What Is an Amalgamation?

An amalgamation is a combination of two or more companies into a new entity. Amalgamation is distinct from a merger because neither company involved survives as a legal entity. Instead, a completely new entity is formed to house the combined assets and liabilities of both companies.

The term amalgamation has generally fallen out of popular use in the United States, being replaced with the terms merger or consolidation even when a new entity is formed. But it is still commonly used in countries such as India.

Understanding Amalgamations

Amalgamation typically happens between two or more companies engaged in the same line of business or those that share some similarity in operations. Companies may combine to diversify their activities or to expand their range of services.

Since two or more companies are merging together, an amalgamation results in the formation of a larger entity. The transferor company—the weaker company—is absorbed into the stronger transferee company, thus forming an entirely different company. This leads to a stronger and larger customer base, and also means the newly formed entity has more assets.

Amalgamations generally take place between larger and smaller entities, where the larger one takes over smaller firms.

The Pros and Cons of Amalgamations

Amalgamation is a way to acquire cash resources, eliminate competition, save on taxes, or influence the economies of large-scale operations. Amalgamation may also increase shareholder value, reduce risk by diversification, improve managerial effectiveness, and help achieve company growth and financial gain.

On the other hand, if too much competition is cut out, amalgamation may lead to a monopoly, which can be troublesome for consumers and the marketplace. It may also lead to the reduction of the new company’s workforce as some jobs are duplicated and therefore make some employees obsolete. It also increases debt: by merging the two companies together, the new entity assumes the liabilities of both.

Amalgamation Procedure

The terms of amalgamation are finalized by the board of directors of each company. The plan is prepared and submitted for approval. For instance, the High Court and Securities and Exchange Board of India (SEBI) must approve the shareholders of the new company when a plan is submitted.

The new company officially becomes an entity and issues shares to shareholders of the transferor company. The transferor company is liquidated, and all assets and liabilities are taken over by the transferee company.

Example of Amalgamation

In late 2021, it was announced that media companies Time Warner and Discovery, Inc. would combine in a deal worth an estimated $43 billion. Owned by AT&T, Time Warner (which the telecom company acquired in 2018) would be spun off and then amalgamated with Discovery. The new entity, known as Warner Bros. Discovery, Inc., is expected to close at some point in late 2022 and will be headed by Discovery CEO David Zaslav.

Types of Amalgamation

One type of amalgamation—similar to a merger—pools both companies’ assets and liabilities, and the shareholders’ interests together. All assets of the transferor company become that of the transferee company.

The business of the transferor company is carried on after the amalgamation. No adjustments are made to book values. Shareholders of the transferor company holding a minimum of 90% face value of equity shares become shareholders of the transferee company.

The second type of amalgamation is similar to a purchase. One company is acquired by another, and shareholders of the transferor company do not have a proportionate share in the equity of the combined company. If the purchase consideration exceeds the net asset value (NAV), the excess amount is recorded as goodwill. If not, it is recorded as capital reserves.

What Is an Allowance for Bad Debt?

An allowance for bad debt is a valuation account used to estimate the amount of a firm’s receivables that may ultimately be uncollectible. It is also known as an allowance for doubtful accounts. When a borrower defaults on a loan, the allowance for bad debt account and the loan receivable balance are both reduced for the book value of the loan.

How an Allowance for Bad Debt Works

Lenders use an allowance for bad debt because the face value of a firm’s total accounts receivable is not the actual balance that is ultimately collected. Ultimately, a portion of the receivables will not be paid. When a customer never pays the principal or interest amount due on a receivable, the business must eventually write it off entirely.

Methods of Estimating an Allowance for Bad Debt

There are two primary ways to calculate the allowance for bad debt. One method is based on sales, while the other is based on accounts receivable.

Sales Method

The sales method estimates the bad debt allowance as a percentage of credit sales as they occur. Suppose that a firm makes $1,000,000 in credit sales but knows from experience that 1.5% never pay. Then, the sales method estimate of the allowance for bad debt would be $15,000.

Accounts Receivable Method

The accounts receivable method is considerably more sophisticated and takes advantage of the aging of receivables to provide better estimates of the allowance for bad debts. The basic idea is that the longer a debt goes unpaid, the more likely it is that the debt will never pay. In this case, perhaps only 1% of initial sales would be added to the allowance for bad debt.

However, 10% of receivables that had not paid after 30 days might be added to the allowance for bad debt. After 90 days, it could rise to 50%. Finally, the debts might be written off after one year.

Requirements for an Allowance for Bad Debt

According to generally accepted accounting principles (GAAP), the main requirement for an allowance for bad debt is that it accurately reflects the firm’s collections history. If $2,100 out of $100,000 in credit sales did not pay last year, then 2.1% is a suitable sales method estimate of the allowance for bad debt this year. This estimation process is easy when the firm has been operating for a few years. New businesses must use industry averages, rules of thumb, or numbers from another business.

