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Foreign investment is picking up speed as many Indian corporates are making acquisitions abroad. Companies have various avenues to create an overseas presence, such as setting up branch offices, wholly-owned subsidiaries and so on. The structure of such outbound investments have significant accounting implications.
In Indian GAAP (Generally Accepted Accounting Principles) there is no comprehensive standard for acquisitions. Standards vary for different types of investments. AS 14 Accounting for amalgamations applies only where the acquired entity loses its identity. AS 21 Consolidated Financial Statements applies to investments in subsidiaries, and AS 10 Accounting for fixed assets applies to acquisition of businesses.
Unlike International Financial Reporting Standards (IFRS), Indian GAAP does not require fair value accounting in most cases. However, accounting challenges arise due to the ambiguity in Indian GAAP. There are several accounting challenges facing companies that make outbound investments.
‘Earn out' arrangements
Many business combinations contain both an upfront payment as well as the potential for additional payments in the future, which are conditional on specific events and are often referred to as ‘earn outs'. Currently Indian GAAP does not provide detailed guidance on accounting for earn outs. However, AS 14 states that the additional payment should be included in the consideration if the payment is probable and the amount can be reasonably estimated.
In the absence of a detailed guidance and by using AS 14 analogy, most Indian companies adjust future payments to the goodwill/capital reserve arising on an acquisition. In many cases, earn-out payouts are for future services, which need to be accounted separately. Companies should understand carefully the accounting consequences of earn-out arrangements to avoid any surprises in the future.
Acquisition-related costs
Currently there is no specific guidance on accounting for acquisition-related costs under Indian GAAP. In practice, most companies consider acquisition-related cost for goodwill calculation, which is not in accordance with IFRS or Ind AS, which categorise such costs under income statement. In many cases, such costs are significant. The policy adopted by a company will have a significant bearing on its financial performance.
Accounting for goodwill
Under Indian GAAP, treatment of goodwill differs for different standards. Goodwill arising on amalgamation in the nature of purchase is amortised to income statement over a period not exceeding five years. Goodwill arising under AS 21 need not be amortised, though there is no prohibition.
As pointed above, there is no specific guidance on accounting for goodwill in the case of business combinations. Hence, companies should establish an accounting policy for goodwill and follow it consistently.
Indian GAAP also does not provide any specific guidance on accounting for pre-existing relationships, re-acquired rights, indemnification assets and so on in a business combination.
Reverse GAAP conversion
Acquisition accounting is normally based on book value under Indian GAAP. Hence companies would need to convert the financials of the acquired company into Indian GAAP for consolidation. If the acquired entity is a complex group, then GAAP conversion may involve significant time and cost. Other challenges include alignment of material accounting policies and practices of the acquirer and the acquired entity.
Post-acquisition issues
Post-acquisition, it is often the finance team's responsibility to deliver the purchase accounting information and ongoing financial reporting. The company has to integrate the target's accounting processes into group-wide reporting requirements. This may require developing or updating group accounting manuals and internal control system to ensure appropriate reporting.
Early planning, effective project management, and resolution of accounting issues and challenges are vital for smooth integration and communication of post-acquisition results to various stakeholders.
The author is Partner in a member firm of Ernst & Young Global
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