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Dealing with M&As under new accounting standards

While Ind AS 103 provides beneficial guidance in written standards, conceptual clarity would dawn only upon implementation

Dealing with M&As under new accounting standards

As the Indian Accounting Standards (Ind AS) reporting is set to commence its first season for category-1 companies in India—and while the transition will force companies to address a whole raft of new standards—many might need to unravel the challenges in implementing Ind AS 103-Business Combinations, if they have made an acquisition during the transition period and beyond.

The basic purpose of Ind AS 103 is improving the transparency of acquisition accounting, which was opened to varied interpretations in the past. Ind AS 103 requires, in essence, that all assets on an acquisition, both tangible and intangible, be restated at their market values when accounting for the acquisition.

So, what are the key implications on financial statements from Ind AS 103?

Profit & loss statement

Goodwill amortisation as per the old standard will no longer be required. Instead, amortisation of intangible assets recognised and goodwill on acquisition will step in. There could be charges for impairment where carrying value of intangible assets and/or goodwill is higher than its value. Acquisition costs, which formed part of goodwill in many instances, might have to be written off and included as part of operating costs.

Balance sheet

In case Ind AS 103 is adopted prospectively, goodwill on the balance sheet will be a combination of goodwill brought forward at the date of adoption of Ind AS less pre-Ind AS amortisation, plus post-Ind AS goodwill at the dates of acquisitions and less impairment charges.

Some intangible assets will be stated at their historic valuations, and some intangible asset values will be at fair value less charges for amortisation and impairment.

Inventories taken over on acquisition could be booked at fair value, which might be required to be adjusted for margins in the subsequent years. Further, fresh inventory of similar products post-acquisition will be required to be valued at cost or NRV.

Other factors

Ind AS 103 prohibits use of pooling of interest method for business combination. Pooling method is permitted only for common control transactions. This will significantly impact acquisition strategies of various companies.

In revaluing intangible assets, care needs to be taken to eliminate overlap, as they may be double counted when valued separately (such as brand and customer relationship values, etc). Further, obtaining an independent fair value for such assets on consistent basis will be a challenge.

The management and auditors may need to deliberate on putting a comfortable useful life estimate for intangible assets such as brands and mastheads.

Under AS 14, goodwill is presumed to have a useful life not exceeding five years and is amortised over that period. Under Ind AS 103, amortisation is not permitted and existing partially amortised goodwill is frozen at its net amount at the date of transition.

Impairment testing of goodwill is already a requirement under AS 14, if circumstances indicate that the carrying value may not be recoverable. In practice, this happens rarely as amortisation steadily reduces the carrying value.

Under Ind AS 103, however, goodwill impairment becomes a much bigger issue and tests have to be carried out annually. Any impairment of goodwill is deemed to be permanent and cannot be reversed in the future. As goodwill does not generate cash flows directly, it must be assigned to a cash generating unit and it is the total value of all the assets, including goodwill, of the cash generating unit (CGU) that is compared to the value of future cash flows. In the event of a shortfall, the goodwill is reduced in value by a charge to profit.

Merger accounting is not permitted under Ind AS 103, and one of the entities agreeing to the transaction must be identified as the acquirer, and must apply the purchase method to the transaction.

Contingent liabilities of the acquired entity will be recognised if its fair value can be measured reliably.

Under AS 14, the appointed date is considered as a date from which control is deemed to be obtained, even though the scheme becomes effective on the approval of the High Court which is much later than the appointed date. Under Ind AS 103, this is likely to change. Ind AS 103 requires accounting for acquisition from the date when entity obtains control—considering the importance of the High Court approval, it is likely that control will be assessed to be obtained only when High Court approves the scheme. Accordingly, net assets will be recorded at the fair value on the date when the High Court approval is obtained. Hence, results between appointed date and effective date will not be reflected in the acquirer’s financial statement.

Deferred tax must be provided in full on the fair value adjustments to the book values of acquired assets, but not on the initial recognition of goodwill.

Although the taxation laws have not been amended, but new accounting concepts could impact the calculation of MAT liability.

We would, therefore, suggest that although Ind AS 103 provides beneficial guidance in written standards, the fact remains that conceptual clarity would dawn only upon implementation.

The author is partner, Audit & Assurance, MZSK & Associates—the member firm of BDO International in India

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First published on: 03-09-2015 at 00:18 IST
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