A new chapter in M&A accounting

Updated on: Sep 29, 2013
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The new company law prohibits the creation of treasury shares in a merger and acquisition scheme.

Many companies use merger-and-acquisition schemes to restructure business for reasons ranging from unlocking valuation, rationalising operations and tax benefits to splitting the family wealth. Historically, companies have also used them to clean up balance sheets.

Some companies, for example, have used them to write off expenses or impairment loss directly against the securities premium or other reserves, instead of charging them to profit and loss. This helped present a better P&L and EPS (earnings per share).

To address these anomalies and ensure compliance with accounting standards, listed companies since April 2010 are required to submit an auditor’s certificate stating that the treatment in an M&A scheme complies with accounting standards.

For non-listed companies, the responsibility to ensure compliance rested with the Regional Directors/ Registrar of Companies. Under the new Companies Act, the National Company Law Tribunal will not sanction any M&A scheme unless the company’s auditor certifies compliance with accounting standards.

Hence, all companies, including non-listed, should comply. This will significantly reduce the opportunities for balance sheet clean-up available to non-listed companies.

However, some opportunities may still be available. For example, no standard prohibits adjustment of debit balance in P&L against the securities premium, if the adjustment is directly through balance sheet transfer.

Certain schemes, previously sanctioned by courts, allow departures from accounting standards not only at the appointed date, but also going forward. For example, a court scheme may have permitted write-off of goodwill impairment/ amortisation for the next 10 years directly against reserves rather than through P&L. It may be argued that the new Act applies only to new schemes approved after its enactment and not earlier.

Another area where the new Act may significantly impact M&A accounting is treasury shares. Under the old Act, companies have used M&A schemes to invest in own shares (treasury shares).

Some companies with treasury shares recognise the dividend income and gain/ loss arising on sale of these shares in P&L. The new Act prohibits the creation of treasury shares in an M&A scheme and, hence, these practices will cease. As the new Act is silent on treasury shares previously held by companies, the restriction will seemingly apply only to new treasury shares.

Currently, no notified accounting standard deals with demerger accounting. The draft rules uploaded online by the Ministry of Corporate Affairs on September 20, 2013, contain specific guidance on such accounting.

The draft rules propose that accounting will follow the conditions stipulated in section 2(19AA) of the Income-tax Act. The demerged company will transfer assets and liabilities at book value. It will recognise the difference between the value of assets and liabilities as capital reserve/ goodwill. The resulting company will recognise assets and liabilities at book value. Shares issued will be credited to share capital account. The excess or deficit will be recognised as capital reserve/ goodwill.

While one appreciates the concern arising from the absence of specific guidance on demerger accounting, it is incorrect to prescribe accounting based on the Income-tax Act requirements.

Accounting treatment should be governed by accounting standards. Also, the draft rules assume a very simple example of demerger to prescribe accounting. In practice, it may involve complex structures. Moreover, the accounting proposed is restrictive and limited.

To illustrate, for a demerged company, treating the difference as goodwill/ capital reserve is one option.

Other possibilities not discussed include treating it as investment in the resulting company or as substance distribution to shareholders. Similarly, for the resulting company, it may be possible to use AS-14 analogy and apply the pooling of interest method. This results in adjustment of surplus or deficit to reserves. The Corporate Affairs Ministry should revisit the matter.

(The author is a senior professional in a member firm of Ernst & Young Global)

Published on September 29, 2013

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