Preparing financial statements for mergers and acquisitions (M&A) transactions is one of the most critical and legally sensitive stages of any corporate restructuring or business transfer. In India, financial statements used in M&A transactions are not merely financial documents; they function as legal instruments that influence valuation, negotiation of transaction terms, regulatory approvals, tax outcomes, shareholder decisions, and post-transaction liabilities. Any inaccuracy, inconsistency, or non-compliance in these statements can derail the transaction or expose parties to long-term legal and financial consequences.

Unlike routine annual financial reporting, M&A financial statements are forward-looking, transaction-specific, and subject to scrutiny by multiple stakeholders including acquirers, investors, auditors, regulators, lenders, and courts. Therefore, preparing such statements requires a deep insight of corporate law, accounting standards, taxation laws, securities regulations, foreign exchange rules, and competition law, all of which intersect in M&A transactions.

In this article, CA Manish Mishra talks about Preparing Financial Statements for M&A Transactions.

The Strategic Importance of Financial Statements in M&A Transactions

Financial statements form the backbone of every M&A transaction. They determine how a business is valued, what risks are identified during due diligence, how the purchase consideration is structured, and how liabilities are allocated between the buyer and seller. In negotiations, buyers rely heavily on financial statements to assess profitability, sustainability of earnings, working capital adequacy, and exposure to contingent liabilities. Sellers, on the other hand, use these statements to justify valuation expectations and demonstrate financial stability.

Legally, financial statements are directly linked to representations and warranties in transaction documents. Any misstatement or omission can later result in indemnity claims, price adjustments, or litigation. In regulated transactions, such as mergers requiring tribunal approval or listed-company acquisitions, financial statements also become part of statutory filings and public disclosures, increasing the exposure to regulatory penalties if inaccuracies are discovered.

Transaction Structure and Its Legal Impact on Financial Statements

The structure of an M&A transaction fundamentally determines how financial statements must be prepared and presented. Transactions may be structured as share acquisitions, asset purchases, slump sales, mergers, demergers, or amalgamations. Each structure carries different legal and accounting implications.

In share acquisitions, the legal entity remains unchanged, and historical financial statements of the target company continue to be relevant. In contrast, asset purchases and slump sales require segregation of transferred assets and liabilities, which necessitates detailed schedules and reconciliations. Court-approved schemes of arrangement under the Companies Act, 2013 require comprehensive financial statements that support the fairness and viability of the scheme. Fast-track mergers, while procedurally simpler, still demand legally compliant and accurately prepared financial statements within compressed timelines.

Failing to align financial reporting with the transaction structure can lead to rejection of regulatory filings, adverse audit comments, or disputes between parties regarding scope and consideration.

Statutory Financial Statements and Compliance Under the Companies Act, 2013

Before preparing transaction-specific financial statements, it is essential to ensure that the company’s statutory financial statements are fully compliant with the Companies Act, 2013. These statutory financial statements form the base on which all M&A-related financial analysis is built.

Compliance includes proper classification of assets and liabilities, accurate disclosure of related party transactions, recognition of provisions and contingent liabilities, adherence to prescribed formats, and timely approvals by the board of directors. Any qualification or emphasis of matter in the auditor’s report raises red flags during due diligence and may prompt buyers to demand enhanced warranties, escrow arrangements, or price reductions.

In M&A transactions involving group companies, consolidated financial statements become particularly important, as buyers assess the financial health of the entire group rather than a single entity.

Role of Accounting Standards in Business Combinations

Accounting standards play a decisive role in preparing financial statements for M&A transactions. Companies following Indian Accounting Standards (Ind AS) must apply specific guidance for business combinations, which governs how acquisitions are recognized and measured.

This includes identifying the acquirer, determining the acquisition date, measuring consideration at fair value, and recognizing identifiable assets and liabilities separately from goodwill. Incorrect application of accounting standards can distort post-transaction financials and impact future profitability.

Transactions involving entities under common control require different accounting treatment, often involving pooling of interests rather than fair value accounting. Choosing the wrong accounting approach can lead to restatements, regulatory objections, and disputes with stakeholders.

