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Share for share exchanges

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Published: 12 Aug 2022 Reviewed: 12 Aug 2022 Update History

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Technical helpsheet issued to help ICAEW members to understand the company law and financial reporting implications of a share for share exchange.

Introduction

This helpsheet has been issued by ICAEW’s Technical Advisory Service to help ICAEW members to understand the company law and financial reporting implications of a share for share exchange.

Members may also wish to refer to the following related helpsheets:

Eligible members with access to Bloomsbury Professional Online may also find the following published title of use:

Check whether you have access to Bloomsbury Professional Online.

What is a share for share exchange

A share for share exchange is where one or more shareholders exchange shares they hold in one company for shares in another company. A common example of this is where a new holding company is put on top of an existing group. Shareholders give their shares in the old TopCo to NewCo in exchange for shares in NewCo.

In such situations, confusion often arises over the use of merger relief and merger accounting. Although both include the word ‘merger’ in their names, and both commonly arise in group reconstructions, this is really where the similarities end. Merger relief is a Companies Act relief from recording share premium. Merger accounting is a method of accounting for a business combination. Each can only be used where the relevant criteria are met.

Merger relief

When a company issues shares, the basic rule contained in section 610 of the Companies Act 2006 is that those shares should be accounted for at the value of consideration received in exchange. Any excess over the nominal value of the shares issued is recorded in the share premium account.

Merger relief is a Companies Act relief from the creation of a share premium account on the issue of shares. Broadly, it applies where a company issues equity shares in consideration for the shares of another company (ie, a share for share exchange) where, as part of the arrangement, it secures at least a 90% equity holding in the other company. The specific criteria for merger relief are set out in section 612 of the Companies Act 2006. Where the criteria are met, the relief must be applied and therefore no share premium is recorded on the issue of the shares.

To the extent that the relief from recording share premium is available, section 615 of the Companies Act 2006 and FRS 102 paragraph A3.24 give the option to reduce the carrying value of the related investment by a corresponding amount. In effect, where the investment in the subsidiary is accounted for at cost less impairment, the cost may be recorded at either the nominal value or the fair value of the shares issued in exchange.

Nominal value

If recorded at nominal value, the accounting entries will be:

Dr Cost of investment in subsidiary Nominal value of shares issued

Cr Share capital Nominal value of shares issued

Fair value

If recorded at fair value, the accounting entries will be:

Dr Cost of investment in subsidiary Fair value

Cr Share capital Nominal value of shares issued

Cr Merger relief reserve Balance

There are no strict requirements with regard to the name of the reserve which is created; ‘merger relief reserve’, ‘merger reserve’ or indeed an ‘other reserve’ would all be acceptable, although it is sensible to name it a ‘merger relief reserve’ as it is then clear that it arose from merger relief.

Group accounts

Where a share for share exchange has occurred and the parent company is required to prepare consolidated accounts, the directors should consider whether the business combination is accounted for using:

  • Merger accounting; or
  • Acquisition accounting (the purchase method).

Merger accounting may (but does not have to) be applied if the criteria in FRS 102 paragraph 19.27 are met. If merger accounting is not applied to the business combination, then acquisition accounting must be used.

Under merger accounting, the carrying values of the assets and liabilities of the parties to the combination are not adjusted to fair value on consolidation. Any difference between the consideration and the book value of the net assets acquired is shown as a movement on other reserves (usually in a ‘merger reserve’, although there are no strict requirements on what to call it). Guidance on the merger accounting method is included within FRS 102 paragraphs 19.29 to 19.32.

Under acquisition accounting, a fair value exercise will need to be carried out. The requirements of FRS 102 paragraphs 19.6 to 19.24 will need to be adhered to. It is important to remember that when calculating goodwill, the cost of the business combination must be based on the fair value of the consideration given to acquire the subsidiary. This is the case even if merger relief applies and the directors have elected to record the investment at the nominal value of the shares issued in the parent’s own accounts.

If in doubt seek advice

ICAEW members, affiliates, ICAEW students and staff in eligible firms with member firm access can discuss their specific situation with the Technical Advisory Service on +44 (0)1908 248 250 or via webchat.

Terms and conditions

© ICAEW 2022  All rights reserved.

ICAEW cannot accept responsibility for any person acting or refraining to act as a result of any material contained in this helpsheet. This helpsheet is designed to alert members to an important issue of general application. It is not intended to be a definitive statement covering all aspects but is a brief comment on a specific point.

ICAEW members have permission to use and reproduce this helpsheet on the following conditions:

  • This permission is strictly limited to ICAEW members only who are using the helpsheet for guidance only.
  • The helpsheet is to be reproduced for personal, non-commercial use only and is not for re-distribution.

For further details members are invited to telephone the Technical Advisory Service T +44 (0)1908 248250. The Technical Advisory Service comprises the technical enquiries, ethics advice, anti-money laundering and fraud helplines. For further details visit icaew.com/tas.

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  • Update History
    12 Aug 2022 (12: 00 AM BST)
    First published
    12 Aug 2022 (12: 00 AM BST)
    Changelog created, helpsheet converted to new template
    12 Aug 2022 (12: 00 AM BST)
    Changelog created, helpsheet converted to new template
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