Goodwill and intangibles acquired in merger-and-acquisition transactions represent synergies and benefits accruing to the acquiring enterprise. However, in India there are diverse practices in the recognition and measurement of these assets as there is no unified or single source of guidance in Indian GAAP (Generally Accepted Accounting Principles).

Today, the transaction structure determines the accounting; an asset acquisition is covered by AS-10, a court merger by AS-14, but everything else is practically left out. Further, even within AS-14, there are multiple options. However, most acquisitions today are through acquisition of a company, which is only covered by AS-21 through its guidance on consolidation procedures and which requires line-by-line consolidation of historical values. There is no recognition of the fact that what was acquired may not be reflected by the historically reported values of the acquired entity.

Key value drivers in most transactions today are the intangibles in a business. These could be customer relationships, customer contracts, technology and so on. As most of these intangibles are self-created they are often not recorded in the books of the selling company. However, to the acquirer, the value paid is principally for these elements. Based on current guidance, the value attributed to these elements is accounted as goodwill.

On subsequent measurement of goodwill, for transactions accounted as per AS-10, the standards state it is prudent to amortise, but not required. On the other hand, for goodwill arising on consolidation as per AS-21, there is no specific guidance, hence only tested for impairment if indicators exist. Further, goodwill arising out of a merger as per AS-14 is required to be amortised over five years. So, depending on the transaction structure used to acquire the business, the subsequent accounting is determined and impacts the recognised values on the balance sheet as well as the reported income in subsequent periods. The fact that the amount recorded as goodwill might actually represent some finite life assets is often not considered.

With the move towards convergence with IFRS (International Financial Reporting Standards) through Ind-AS, there is an attempt to harmonise accounting treatment and align Indian standards with international practice by introducing the concept of a business combination transaction and issuing a specific guidance for it.

According to IFRS and Ind-AS, a business combination is a transaction where an acquirer obtains control over one or more businesses, and such transactions may be structured as mergers, outright acquisitions or the creation of a new entity. The meaning of the term is, thus, quite wide and designed to cover typical types of M&A activity.

Accounting for business combinations follows the acquisition method, where a key element is the recognition and measurement of all identifiable assets acquired and liabilities assumed. Thus, intangibles that were not previously recognised — such as customer contracts, relationships, favourable lease arrangements and so on — are also separately identified and valued. Goodwill is the residual amount after allocation of the purchase consideration to the assets and liabilities taken over, including intangibles. The goodwill itself is not amortised but only tested for impairment on an annual basis.

Accounting using this guidance, therefore, helps enterprises communicate to key stakeholders in a much more transparent and measurable manner the business rationale and expected value addition.

This brings to light the myopic nature of existing accounting requirements under Indian standards ,where the economic substance or business logic underlying the acquisition is not really highlighted and varied practices exist on treatment of goodwill and intangibles in M&As. The standards are thus fairly outdated compared to international practice.

Ashish Gupta is Partner and Saurabh Mathur is Manager, Walker Chandiok & Co

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