Local buyers to take a huge goodwill hit

Shareholders, analysts and Dalal Street watchers should make a mental note of the sudden and dramatic shocks that await many Indian companies that have gone in for overseas acquisitions in the past few years. These might surface when the local company has to absorb the ‘goodwill’ loss suffered by the foreign firm that was bought when the going was good.
No Indian corporate has so far encountered such an accounting hit. But this year, many will, when they consolidate the books of their foreign acquisitions. Goodwill of several overseas companies has taken a knock due to the economic meltdown and a trade downturn. But the erosion in goodwill, though an intangible, will not be confined to the balance-sheets of the foreign firms. It will also find its way into the profit and loss accounts of the listed Indian company. Local shareholders could suddenly discover that the net profits of the company have been wiped out — such losses, which accountants call ‘goodwill impairment’, could run into billions of dollars. But this may not be a reason to panic: such hits don’t mean a cash drain or reversal of fortune for the acquirers. Rather, it’s a fallout of stringent accounting rules which force a firm to bluntly admit that the company it bought is less valuable than what it had paid when times were different.
While acquiring a company, the buyer works out the enterprise value (EV) of the target firm — the minimum someone would have pay to buy it. EV is calculated by estimating the fair value of the net assets of the target firm and adding its loans to the number.
The extra money that is forked out over and above the EV is captured in the books as goodwill. Goodwill reflects the extra the acquirer is paying due to synergy benefits, innovation and excellence which have not been factored in the fair value.
A few companies will have to announce the goodwill loss sooner than others if the foreign company has publicly traded securities. According to corporate circles, the market will get a taste of it this month, when a few local companies disclose the goodwill decline suffered by their foreign subsidiaries.
Source: http://economictimes.indiatimes.com/Economy/Local_buyers_to_take_a_goodwill_hit/articleshow/4133592.cms