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Why the new Indian accounting standard may not be good for profitability of companies

Come April 2016, investors may find it less tedious to compare earnings of listed companies with the new Indian accounting standard — Ind-AS — set to be implemented. But, the transparency will come at a cost. Profitability of many companies could be impacted heavily because of the new rules.

A study by brokerage Ambit Capital of companies that are part of the Nifty shows that sectors such as pharma and technology along with conglomerates will be most impacted. Among companies,  Tata MotorsBSE -1.33 %, WiproBSE -0.10 % and Dr Reddy’s could see lower profits under the new accounting standards, said Ambit.

More than 500 listed Indian companies (comprising about 75 per cent of the total market capitalisation) will adopt Ind-AS. Several consultants said investors and analysts may need to brace for sharp variations in earnings from what they had estimated.

“Next year many companies’ results would look very different, as you would have different PE (price-to-earning) ratio, different debt to equity ratio and so on,” said Sandip Khetan, partner in a member firm of EY Global.”

One major impact would be felt on the method companies use to account for goodwill. After the new standards set in, Indian companies would have to calculate their goodwill on a fair value basis.

“For many companies the return on investment (RoI) would fall significantly as their net worth would increase after their goodwill would be calculated on a fair value basis. So, while for some companies their goodwill would increase but return on investment would come down, now whether the company looks at this change as positive or negative is a matter of their perception,” said Ashish Gupta, partner, Walker Chandiok & Co.

While all sectors would be hit by the Ind-AS, the implications could be more severe in some.

Companies with a lot of subsidiaries or even special purpose vehicles (SPVs) could see their net worth going down substantially.

“In a situation where the company has an SPV, where there is a private equity or strategic investor involved, who has a say in the operations of that SPV, it may be concluded that the control over that SPV is shared. And, therefore, the assets and liabilities of that SPV would not be consolidated in the company’s balance sheet,” said Sai Venkateshwaran, partner and head of accounting advisory services at KPMG.

The article appeared in the Economic Times. The article can be found here.