Growmoor plc has carried on business as a food retailer since 1900. It had traded prof- itably until the late 1980s when it suffered from fierce competition from larger retailers. Its turnover and margins were under severe pressure and its share price fell to an all time low. The directors formulated a strategic plan to grow by acquisition and merger. It has an agreement to be able to borrow funds to finance acquisition at an interest rate of 10% per annum. It is Growmoor plc's policy to amortise goodwill over ten years.

1.  Investment in Smelt plc

On 15 June 1994 Growmoor plc had an issued share capital of 1 625 000 ordinary shares of £1 each. On that date it acquired 240 000 of the 1 500 000 issued £1 ordinary shares of Smelt plc for a cash payment of £164 000. Growmoor plc makes up its accounts to 31 July. In early 1996 the directors of Growmoor plc and Smelt plc were having discussions with a view to a combination of the two companies.

The proposal was that:

(i) On 1 May 1996 Growmoor plc should acquire 1 200 000 of the issued ordinary shares of Smelt plc which had a market price of £1.30 per share, in exchange for 1 500 000 newly issued ordinary shares in Growmoor plc which had a market price of £1.20p per share. There has been no change in Growmoor plc's share capital since 15 June 1994. The market price of the Smelt plc shares had ranged from £1.20 to £1.50 during the year ended 30 April 1996.

(ii) It was agreed that the consideration would be increased by 200 000 shares if a contin- gent liability in Smelt plc in respect of a claim for wrongful dismissal by a former director did not crystallise.

(iii) After the exchange the new board would consist of 6 directors from Growmoor plc and 6 directors from Smelt plc with the Managing Director of Growmoor plc becom- ing Managing Director of Smelt plc.

(iv) The Growmoor plc head office should be closed and the staff made redundant and the Smelt plc head office should become the head office of the new combination.

(v)   Senior managers of both companies were to re-apply for their posts and be inter- viewed by an interview panel comprising a director and the personnel managers from each company. The age profile of the two companies differed with the average age of the Growmoor plc managers being 40 and that of Smelt plc being 54 and there was an expectation among the directors of both boards that most of the posts would be filled by Growmoor plc managers.

2. Investment in Beaten Ltd

Growmoor plc is planning to acquire all of the 800 000 £1 ordinary shares in Beaten Ltd on 30 June 1996 for a deferred consideration of £500 000 and a contingent consideration payable on 30 June 2000 of 10% of the amount by which profits for the year ended 30 June 2000 exceeded £100 000. Beaten Ltd has suffered trading losses and its directors, who are the major shareholders, support a takeover by Growmoor plc. The fair value of net assets of Beaten Ltd was £685 000 and Growmoor plc expected that reorganisation costs would be

£85 000 and future trading losses would be £100 000. Growmoor plc agreed to offer four year service contracts to the directors of Beaten Ltd.

The directors had expected to be able to create a provision for the reorganisation costs and future trading losses but were advised by their Finance Director that FRS 7 required these two items to be treated as post-acquisition items.

Required

(a) (i) Explain to the directors of Growmoor plc the extent to which the proposed terms of the combination with Smelt plc satisfied the requirements of the Companies Act 1985 and FRS 6 for the combination to be treated as a merger; and

(ii) If the proposed terms fail to satisfy any of the requirements, advise the directors on any changes that could be made so that the combination could be treated as a merger as at 31 July 1996.

(b) Explain briefly the reasons for the application of the principles of recognition and measurement on an acquisition set out in FRS 7 to provisions for future operating losses and for re-organisation costs.

(c) (i) Explain the treatment in the profit and loss account for the year ended 31 July 1996 and the balance sheet as at that date of Growmoor plc on the assumption that the acquisition of Beaten Ltd took place on 30 June 1996 and the consideration for the acquisition was deferred so that £100 000 was payable after one year, £150 000 after two years and the balance after three years. Show your calculations.

(ii) Calculate the goodwill to be dealt with in the consolidated accounts for the years ending 31 July 1996 and 1997, explaining clearly the effect of deferred and con- tingent  consideration.

(iii) Explain and critically discuss the existing regulations for the treatment of negative goodwill.