P/E ratio January, 2011 to March, 2011 10 8


The following additional information is also furnished to you in respect of adjustments required to the profit figure as given above:


  1. The profits of the respective companies would be adjusted for half the value of contingent liabilities as on 31st March, 2011.
  2. Debtors of Small Ltd. include an irrecoverable amount of Rs 2 lakh against which Rs 1 lakh was recovered but kept in Advance account.
  3. Little Ltd. had omitted to provide for increased FOREX liability of US$10,000 on loan availed in financial year 2007-08 for purchase of Machinery. The machinery was acquired on 1st January, 2008 and put to use in financial year 2008-09. The additional liability arose due to change in exchange rates and is arrived at in conformity with prevailing provisions of AS 11. The exchange rate is US $ 1 = INR 50.
  4. Small Ltd. has omitted to invoice a sale that took place on 31st March, 2011 of goods costing Rs 2,50,000 at a mark up of 15 per cent instead the goods were considered as part of closing inventory.
  5. Closing Inventory of Rs 45 lakhs of Little Ltd. as on 31st March, 2011 stands undervalued by 10 per cent.
  6. Contingent liabilities of Small Ltd. and Little Ltd. as on 31st March, 2011 stands at Rs 5 lakhs and Rs 10 lakhs respectively.


The terms of the share issue are as under:

(i) Shares in Big Ltd. will be issued at a premium of Rs 13 per share for all external shareholders of Small Ltd. The Premium will be Rs 15 per share for shares in Big Ltd. issued to all external shareholders of Little Ltd.

(ii) No shares in Big Ltd. will be issued in lieu of the investments (intercompany holdings) of both companies. Instead the shares so held shall be transferred to Big Ltd. at the close of the financial year ended 31st March, 2012 at Par Value consideration payable on date of transfer.

  • Big Ltd. would in addition to the issue of shares to outside shareholders of Small Ltd. and Little Ltd. make a preferential allotment on 31st March, 2012 of 2 lakhs ordinary shares at a premium of Rs 28 per share to Virgin Capital Ltd. (VCL). These shares will not be eligible for any dividends declared or paid till that date.
  • Big Ltd. will go in for a 18 per cent unsecured Bank overdraft facility to meet incorporation costs of Rs 16 lakhs and towards management expenses till 31st March, 2012 estimated at Rs 14 lakhs. The overdraft is expected to be availed on 1st February, 2012 and closed on 31st March, 2012 out of the proceeds of the preferential allotment.
  • It is agreed that interim dividends will be paid on 31.03.2012 for the period January, 2012 to March, 2012 by Big Ltd. at 2 per cent; Small Ltd. at 3 per cent and Little Ltd. at 2.5 per cent. Ignore Dividend Distribution tax.
  • The prevailing Income Tax Rate is 25 per cent.


You are required to compute the number of shares to be issued to the shareholders of each of

the companies and prepare the projected Profit and Loss Account for the period from 1st January, 2012 to 31.03.2012 of Big Ltd. and its Balance Sheet as on 31st March, 2012.


Computation of number of shares issued

Calculation of Rectified Profits and Purchase consideration

Rs. Rs.
Small Ltd.
Given profits 50,00,000
Less: Irrecoverable Debtors 1,00,000
50% Contingent Liability 2,50,000 (3,50,000)


Add: Profit on omitted sale (15% of Rs 2,50,000) 37,500


Less: Debenture interest (2,00,000)


Less: Income Tax @ 25% (11,21,875)
Profits after Tax (PAT) 33,65,625
Less: Preference Dividend (10% of Rs 2,00,00,000) (20,00,000)
Rectified Profits

Average PE ratio = 10

Total consideration for all equity shareholders (Average PE ratio x Profit) 1,36,56,250
Less:10% thereof for shareholders of Little Ltd. (13,65,625)
Balance available for other shareholders of Small Ltd.

Little Ltd.

Given profits 25,00,000
Less: Increase in FOREX liability (US$10,000 x 50) 5,00,000
50% Contingent Liability 5,00,000 (10,00,000)


Add: Undervaluation of inventory (45,00,000×10/90) 5,00,000



Rs. Rs.
Less: Debenture interest (2,00,000)


Less: Income Tax @ 25% (4,50,000)
Profits after Tax (PAT) 13,50,000
Less: Preference Dividend (10% of Rs 20,00,000) (2,00,000)
Rectified Profits

Average PE ratio = 8

Total consideration for all equity shareholders (Average PE ratio * Profit) 92,00,000
Less:10% thereof for shareholders of Small Ltd. (9,20,000)
Balance available for other shareholders of Little Ltd.

