To enhance the quality of disclosures, SEBI has mandated that the offer document of a company going in for IPO should include, in addition to historical financial information, proforma financial statements if it acquires or divests a material subsidiary after the end of its latest disclosed annual financial results.

To explain, let’s say a company’s offer document includes financial statements for the year ended March 31, 2012. The company will include proforma financial statement in the offer document if it acquires or divests a material subsidiary on or after April 1, 2012. The Institute of Chartered Accountants of India recently issued its ‘Guide to Reporting on Proforma Financial Statements’.

Key points

SEBI’s decision on inclusion of proforma financial statements, and the ICAI’s guide are welcome. Presentation of proforma financial statement will provide stakeholders updated information on the likely impact a material acquisition/ divestment may have, by showing how it could have affected the company’s historical financial information if the transaction had taken place earlier.

Also, the requirement for proforma financial statement is likely to bring disclosures by Indian companies on par with global peers. Globally, some regulators call for a proforma financial statement if a company acquires a new business and/or disposes off an existing business, and the impact of such a move is not reflected in the historical financial statements. In the US, the Securities and Exchange Commission requires registrants or proposed registrants to prepare a proforma financial statement for significant business transactions.

Practical issues

The requirement for proforma financial statement applies only if a company has acquired/ divested material subsidiary. However, it does not apply in cases such as acquisition/ divestment of business division, or associate or joint venture.

As these acquisitions/ divestures can also be material and are not significantly different from an acquisition/ divesture of subsidiary, it is possible that SEBI may call for a proforma financial statement here too. A company may also present a proforma financial statement on a voluntary basis.

In proforma, a company can give effect to only the adjustments that are

directly attributable to the transaction, and

factually supportable.

The identification of such adjustments may involve significant judgment. A company may determine that management charges from a previous parent for supply of support services will not recur. However, it may not have factual support for the additional costs to be incurred. Hence, it may not make any adjustment for it and disclose the matter in notes.

The company prepares proforma profit-and-loss as if acquisition/ divestment occurred at the beginning of the period, and proforma balance sheet as if the transaction(s) occurred at balance sheet date. This requires the company to determine acquisition/ divesture effect on two different dates. Also, proforma financial statement will not reflect profit and loss, and balance sheet relationship, which is traditionally applied. For example, to prepare proforma profit and loss, the company will presume acquisition at the beginning of the year and determine amortisation/ impairment charge on goodwill accordingly. For preparing proforma balance sheet, it will assume that acquisition has happened at year-end. Hence, goodwill amount will not be reduced for amortisation/ impairment charge recognised in the proforma P&L.

For a company covered by the requirement, presentation of proforma financial statements will be a time-consuming process with peculiar challenges. Hence, such companies should familiarise themselves with the requirements in advance. From an investors’ perspective, the new requirement is welcome as it will provide more useful information for decision-making.

Vishal Bansal is senior professional in a member firm of Ernst & Young Global