Default Considerations

When a lender confirms that a specific loan balance is in default, the company reduces the allowance for doubtful accounts balance. It also reduces the loan receivable balance, because the loan default is no longer simply part of a bad debt estimate.

Adjustment Considerations

The allowance for bad debt always reflects the current balance of loans that are expected to default, and the balance is adjusted over time to show that balance. Suppose that a lender estimates $2 million of the loan balance is at risk of default, and the allowance account already has a $1 million balance. Then, the adjusting entry to bad debt expense and the increase to the allowance account is an additional $1 million.

What Is the Average Cost Basis Method?

The average cost basis method is a system of calculating the value of mutual fund positions held in a taxable account to determine the profit or loss for tax reporting. Cost basis represents the initial value of a security or mutual fund that an investor owns.

The average cost is then compared with the price at which the fund shares were sold to determine the gains or losses for tax reporting. The average cost basis is one of many methods that the Internal Revenue Service (IRS) allows investors to use to arrive at the cost of their mutual fund holdings.

Understanding the Average Cost Basis Method

The average cost basis method is commonly used by investors for mutual fund tax reporting. A cost basis method is reported with the brokerage firm where the assets are held. The average cost is calculated by dividing the total amount in dollars invested in a mutual fund position by the number of shares owned. For example, an investor that has $10,000 in an investment and owns 500 shares would have an average cost basis of $20 ($10,000 / 500).

Types of Cost Basis Methods

Although many brokerage firms default to the average cost basis method for mutual funds, there are other methods available.

FIFO

The first in, first out (FIFO) method means that when shares are sold, you must sell the first ones that you acquired first when calculating gains and losses. For example, let’s say an investor owned 50 shares and purchased 20 in January while purchasing 30 shares in April. If the investor sold 30 shares, the 20 in January must be used, and the remaining ten shares sold would come from the second lot purchased in April. Since both the January and April purchases would have been executed at different prices, the tax gain or loss would be impacted by the initial purchase prices in each period.

Also, if an investor has had an investment for more than one year, it would be considered a long-term investment. The IRS applies a lower capital gains tax to long-term investments versus short-term investments, which are securities or funds acquired in less than one year. As a result, the FIFO method would result in lower taxes paid if the investor had sold positions that were more than a year old.

LIFO

The last in first out (LIFO) method is when an investor can sell the most recent shares acquired first followed by the previously acquired shares. The LIFO method works best if an investor wants to hold onto the initial shares purchased, which might be at a lower price relative to the current market price.

High-Cost and Low-Cost Methods

The high-cost method allows investors to sell the shares that have the highest initial purchase price. In other words, the shares that were the most expensive to buy get sold first. A high-cost method is designed to provide investors with the lowest capital gains tax owed. For example, an investor might have a large gain from an investment, but doesn’t want to realize that gain yet, but needs money.

Having a higher cost means the difference between the initial price and the market price, when sold, will result in the smallest gain. Investors might also use the high-cost method if they want to take a capital loss, from a tax standpoint, to offset other gains or income.

Conversely, the low-cost method allows investors to sell the lowest-priced shares first. In other words, the cheapest shares you purchased get sold first. The low-cost method might be chosen if an investor wants to realize a capital gain on an investment.

Choosing a Cost-Basis Method

Once a cost basis method has been chosen for a specific mutual fund, it must remain in effect. Brokerage firms will provide investors with appropriate annual tax documentation on mutual fund sales based on their cost basis method elections.

Investors should consult a tax advisor or financial planner if they are uncertain about the cost basis method that will minimize their tax bill for substantial mutual fund holdings in taxable accounts. The average cost basis method may not always be the optimal method from a taxation point of view. Please note that the cost basis only becomes important if the holdings are in a taxable account, and the investor is considering a partial sale of the holdings.

Specific Identification Method

The specific identification method (also known as specific share identification) allows the investor to choose which shares are sold in order to optimize the tax treatment. For example, let’s say an investor purchases 20 shares in January and 20 shares in February. If the investor later sells 10 shares, they can choose to sell 5 shares from the January lot and 5 shares from the February lot.

Example of Cost Basis Comparisons

Cost basis comparisons can be an important consideration. Let’s say that an investor made the following consecutive fund purchases in a taxable account:

• 1,000 shares at $30 for a total of $30,000
• 1,000 shares at $10 for a total of $10,000
• 1,500 shares at $8 for a total of $12,000

The total amount invested equals $52,000, and the average cost basis is calculated by dividing $52,000 by 3,500 shares. The average cost is $14.86 per share.

Suppose the investor then sells 1,000 shares of the fund at $25 per share. The investor would have a capital gain of $10,140 using the average cost basis method. The gain or loss using average cost basis would be as follows:

• ($25 – $14.86) x 1,000 shares = $10,140.

