There has been a huge transformation in the structure of Indian business houses in the past two decades. Family-owned, single-entity businesses have diversified into multiple entities — both within India as well as globally.
Making the most of opportunities available, they are growing through organic and inorganic routes. In the process, they have not hesitated to shed their non-core businesses.
Corporate restructuring is currently undertaken for various reasons, such as business segmentation, new acquisitions, tax planning strategies, fund raising in profitable business, setting aside non-profitable business, and so on. This, in turn, has led to the use of multi-layer corporate entity and special purpose entities (SPE) — for example, an intermediate company in a tax-haven country for an efficient tax structure, or a cash-consuming R&D unit in an SPE to keep it outside the group.
When making such well-planned decisions, a company also needs to address challenges such as
The challenges in preparing consolidated financial statements range from identifying entities qualified for consolidation to the process of consolidation.
At present, Indian GAAP (generally accepted accounting principles) defines a subsidiary as ‘an entity where the investor entity has more than 50 per cent voting rights or majority of board members’. However, Indian Accounting Standards (Ind-AS) defines a subsidiary as ‘that which is in substance controlled by the investor entity, that is, power to unilaterally govern the financial and operating policies’.
For example, entities A and B hold a 75:25 interest in C. B has certain veto rights over the financial and operating policies of C. Under Indian GAAP, C is a subsidiary of A, while under Ind-AS it may not due to the veto rights held by B.
Companies set up SPEs with minimal equity investment. Generally, under Indian GAAP, SPEs may not qualify as subsidiary, while Ind-AS has specific guidance for them.
Ind-AS requires substance-over-form evaluation, which may bring such SPEs on to the balance sheet. For example, entity X is an R&D unit, whose directors are employees of Y. R&D activities are funded directly and indirectly by Y, which holds a beneficial interest in X. Under Indian GAAP, X is usually considered a third party, while Ind-AS will mostly qualify it as a subsidiary of Y.
Consolidation process
Consolidated financial statements should be presented using common group accounting policies. However, this becomes a challenge for an evolving group structure coupled with the diversified business in different industries and countries. For example, when an Indian real-estate infrastructure business planned its first consolidated financial statements, the biggest challenge was to manage the change and convince its subsidiaries to align with the common accounting policies.
With offshore investments, the challenge is in the form of multi-GAAP, currency, tax laws, accounting period and language environment. For example, US and UK subsidiaries under US GAAP and IFRS, respectively, have to report to an Indian parent under Indian GAAP. This may lead to the double challenge of ensuring the offshore local management will have knowledge of Indian GAAP, and their auditor is familiar with such reporting.
Given the challenges, companies make a lot of assumptions — to an extent they assume the subsidiaries’ accounting policies are acceptable under Indian GAAP and do not call for any significant GAAP adjustment.
However, this poses a challenge to their Indian auditors due to lack of access to the subsidiary auditors’ work papers. Alternatively, the Indian auditor can sign-off on both the foreign and Indian GAAP financials of the subsidiary; however, this could be a challenge owing to the limited knowledge of foreign GAAP/ laws and jurisdictional restrictions.
Sustainable reporting
In the Indian context, however, consolidation is mandated only for listed entities. It is a matter of time — either stemming from business needs or Ind-AS implementation — before consolidation becomes a requirement for most companies. In order to remain sustainable and profitable, businesses should plan and make financial reporting a sustainable affair. It is, after all, the most important medium of communication with stakeholders.
Best practices will require companies to have a year-end evaluation plan, compliance checklists, group chart of accounts, and group accounting policies-cum-manual.
These can be supported by automated consolidation engines and customised reporting packs to ensure comprehensiveness and capture information with minimal manual intervention in a maker-checker control environment. This will ensure smooth periodic closing within the desirable time frame.
Shrenik Baid is Executive Director- PwC India