MUMBAI: Automobile companies are rushing to renegotiate contracts with parts suppliers, because the new accounting standards will change the way assets and liabilities are recorded under such agreements, potentially upsetting loan covenants and creating tax complications.
Tata Motors, Mahindra & Mahindra, Maruti SuzukiBSE -0.42 %, and the local units of Hyundai Motor and Honda Motor are among companies that have already conducted an impact analysis of the new accounting standards – called Ind-AS – that will come into force on April 1. Some of these companies are working on rewording the contracts with their component manufacturers to avoid any negative impact, said people with knowledge of the matter.
The problem is peculiar to the automotive sector, where the vehicle maker, or the original equipment manufacturer (OEM), provides equipment and raw material, often free of cost, to the parts maker to produce components based on specific requirements.
These tools are in some cases not accounted for, but the new accounting standards could put them on the balance sheet of the OEM. The OEM may also have to record corresponding revenue against the assets and, in some cases, take the liability of the vendor on its own books. This could affect the existing loan agreements with lenders.
“These are typically ‘take or pay’ contracts,” and are often accounted for as service or supply agreements by the auto maker, said Sumit Seth, partner and IFRS leader at Price Waterhouse. “They would potentially become leases under Ind-AS, bringing on those suppliers’ assets on to the balance sheet of the auto company.”
In fact, since the OEMs could control these tools, under the new rules these contracts with the component manufacturers could be consolidated in the OEM’s balance sheet.
Industry trackers said the OEMs are already evaluating their contractual arrangements with their vendors to understand the impact.
Mahindra and Tata MotorsBSE 1.41 % said they don’t see any specific impact on them because of the rule changes, while Maruti, Hyundai and Honda didn’t immediately comment. Some parts makers ET spoke to confirmed the possible impact on the contracts and the discussions with auto makers, but none was ready to speak on record.
Vishal Seth, managing director and leader at financial reporting advisory Protiviti India, said Ind-AS could have a substantial impact on the funding arrangements with banks, particularly, where the assets have been hypothecated by the parts maker for seeking financing.
Apart from that, there could also be an impact on the taxation, he said. “There could be direct and indirect tax implications in cases where OEMs record revenue for the use of the tools or dies without a corresponding invoiced amount.”
Analysts said under the new accounting standards, some of the long-term arrangements between component manufacturers and OEMs could also be impacted Some of these long-term arrangements are such that component manufactures set up dedicated factories for one auto major.
“In substance, the auto manufacturer may be controlling the use and physical access of such facility. At present, these arrangements are accounted for as normal sale or purchase contracts,” said Seth.
Auto companies want some of their assets off the balance sheet and so they enter in to such outsourced manufacturing arrangements, but now these could be treated as embedded leases, said industry trackers. In such cases, the OEM may have to take such parts makers’ assets and liabilities on its books.
VS Parthasarathy, group finance chief at Mahindra, said the company has studied the implications of the Ind-AS on the auto maker’s contracts with vendors. “At present, we do not expect any specific impact. The company and its operating management consider Ind-AS impact on supplier arrangements on an ongoing basis,” he said.
Tata Motors has also conducted an impact analysis. “Our arrangements with our suppliers and component manufacturers have been reviewed and periodically tested as a NYSE-listed entity under IFRS reporting requirements for many years. We, therefore, do not expect any impact or change with the application of the Ind AS requirements now,” a spokesperson said.