While the India Inc is fully geared up for the first time convergence of Indian Accounting Standards (Ind IAS) to International Accounting Standards, there are many clauses in the new Ind IAS which are subject to judgment/ interpretation and one of those is around determining the Acquisition date as per Ind IAS 103 for Consolidated Financial Statements.
Under the roadmap of the Corporate Affairs Ministry, Ind IAS would be mandatory for companies whose equity and/or debt securities are listed or are in the process of listing on any stock exchange in India or outside India and having net worth of Rs 500 crore or more, from April 1, 2016.
Ind IAS 103 provides guidance around Business Combinations accounting to improve the relevance, reliability and comparability of the information that a reporting entity provides in its financial statements about a business combination and its effects. The applicability of this standard is changing the landscape for merger & acquisition deals in India, since it has impacted the accounting, recording of assets & liabilities and accordingly the book profits for shareholder’s EPS calculation and tax computations.
The standard clearly lays guidance for identifying a business combination, which requires that the assets acquired and liabilities assumed constitute a business and mere acquisition of assets are not a business.
An entity shall account for each business combination by applying the acquisition method. Applying the acquisition method requires:
(a) identifying the acquirer;
(b) determining the acquisition date;
(c) recognising and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; and
(d) recognising and measuring goodwill or a gain from a bargain purchase.
The Acquisition date determination is a key as Ind IAS 103 requires mandatory use of purchase method of accounting for business combination. It also mandates recording of all assets acquired and liabilities assumed to be recorded at fair value. As per para 18 of the standard, the acquirer shall measure the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values.
Para 8 and 9 of the standard, provides guidance of determining the acquisition date. ‘The acquirer shall identify the acquisition date, which is the date on which it obtains control of the acquiree. The date on which the acquirer obtains control of the acquiree is generally the date on which the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquiree—the closing date. However, the acquirer might obtain control on a date that is either earlier or later than the closing date. For example, the acquisition date precedes the closing date if a written agreement provides that the acquirer obtains control of the acquiree on a date before the closing date. An acquirer shall consider all pertinent facts and circumstances in identifying the acquisition date.”
In many cases, the acquisition date depends on shareholders and regulatory approvals required to transfer the control. As per interpretation, it’s being contended by various corners and there is a view floating that considering the importance of High Court approval in merger, it is likely that control will be assessed to be obtained only when High Court approves the scheme. This will mean that acquisition accounting will be done on the date when entity obtains control i.e. when High Court approval is obtained. Net assets will be recorded at the fair value on the date when High Court approval is obtained. However, I have a personal view which is different from above and determination of acquisition date is not as crystal clear as mentioned above. It will require management to exercise significant judgment to determine when an acquired entity is controlled.
As per Ind IAS 103, the control is defined as the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. While the Ind IAS 110 – Consolidated Financial Statements, gives detailed definition with examples. The definition of control for purpose of consolidation as per Ind IAS 110 is given as below:
An investor consolidates an investee when it controls the investee. The investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. This principle applies to all investees, including structured entities. An investor must possess all of the following elements to be deemed to control an investee:
- Power over the investee, which is described as having existing rights that give the current ability to direct the activities of the investee that significantly affect the investee's returns (such activities are referred to as the 'relevant activities')
- Exposure, or rights, to variable returns from its involvement with the investee
- Ability to exert power over the investee to affect the amount of the investor's returns
Ind IAS 110 has been taken from IFRS10, which when become first applicable in year 2013, it was quoted by finance experts in Industry that significant judgment may be required to determine whether an investor has control.
Ind IAS 110 states that in order to apply the control model, several initial steps are necessary before the assessment of whether each of the three elements of control are present. These steps are:
- Identify the investee
- Understand the purpose and design of the investee
- Identify the relevant activities of the investee and how decisions about these relevant activities are made
Ind IAS110 provides additional application guidance regarding situations in which the assessment of control is difficult including those involving:
- Power without a majority of voting rights (i.e. de facto power);
- Potential voting rights (held by the investor or others);
- Agency relationships; and
- Relationships with entities designed so that voting rights are not the dominant factor in assessing control (referred to hereafter as “structured entities”).
Relevant activities are the activities of the investee that significantly affect the investee’s returns. Examples of activities that, depending on the circumstances, can be relevant activities include: Selling and purchasing of goods or services; determining a funding structure or obtaining funding; Appointing, remunerating and terminating an investee’s key management etc. Determining what constitutes the relevant activities of the investee requires judgment.
Also it will be relevant to note that as per MCA Notification G.S.R. 111(E) dated February 16, 2015 for Ind IAS implementation, “Annexure A. General Instruction. - (1) Indian Accounting Standards, which are specified, are intended to be in conformity with the provisions of applicable laws. However, if due to subsequent amendments in the law, a particular Indian Accounting Standard is found to be not in conformity with such law, the provisions of the said law shall prevail and the financial statements shall be prepared in conformity with such law.” It means that in the case of conflict, the Indian law should prevail. Hence, the management will also have to refer to provisions on Merger and amalgamation of companies, as specified in Companies Act 2013 as per Section 232 (6) on appointment date and the various case laws/ Apex court rulings on appointment date as per Income tax Act, 1961.
Conclusion: Considering that determining whether the acquirer entity has obtained control of the acquiree, requires significant judgment there lies ambiguity in determining the acquisition date for any business combination which is key for fair valuation of assets & liabilities for consolidation of financial statements as per purchase method of accounting. Since year 2016, is the first year for adoption of Ind IAS 103 for many Indian Corporate, I believe that acquisition date determination will require expert advice and is subject to judgment by management.