There are currently two possible methods of preparing consolidated financial statements when two or more separate legal entities combine to form a single economic entity in the form of a group. The most commonly used method is the acquisition method. However, another method is sometimes appropriate when two or more separate legal entities unite into one economic entity by means of an exchange of equity shares. This method is known as the merger method.

Recent developments suggest that Standard setters are considering a change that would prevent the merger method ever being used and require that the acquisition method be used to prepare consolidated financial statements following a business combination.

Top plc and Bottom plc are two listed companies that operate in the same sector. The two sets of directors have been speculating for some time that it would be in the mutual interest of the two companies to combine together to form a single economic entity while maintaining the separate legal status of the two companies. Accordingly, on 30 April 2001 Top plc made an offer to all the equity shareholders of Bottom plc to acquire their shares. The terms of the offer were 4 equity shares in Top plc for every 3 equity shares in Bottom plc. The offer was accepted by all the equity shareholders in Bottom plc and the exchange of equity shares took place on 31 May 2001. The directors of Top plc wish to use merger accounting to prepare the consolidated financial statements for the year ended 31 January 2002. Any computational work in this question should assume that merger accounting principles will be adopted.

The relevant profit and loss accounts and balance sheets of Top plc and Bottom plc are given below:

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Profit and loss accounts-year ended 31 January 2002 Top plc Bottom ple 000 000 Turnover Cost of sales 80 000 (40000) 75000 (38000) Gross profit 40000 37000 Other operating expenses (10000) (9000) Operating profit 30000 28000 Investment income 10000 Interest payable (5500) (4000) Profit before taxation 34500 24000 Taxation (7500) (7000) Profit after taxation 27000 17000 Dividends paid 30 November 2001 (15000) (10000) Retained profit 12000 7000 Retained profit - 1 February 2001 20000 18000 Retained profit-31 January 2002 32000 25000 Balance sheets at 31 January 2002 Top plc Bottom ple 000 000 Tangible fixed assets 89000 65000 Investments - see Note 1 [below] 40 800 Net current assets 27200 25000 Loans (25000) (20000) 132000 70000 Called-up share capital - 1 equity shares 84000 30000 Share premium account 10000 11000 Revaluation reserve 6000 4000 Profit and loss account 32000 25000 132000 70000