Statement showing Disposal of Purchase Consideration

Small Ltd. Little Ltd. Total
Number of shares [Purchase consideration/(Face Value + Securities Premium)]

Share Capital

Securities Premium

Purchase Consideration














Projected Profit and Loss Account of Big Ltd. for the period 1st January, 2012 to 31st March, 2012

Note No. Rs.
I. Revenue from operations
II. Other income 5 17,00,000
III. Total Revenue(I+II) 17,00,000
IV. Expenses:
Employee benefits expense 7 14,00,000
Finance costs 6 90,000
Other expenses 8 16,00,000
V. Total expense 30,90,000
VI. Loss for the period (V – IV) (13,90,000)







Projected Balance Sheet of Big Ltd. as on 31st March, 2012

Particulars Note No. (Rs in Lacs)
I. Equity and Liabilities (1) Shareholder’s Funds

(a) Share Capital

1 1,06,55,750
(b) Reserves and Surplus 2 1,59,51,760
Total 2,66,07,510




Particulars Note No. (Rs in Lacs)
II. Assets

(1)       Non-current assets

Non-current investments

(2)       Current assets

Cash and cash equivalents









Notes to Accounts

(Rs) (Rs)
1. Share Capital

20 lakhs shares of Rs 10 each

Issued & Paid up

10,65,575 shares of Rs 10 each (out of the above 8,65,575 shares have been issued for consideration other than cash)

1,06,55,750 1,06,55,750
2. Reserves and surplus
Securities Premium (Rs 1,19,14,875 + 56,00,000)

Loss for the period

(13,90,000) 1,75,14,875
Less: Proposed Dividend (2% of Rs 86,55,750) 11,73,115) (15,63,115)
Balance of Profit and Loss Account carried forward 1,59,51,760
3. Non-current investments
Shares in Subsidiaries (W.N. 4) 2,65,70,625
4. Cash and cash equivalents
Cash at Bank (W.N. 3) 36,885
5. Other income
Dividends received from Subsidiaries (Rs 12,00,000 + 5,00,000) 17,00,000
6. Finance costs
Interest on Bank O/D 90,000
7. Employee benefits expenses
Management expenses 14,00,000
8. Other expenses
Preliminary expenses * 16,00,000



Working Notes:

  1. Shares issued by Big Ltd. to Virgin capital Ltd. (VCL)
Number of shares issued 2,00,000
Face Value of Share Capital @ Rs 10 each Rs 20,00,000
Securities Premium @ Rs 28 each Rs 56,00,000
Total cash received from VCL Rs 76,00,000


* As per para 56 of AS 26, preliminary expenses are to be recognized as expenses as and when they are incurred.


A ‘Deferred Tax Asset’ has not been computed as the company is a loss making company. This is based on the assumption that the concept of prudence would not be satisfied for creation of DTA as per AS 22.


  1. Overdraft of Big Ltd. as on 31.3.2012
Towards Incorporation expenses i.e. preliminary expenses 16,00,000
Towards Management expenses 14,00,000
Total Bank Overdraft availed 30,00,000
Interest @ 18% p.a. for 2 months 90,000


  1. Bank balance of Big Ltd. as on 31.3.2012


Bank Account of Big Ltd.

01.02.2012 To Overdraft 30,00,000 01.02.2012 By Incorporation expenses 16,00,000
31.03.2012 To VCL 76,00,000 31.03.2012 By Management expenses 14,00,000
31.03.2012 To Dividend 31.03.2012 By Interest on
Overdraft 90,000
Small 12,00,000 1 31.03.2012 By Overdraft 30,00,000
Little 5,00,000 [1] 31.03.2012 By Dividend paid 1,73,1153
31.03.2012 By Shares in Small Ltd.
bought from Little Ltd.
31.03.2012 By Shares in Little Ltd.
bought from Small Ltd. 20,00,000
By Balance c/d
(Bal.fig.) 36,885
1,23,00,000 1,23,00,000






  1. Investments of Big Ltd. in Projected Balance Sheet
Purchase consideration paid for acquiring shares of outside holders of- Small Ltd

Small Ltd

Little Ltd.

Consideration pay in cash for acquiring cross holdings

From Small Ltd. (shares of Little Ltd.)

From Little Ltd. (shares of Small Ltd.)






1    (40,00,000 x 10) x 3% = 12,00,000.

2    (20,00,000 x 10) x 2.5% = 5,00,000.

3    [(5,34,375 + 3,31,200) x 10] x 2% = 1,73,115.


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