Results can vary depending on the cost-basis method chosen for tax purposes:

• First in first out: ($25 – $30) x 1,000 shares = – $5,000
• Last in first out: ($25 – $8) x 1,000 = $17,000
• High cost: ($25 – $30) x 1,000 shares = – $5,000
• Low cost: ($25 – $8) x 1,000 = $17,000

From strictly a tax standpoint, the investor would be better off selecting the FIFO method or the high-cost method to calculate the cost basis before selling the shares. These methods would result in no tax on the loss. However, with the average cost basis method, the investor must pay a capital gains tax on the $10,140 in earnings.

Of course, if the investor sold the 1,000 shares using the FIFO method, there’s no guarantee that when the remaining shares are sold that $25 will be the selling price. The stock price could decrease, wiping out most of the capital gains and an opportunity to realize a capital gain would have been lost. As a result, investors must weigh the choice as to whether to take the gain today and pay the capital gains taxes or try to reduce their taxes and risk losing any unrealized gains on their remaining investment.

What Is Analysis of Variance (ANOVA)?

Analysis of variance (ANOVA) is an analysis tool used in statistics that splits an observed aggregate variability found inside a data set into two parts: systematic factors and random factors. The systematic factors have a statistical influence on the given data set, while the random factors do not. Analysts use the ANOVA test to determine the influence that independent variables have on the dependent variable in a regression study.

The t- and z-test methods developed in the 20th century were used for statistical analysis until 1918, when Ronald Fisher created the analysis of variance method. ANOVA is also called the Fisher analysis of variance, and it is the extension of the t- and z-tests. The term became well-known in 1925, after appearing in Fisher’s book, “Statistical Methods for Research Workers.” It was employed in experimental psychology and later expanded to subjects that were more complex.

The Formula for ANOVA is:


$\begin{aligned} &\text{F} = \frac{ \text{MST} }{ \text{MSE} } \\ &\textbf{where:} \\ &\text{F} = \text{ANOVA coefficient} \\ &\text{MST} = \text{Mean sum of squares due to treatment} \\ &\text{MSE} = \text{Mean sum of squares due to error} \\ \end{aligned}$​F=MSEMST​where:F=ANOVA coefficientMST=Mean sum of squares due to treatmentMSE=Mean sum of squares due to error​

What Does the Analysis of Variance Reveal?

The ANOVA test is the initial step in analyzing factors that affect a given data set. Once the test is finished, an analyst performs additional testing on the methodical factors that measurably contribute to the data set’s inconsistency. The analyst utilizes the ANOVA test results in an f-test to generate additional data that aligns with the proposed regression models.

The ANOVA test allows a comparison of more than two groups at the same time to determine whether a relationship exists between them. The result of the ANOVA formula, the F statistic (also called the F-ratio), allows for the analysis of multiple groups of data to determine the variability between samples and within samples.

If no real difference exists between the tested groups, which is called the null hypothesis, the result of the ANOVA’s F-ratio statistic will be close to 1. The distribution of all possible values of the F statistic is the F-distribution. This is actually a group of distribution functions, with two characteristic numbers, called the numerator degrees of freedom and the denominator degrees of freedom.

Example of How to Use ANOVA

A researcher might, for example, test students from multiple colleges to see if students from one of the colleges consistently outperform students from the other colleges. In a business application, an R&D researcher might test two different processes of creating a product to see if one process is better than the other in terms of cost efficiency.

The type of ANOVA test used depends on a number of factors. It is applied when data needs to be experimental. Analysis of variance is employed if there is no access to statistical software resulting in computing ANOVA by hand. It is simple to use and best suited for small samples. With many experimental designs, the sample sizes have to be the same for the various factor level combinations.

ANOVA is helpful for testing three or more variables. It is similar to multiple two-sample t-tests. However, it results in fewer type I errors and is appropriate for a range of issues. ANOVA groups differences by comparing the means of each group and includes spreading out the variance into diverse sources. It is employed with subjects, test groups, between groups and within groups.

One-Way ANOVA Versus Two-Way ANOVA

There are two main types of ANOVA: one-way (or unidirectional) and two-way. There also variations of ANOVA. For example, MANOVA (multivariate ANOVA) differs from ANOVA as the former tests for multiple dependent variables simultaneously while the latter assesses only one dependent variable at a time. One-way or two-way refers to the number of independent variables in your analysis of variance test. A one-way ANOVA evaluates the impact of a sole factor on a sole response variable. It determines whether all the samples are the same. The one-way ANOVA is used to determine whether there are any statistically significant differences between the means of three or more independent (unrelated) groups.

A two-way ANOVA is an extension of the one-way ANOVA. With a one-way, you have one independent variable affecting a dependent variable. With a two-way ANOVA, there are two independents. For example, a two-way ANOVA allows a company to compare worker productivity based on two independent variables, such as salary and skill set. It is utilized to observe the interaction between the two factors and tests the effect of two factors at the same time.