Large Indian companies could report a sharp fall in the valuation of their assets as new accounting norms prompt these firms to reassess the fair value of their units, a mandatory condition under globalised reporting standards. Adoption of the International Financial Reporting Standards (IFRS), a modern accounting system that Indian companies have to migrate to from next year, could see local firms publicly admit to any erosion in the value of their subsidiaries or other assets — like Vodafone that recently shaved off $3.2 billion (about Rs 14,600 crore) from its Indian unit due to adverse market conditions.
Such instances may also be found in Indian companies that had acquired large foreign firms in the past three to four years as the global economic situation took a toll on most of these companies. Companies like Tata Steel, Tata Motors and Hindalco, that acquired big companies overseas through borrowed funds, paid additional amounts above the enterprise value for the goodwill of the foreign companies, that typically reflects the extra amount for synergy benefits, research and development and other off-balance sheet items.
These acquisitions have suffered a drop in their values due to the economic crisis. Such drop in values will now have to be reported by the companies and charged to their profit and loss accounts, which implies a run on their profitability, say auditors who deal with the financial statements of large Indian companies.
“Under IFRS, companies have to do an impairment test annually to determine what is the fair value of their business today, compared to the price at which it was acquired. If there is a fall, it is charged to the profit and loss account,” said Jamil Khatri, an executive director with global consulting firm KPMG. Tata Steel, which acquired UK’s Corus in 2007 in a high profile $12-billion transaction, was catapulted to the world’s sixth-largest steelmaker position that year, with the added benefits of a global customer profile.
However, the liquidity crisis in 2008 and the accompanying recession forced Corus to cut its output and close down units. Corus’s Teesside unit suffered the most after its main buyer walked off from a contract prompting the steel major to shut the unit. Indian brokerages estimate the loss from the closure to be about 15% of the output or about Rs 4,000 crore in value. A Tata Steel spokesperson said the company would not comment as it is scheduled to announce its earnings on May 26.
Tata Motors is also coming to terms with its acquisition of Jaguar Land Rover, the embattled UK auto maker that it bought for $2.3 billion in 2008. While JLR had also encountered slowing demand during the recession, Tata Motors introduced a series of restructuring measures to pare down high costs and a falling market share. In April, retail sales of Jaguar, which competes with German majors like BMW, Mercedes-Benz and Audi, fell 25% to 3,900 units. While JLR returned to profitability in the third quarter of fiscal 2010 — the first time since Tata Motors acquired the company — analysts say JLR may not be able to sustain the trend due to the debt crisis in Europe.
However, to get a perspective of the extent of possible write downs, it may be mentioned that in the past, from the period CY05 to the first quarter of CY08, Ford, the earlier owner of JLR made an impairment charge of $3.6 billion on its assets due to declining cash flows. Apart from direct loss in business, companies also suffer from a loss in intangibles like R&D, intellectual property, loyal customers and customer relations. The modern accounting norms also find it impossible to value such items.
“It’s high-time people realise that valuation of companies have shifted out of the tangibles. Testing the valuation of intangibles is different under IFRS-3. Even Western companies are grappling with the concept and it’s already showing in the way Vodafone wrote down the valuation of its Indian subsidiary,” said Unni Krishnan, MD of Brand Finance, a brand evaluation consultancy.
While Indian accounting norms have also pressed for reporting such impairment, many Indian companies typically took refuge under a small provision in the Companies Act that allows such change in valuations to be adjusted against Reserves. “Also, boards of many companies need to take a call on whether any drop in valuations is typical to that industry,” said KH Viswanathan, an executive director with audit firm RSM Astute.
“If the steel industry, which is a cyclical sector, is going through a low phase, that factor needs to be considered before making any impairment. Such calls are also made by an independent expert,” he said. Aditya Birla group’s Hindalco, that made a big ticket acquisition in 2007 by buying Canada-based Novelis for $6 billion, faced similar prospects when the recession compounded the slowing market situation and exposed a faulty price ceiling contract. This forced Novelis to sell its final products to a select customer at a lower price.
The contract, which existed for three years, affected Novelis’s profitability. In February last year, Novelis posted a net loss of $1.8 billion for the December quarter of 2008 due to asset impairment charge and derivative losses. While the Canadian company has since completed the restrictive price ceiling contract tenure, a Hindalco official said that they are continuing with the audit procedure and can’t comment any further. Hindalco is scheduled to announce its earnings on June 4.
A Novelis statement said: “In accordance with FASB 142 (Financial Accounting Standards Board), we evaluate the carrying value of goodwill for potential impairment annually during the fourth quarter of each fiscal year or on an interim basis if an event occurs or circumstances change that indicate that the fair value of a reporting unit is likely to be below its carrying value.”
The company said that no additional impairment was identified at March 31, 2009, nor in the nine months ended December 31, 2009.
Shareholders and investors in Indian companies are yet to know that there are differences between IFRS and Indian accounting norms. The Indian norms permit reversal of impairment of goodwill when certain conditions are met. This is not there under IFRS. There is also a difference in the types of assets to be tested, with the Indian GAAP including all intangible assets with a useful life of more than 10 years. Under IFRS, only intangible assets with indefinite useful life are taken. However, it also needs to be mentioned that impairment charges don’t necessarily mean a cash drain. It’s only a fallout of stringent accounting rules, say auditors.