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Shift to IFRS may affect M&As
March, 11th 2011

Companies preparing for acquisitions in the coming fiscal year face two big challenges.

One, companies will need an approval from the Competition Commission of India, or CCI, if the acquisition size is above a specific thresholda new regulatory requirement.

Two, the convergence to the International Financial Reporting Standards, or IFRS, from April will hurt their profits as intangibles will be recorded at fair value.

The ministry of corporate affairs has over the past few days notified 32 accounting standards, also known as Ind-AS, to help converge the Indian Accounting Standards with IFRS.

It also notified provisions on mergers and acquisitions (M&As) for CCI to scrutinize the transactions before they are executed.

There were at least 1,200 M&A deals in India in 2009 involving $20 billion (Rs.90,000 crore), mainly in the oil, gas, pharma and biotech sectors, according to audit and consultancy firm PricewaterhouseCoopers (PWC).

Experts warn that companies need to watch their post-merger profits under the converged IFRS regime.

This is because intangibles such as brands, customer relationships, know-how, acquisition costs and contingent considerationall integral to any M&Awill have to be reported at fair value. Accordingly, depreciation or amortization costs will increase.

In a merger, fair value of net assets acquired would include intangibles arising on the acquisition, said Rahul Chattopadhyay, partner, Price Waterhouse, a unit of PWC. While most intangibles would need to be amortized over their respective useful lives and, therefore, meaning a charge in the income statement, some like goodwill would be tested for impairment annually.

Under Indian GAAP (generally accepted accounting principles), there is no strict standard on business combinations and these items were, therefore, either not accounted for or were shifted to reserves.

The Ind-AS on business combinations is consistent on requirements under IFRS. Jamil Khatri, executive director and head of accounting advisory services at audit and consulting firm KPMG in India, said previously unrecorded intangibles will have to be recorded by the acquirer. Besides, several of these intangibles will need to be amortized through the profit and loss account post-acquisition, said Khatri.

Chattopadhyay, too, said as goodwill will be treated differently under IFRS, profits may suffer. Goodwill is the excess consideration paid for an acquisition over the fair value of the net assets acquired. Under Indian GAAP, goodwill is measured on the book value and is often accounted for in reserves.

Charanjit Attra, chief financial officer of ICICI Securities Ltd, agrees. Under Indian GAAP, goodwill and intangible assets are amortized over a period of 5-10 years. Under IFRS, goodwill is not amortized but tested for impairment on an annual basis. Impairment will lead to a hit in the bottomline, he said.

Another change is that all acquisition-related costs such as legal expenses and investment banker fees will be expensed as incurred and not capitalized, as done now. Thus, there may be one-time charges in periods around M&A activity, said Khatri. Contingent consideration would also need to be recognized at fair value as at the date of acquisition, affecting income statements. Currently, this is recorded as an additional acquisition cost and the amount is determined when a contingency is resolved. Contingent consideration is a promised balance sum to be paid by the acquirer based on future earnings.

As for the first challenge, two groups of Indian firms involved in an acquisition have to notify CCI on the proposed deal if their combined annual revenue exceeds Rs.12,000 crore.

Two merging foreign firms with Indian presence will have to notify the watchdog if their combined annual sales exceeds $1.5 billion (Rs.6,750 crore). For global groups, the threshold is a combined revenue of $6 billion, with Indian subsidiaries having a combined sales of Rs.1,500 crore.

Dhanendra Kumar, chairman of CCI, said last week the watchdog will clear 90-95% of deals within 30 days and only 5-7% would need 180 days, the maximum period stipulated by CCI under the new draft regulation posted on its website on 1 March.

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