Historical Financial Statements and Their Legal Relevance

Audited historical financial statements provide the foundation for M&A valuation and due diligence. Typically, buyers expect at least three years of audited financial statements, though longer periods may be required for regulated or capital-intensive industries.

These historical statements help assess revenue trends, cost structures, capital expenditure patterns, and historical compliance with tax and regulatory requirements. From a legal standpoint, these statements also establish past practices, which become relevant when interpreting representations and warranties related to accounting consistency and compliance.

Any restatement or revision of historical financial statements close to a transaction often raises concerns and must be carefully explained and documented.

Interim and Cut-Off Date Financial Statements

Given the time gap between the last audited financial statements and transaction closing, interim financial statements play a crucial role. These statements capture financial performance and position during the interim period and are often used to adjust purchase consideration.

Cut-off date financial statements are particularly important where closing accounts mechanisms are adopted. These statements determine final working capital adjustments and allocation of profits or losses up to the closing date. Legally, disputes over cut-off date financials are common and can escalate into arbitration or litigation if definitions are unclear or calculations are inconsistent.

Carve-Out Financial Statements in Business Transfers

In asset sales or slump sale transactions, financial statements must isolate the financial performance of the transferred business. These carve-out financial statements are among the most complex and judgment-intensive aspects of M&A reporting.

Shared costs, corporate overheads, employee benefits, and common assets must be allocated on a reasonable and consistent basis. From a legal perspective, poor documentation of allocation methodologies can expose sellers to misrepresentation claims and buyers to integration risks.

Carve-out financials must also align with tax computations, particularly in slump sales, where net worth and capital gains calculations depend directly on financial statement figures.

Quality of Earnings and Earnings Normalization

Quality of earnings analysis enhances traditional financial statements by focusing on sustainability of profits. While not legally mandated, it has significant legal implications because it influences valuation, earn-out clauses, and post-closing adjustments.

Normalizing adjustments remove non-recurring items such as one-time legal settlements, restructuring costs, or extraordinary income. However, aggressive or unsupported adjustments can later be challenged as misleading, especially if financial projections rely on them.

Clear documentation and conservative assumptions reduce legal exposure and build credibility in negotiations.

Working Capital Adjustments and Closing Account Mechanisms

Working capital is often a key negotiation point in M&A transactions. Financial statements must clearly identify current assets and liabilities, excluding items agreed to be treated as debt or leakage.

Closing account mechanisms require preparation of detailed closing statements post-completion. Any ambiguity in definitions or inconsistency with historical practices increases the risk of disputes. Preparing sample closing accounts during negotiations helps align expectations and reduce post-closing litigation.

Tax Law Integration in M&A Financial Statements

Tax considerations permeate every aspect of M&A financial statement preparation. Financial statements must accurately reflect tax liabilities, deferred taxes, unutilized losses, and contingent tax exposures.

In mergers and demergers, statutory conditions for tax neutrality must be demonstrably satisfied. Slump sale transactions require precise calculation of net worth. Any mismatch between financial statements and tax filings increases exposure to reassessment and penalties.

Listed Company Transactions and Securities Law Sensitivity

For listed companies, financial statements prepared for M&A transactions are subject to enhanced scrutiny by regulators and public shareholders. Disclosures must be consistent, timely, and accurate.

Financial statements influence open offer pricing, valuation disclosures, and shareholder approvals. Any inconsistency between disclosed financials and transaction documents can result in regulatory action and erosion of investor confidence.

Competition Law and Financial Threshold Analysis

Competition law compliance relies heavily on accurate financial statements. Asset and turnover thresholds determine whether regulatory notification is required. Errors in financial reporting can lead to incorrect filings, delays, or penalties.

Financial statements must also support market analysis and assessment of competitive impact, making accuracy and consistency legally critical.

Foreign Exchange Compliance and Cross-Border Deals

In cross-border M&A transactions, financial statements support valuation, pricing, and regulatory reporting under foreign exchange laws. Even domestic transactions involving non-resident shareholders require careful financial documentation.

Accurate reporting reduces the risk of regulatory delays and post-transaction compliance issues.

