Goodwill write off and R&D destinations

Until the first half of 2008, it looked like nothing could stop India Inc’s fetish for global assets. Everything worked in its favor – the economy was on a roll and finance was easily available and the leading the pack was the Tata group. But over the last several months, things have taken a dramatic turn, and for the worse. With economic slow down hardly sparing any business or geography, industry experts say that the Tata group may take the maximum hit on goodwill loss arising from its acquisitions as various Tata entities consolidates its books during Q4 FY09.

Writing off goodwill losses has made an entry into India Inc’s accounts with the announcement of Aditya Birla group’s Hindalco writing off $1.5 billion worth of goodwill.

A HDFC Securities report in December 2008 showed that going by 2008-09 annual accounts, India Inc had good will worth in excess of Rs 1,01,000 crore. Of this, the Tata group had goodwill worth a little over Rs 34,000 crore. In the last five years, the Tatas have made some 40 acquisitions picking up well known assets like Corus, Jaguar-Land Rover, Daewoo’s truck division, Tetley and General Chemicals.

For India Inc, the goodwill valuation of this magnitude would be its first such accounting experience. And if companies chose to write off the investment in the P&L account, with the meltdown already spoiling the party, it might drag profits further down or could even result into a loss. Recently, Daiichi Sankyo wrote down a 354 billion yen valuation loss associated with its investment in Ranbaxy.

A goodwill loss occurs when purchase price is higher than net asset value of the acquired entity. This could either be reflected in the profit & loss statement or the balance sheet. In the balance sheet, it could be settled to the share premium account or the general reserve account. Accounting standards mandates that companies must conduct the goodwill impairment test once every fiscal. In India, firms account for the goodwill loss (if any) in Q4 as it consolidates the results of its subsidiaries for the full year.

This (goodwill loss) could impact a company’s ability to refinance debt considering that many Indian firms have made foreign acquisitions through leveraged finance. And if companies offset the goodwill loss against the securities premium account, similar to what Hindalco is doing with the goodwill loss on account of Novelis, it would reduce the acquirer’s balance sheet to that extent.

Impairing goodwill has no tax advantage in India. But in countries like Switzerland, companies get tax benefits.

Although goodwill impairment could affect the bottom line of several companies, their stocks might not be impacted substantially. The market has already factored in the potential goodwill loss at various companies.

Even in global meltdown India and China top destinations:

Emerging economics like India and China, rich in scientific talent are fast becoming most favored destinations for global R&D with top MNCs like GM, IBM, Cisco, Motorola and GE setting up large centers in India.

What is surprising is India and China are high up looking at R&D centers. As far as countries attracting more R&D centers is concerned India ranks fifth while China is fourth.

The research that is being conducted with some of my colleagues in Britain and US suggests that a large number of science and technology PhDs that India produces, is a major driver for attracting R&D centers.

The fact that India produces a large number of high quality PhDs remained a major driver and the factor did well than a host of other potential like GDP growth and intellectual property protection.

In fact, a large number of MNCs are locating their R&D centers outside the developed nations, showed that China and India are rising in terms of multinational R&D facilities while the US still dominates in terms of inbound R&D units.

Unlike the past when MNC’s preferred R&D close to headquarters, the trends have changed in the last five years, he said citing example of GM, which kept its R&D center at Warren, close to its headquarters for eight decades.