India is a booming economy attracting corporate players and capital funding around the globe. In recent times, dynamic Indian business houses have shown a keen interest in expanding their landscape presence into global markets through acquisitions or joint ventures. The challenge of moving into this phase of growth has magnified with the increasing focus on quality and transparency of financial reporting by various stakeholders and the challenging financial reporting regulations. On the contrary, global leading companies have consolidated with Indian corporates to expand their presence in the domestic landscape.
The precise definition of Consolidation in business means any amalgamation like merger or acquisition of many smaller companies into a few much larger ones. In the context of financial accounting, consolidation refers to the aggregation of financial statements of a group company as a single consolidated financial statement.
Why are corporations keen to consolidate in India?
Let’s assume you own a company which is into the business of plastic bottle manufacturing. After an extensive discussion with your management team, you decide to consolidate with a leading plastic material supplier.
- The first and foremost reason for consolidation in the back of your mind lies in the fact that it increases the shareholder’s wealth. Mergers or acquisitions improves the strength and profitability of the dominant company by means of growth and diversifying into different sectors of the economy. For instance, the banking sector saw Kotak Mahindra taking ING Vysya Bank in November 2014 in an all-stock deal valued at over 15,000 crore INR which opened the doors of opportunity to build robust banking franchise system in India. Consolidation results in reduced overheads by way of shared marketing budgets increased purchasing power and lower costs.
- Corporations merging in the same businesses can achieve a higher output through synergy benefits, thereby, economies of scale come into play. India’s e-commerce sector is a hotbed of consolidation activity. Likewise, with large global players like Amazon and Uber taking on a dominant role with their deep pockets, the sector is now in consolidation mode, which has become an imperative need for survival for many.
- Your company might emerge as a leading company surpassing international competition by reducing competition. By consolidating with rivals, many firms often deal with the threat of multinationals & compete on an international scale.
- The need to maintain many accounts vanishes. Companies that merge do not need to keep subsidiary accounts open any longer for a variety of reasons. As a result, they can be eliminated from the consolidated financial statements. They record debits for the subsidiary’s account balances of common stock, retained earnings and paid-in capital and credit for subsidiary account investments to close out the accounts. Any inter-company transactions between the companies involved in the merger can also be eliminated. Like, any advances, dividends and bonds on accounts receivable or accounts payable between the companies involved in the merger can be eliminated within the balance sheet.
- The rationale for presenting consolidating rather than separate financial statements for companies post consolidation is that the commonality of ownership creates a single economic entity, even though there are several legal entities. Issues in the context of purchase method versus the pooling of interest method of accounting for business combinations has received considerable attention over the years. Although the matter of purchase versus pooling is really a question of acquisition accounting, the choice of method impacts subsequent consolidate statements.
The list of advantages for the amalgamation of corporates is not exhaustive and it can be access to foreign capital, access to new markets, be it new geographies, new products or new lines of business and so forth. It is pretty interesting to see that several sectors in India are in consolidation mode. The renewable energy sector witnessed Tata Power acquiring Welspun Energy’s assets in June 2016 in a deal valued at over 9,000 crore INR which emerged out to be a successful merger. It is clearly visible that the importance of the growth of consolidation of corporates cannot be ignored when India is witnessing so many acquisitions and mergers.
What problems are plaguing the consolidation of Indian corporations?
Consolidation of corporates is not easy for professionals and accountants when two entities consolidate within the domestic landscape. Some of the key questions inter-alia include:
- Identifying entities that will be regarded as subsidiaries, associates or joint ventures. Further, with the application of IND AS, the identification of entities to be consolidated might also change and the procedure for identification as well as the elimination of inter-company transactions.
- Accounting for historical acquisitions like opening balance sheet, purchase price allocation, computing goodwill and so on and how different ERP/IT systems across geographies and entities will be installed.
- If Company A is preparing the financials on the erstwhile IGAAP norms and Company B is following the IND AS basis of financial statement preparation then accounting issues relating to the ambiguity of data arises.
- What will be the treatment of losses of one entity in the books of accounts of the ownership entity post consolidation and how these losses will be set off or carried forwarded?
- When consolidating entities having complex capital structures. If preference shareholders are not made any offer during the takeover, they might become a minority of the group and are included in the calculation of minority interest of the entity.
- The appropriateness of consolidated reporting has long been accepted, although there has been a debate on how universal consolidation policy should be and the circumstances under which subsidiaries should or should not be accepted.
What issues need to be dealt with while consolidating at the international front?
Consolidation isn’t easy when two entities seek cross-border acquisition or merger. Let’s have a look at the major issues:
- Defining and aligning Group Chart of Accounts (GcoA) and streamlining multiple accounting practices and standards across various group entities.
- Developing group reporting packs for collation of information from multiple entities/locations and how to answer different accounting periods for different group entities.
- What price should the product or service be offered to the public and how it shall be reflected in the books of accounts need to be addressed. Transfer Pricing regulations from section 92 to 92F of Income Tax Act, 1961 must be looked at for fair pricing of any transaction.
- Consolidation is affected by many legal issues ranging from regulatory issues, environmental matters to intellectual property including trademarks and patents. If one company has government-mandated environmental cleanup issues that are costly, the other company may not want to participate in consolidation.
- Buyers and sellers during consolidation face many tax considerations that require planning. Sellers will want to minimize and defer tax while buyers will want to accelerate tax benefits. How the advent of General Anti Avoidance Rule (GAAR) and Base Erosion and Profit Shifting (BEPS) will impact the global mergers of the corporation?
Author | Kshitij Chitransh