Audit, Governance, and Litigation Preparedness

M&A financial statements must withstand scrutiny from auditors, regulators, lenders, and courts. Documentation of accounting judgments, board approvals, and internal controls strengthens legal defensibility. Strong governance practices reduce the risk of disputes and enforcement actions long after the transaction closes.

Conclusion

Preparing financial statements for M&A transactions in India is a complex, legally intensive process that demands coordination across finance, legal, tax, and regulatory functions. These statements influence valuation, contractual protections, regulatory approvals, and long-term risk allocation.

In an evolving regulatory environment, companies that treat M&A financial reporting as a strategic and legal priority are better positioned to execute transactions smoothly and protect stakeholder interests. Accurate, compliant, and well-documented financial statements are not just deal enablers they are the foundation of a legally sound and successful M&A transaction.

Frequently Asked Questions (FAQs)

Q1. Why are financial statements so critical in M&A transactions?

Ans. Financial statements are the primary documents used to evaluate a company’s financial health, profitability, liabilities, and risks in an M&A transaction. They directly influence valuation, negotiation of price, representations and warranties, tax structuring, regulatory approvals, and post-closing adjustments. Any error or omission can result in deal delays, price reductions, or future legal disputes.

Q2. What types of financial statements are typically required in an M&A transaction?

Ans. An M&A transaction usually requires audited historical financial statements, interim financial statements up to a recent date, and transaction-specific financial statements such as cut-off date accounts or closing accounts. In certain cases, carve-out financial statements or pro forma financial statements are also required to reflect the financial impact of the transaction.

Q3. Are statutory financial statements under the Companies Act sufficient for M&A purposes?

Ans. Statutory financial statements form the base but are not sufficient on their own. For M&A purposes, additional schedules, reconciliations, working capital analyses, and transaction-specific adjustments are required. Buyers rely on enhanced financial information to understand the true financial position beyond statutory disclosures.

Q4. What role do accounting standards play in M&A financial statements?

Ans. Accounting standards determine how assets, liabilities, income, expenses, goodwill, and reserves are recognized and measured. Proper application of accounting standards is essential to ensure that the financial statements reflect the economic substance of the transaction and remain legally defensible during audits, regulatory reviews, or disputes.

Q5. What are carve-out financial statements and when are they required?

Ans. Carve-out financial statements are prepared when a specific business, division, or unit is being sold rather than the entire legal entity. They isolate the financial performance and position of the transferred business. These statements are complex because they involve allocation of shared costs and assets, which must be reasonable, consistent, and well-documented to avoid legal challenges.

Q6. What is the difference between interim financial statements and cut-off date financial statements?

Ans. Interim financial statements cover a period between the last audited financials and a specified date, such as signing or closing. Cut-off date financial statements determine the financial position exactly up to the closing date and are often used for purchase price adjustments. Both play a crucial role in ensuring fair allocation of profits and liabilities between buyer and seller.

Q7. How do financial statements impact valuation in M&A transactions?

Ans. Valuation models are built directly on financial statement data. Revenue trends, margins, working capital levels, debt positions, and contingent liabilities all affect valuation. Any inconsistency or aggressive accounting assumption may reduce buyer confidence and lead to valuation discounts or additional safeguards in transaction documents.

Q8. What is quality of earnings (QoE) and why is it important?

Ans. Quality of earnings analysis evaluates the sustainability and reliability of a company’s earnings. It separates recurring operational income from one-time or non-recurring items. QoE is important because it influences valuation, earn-out structures, and post-closing expectations, and reduces the risk of disputes over financial performance.

Q9. How are working capital adjustments determined in M&A transactions?

Ans. Working capital adjustments are based on agreed definitions of current assets and current liabilities. Financial statements must accurately reflect historical working capital levels and support the calculation methodology. Disputes often arise when definitions are unclear or inconsistent with past practices.

Q10. What tax aspects must be reflected in M&A financial statements?

Ans. M&A financial statements must account for current tax liabilities, deferred taxes, unutilized losses, and contingent tax exposures. In mergers, demergers, or slump sales, financial statements also support eligibility for tax exemptions or neutrality. Inaccurate tax reporting can lead to reassessments and deal renegotiations.