Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.11  Query:  

  Exhibition of value of fixed assets acquired against a foreign currency loan.

 

1. In accordance with the instructions in the Form of Balance Sheet-Part I of Schedule VI to the Companies Act, 1956- where a fixed asset has been acquired from a country outside India and in consequence of a change in the rate of exchange at any time after the acquisition of such asset, if there has been an increase/reduction in the liability of the company, as expressed in Indian currency for making payment towards the cost of the asset or for repayment of moneys borrowed in foreign currency specifically for the purpose of acquiring the asset, the amount by which the liability is so increased or reduced during the year shall be added to/deducted from the cost and the amount arrived at after such addition or deduction shall be taken to be the cost of the fixed asset.

 

2. Section 43 A of the Income-tax Act requires that any such increase/decrease in the value of foreign currency loans during the year consequent upon the change in the rate of exchange should be added/deducted from the cost of the asset.

 

3. A company has acquired three ships on 2.8.1985, 25.9.1986 and on 30.12.1986 in Japan at a total cost of Yen 14211 millions. Part of the cost of the acquisition was met out of the company’s funds and the balance amounting to Yen 11125 millions was met out of funds provided by the State Bank of India, Tokyo and Bank of Tokyo against foreign currency loans at specified Japanese Long Term Prime Rates repayable in half-yearly instalments over a period of eight years. Every year, on the balance sheet date, for the outstanding portion of the Yen loans, any increase or decrease in rupee terms as compared to the previous years’ balance sheet date value is respectively debited or credited to the value of the asset. Any corresponding increase or decrease is treated as adjustments, additions or deductions in the fixed assets schedule. For the instalments repaid during the year, any increase or decrease in the actual rupee outgo as compared to the rate adopted at the previous year’s balance sheet date, would be debited or credited to the profit and loss account as exchange rate difference in financing charges if there is an increase in outgo and as exchange rate gain if there is a decrease in the net outgo.

 

4.The ships are used for transporting coal for the thermal power stations of a State Electricity Board (SEB). The company has entered into a freight rate agreement with the SEB setting out the formula for determining the various elements going into the cost of operations. The querist has supplied a copy of the same.

 

5. Freight rate working assumes a constant capital cost, translating the purchase value@ Yen 2000=Rs. 100, prevailing at the time of concluding the ship-building contract, to avoid frequent modification of the capital cost and the consequent depreciation factor going into the freight rate determination. For similar reasons, freight rate working has no component towards loan on account of exchange rate variations.

 

6. On a particular date, the additional liability of the company, due to deteriorating exchange rates, could not be determined in advance with any degree of certainty. The SEB agreed to reimburse the additional liability in debt-servicing arising out of exchange rate deprecation with reference to a loan rate of Yen 2000=Rs.100. Additional liability due to exchange rate deprecation on interest payments is reimbursable soon after such remittance. The liability related to repayment of principal is agreed to be reimbursed in a phased manner more or less corresponding to the life of the asset attributing it as a component of depreciation.

 

7. In this background, the company charges freight to SEB at a rate worked out on the basic rate formula for the actual quantity moved and debits SEB for the exchange rate variation (always a loss) with reference to agreed base rate of exchange on the amount paid out for interest and instalments of loan repayment. The debits on exchange rate loss are accounted as part of freight recognising it as an extension of freight rate working. For example, for the year ended 1989-90, the freight earnings of Rs. 3758.77 lakhs are made up of freight worked out a basic rate of freight formula Rs. 2413.01 lakhs and Rs. 1345.76 lakhs towards exchange rate component.

 

8.The company has, for its annual accounts, translated the value of liabilities under foreign currency loans strictly in accordance with the instructions in Schedule VI to the Companies Act as stated in para 1 above and adjusting the value of fixed assets per contra.

 

9. The Accountant General, Tamil Nadu, who is conducting the review of the accounts under Section 619 of the Companies Act, 1956, has made a comment that such a revision of the cost of fixed assets is not correct in the context of the SEB agreeing to reimburse the exchange rate loss. The comments of the Comptroller and Auditor General of India on the accounts of the company for the year ended March 1989 and the replies of the company are given in the Annexure. Similar comments have been made in the accounts of the preceding year also and the accounts of the latest year ended March 1990 are also likely to attract similar comments. The company is, however, consistently making up the accounts as stated above with the full concurrence of the statutory auditors.

 

10. The querist has sought the opinion of the Expert Advisory Committee of the Institute of Chartered Accountants of India on the appropriateness or otherwise of the practice followed with reference to the provisions of the Companies Act, 1956, and the principles of accounting normally to be observed in such circumstances.

                                                                                Opinion                                 April 24, 1991

 

1.The Committee notes the following clause from the papers submitted by the querist regarding ‘Freight Rate Fixation’:

 

“The freight rate worked out accordingly amounts to Rs. 129.35 per tonne for the period from 25.8.85 to 31.3.87 vide the Annexure. This rate will be subject to the following:

           

(i) The capital cost of the vessel has been worked out adopting the rate of exchange at yen 2000=Rs.100/-. SEB will make settlements on this basis as regards actual escalation in Yen for the period 25.8.85 to 31.3.87. The amount payable due to such escalation as regards the Deferred Credit repayment portion will be limited to 50% of the actual amount in a year. The escalation amount incurred in the first year by the company settled by SEB in the first two years and the escalation amount paid by the company in the second year settled by SEB in the third year and fourth year and so on. The escalation amount paid by the company until the repayment of the Deferred Credit over a period of 8.5 years will be thus settled by SEB over a period of 17 years against the normal spread-over of 20 years. This approach has been adopted for the sake of simplicity with a view to average out the liability without disturbing the depreciation element included in the freight rate working.”

 

2.The Committee notes paragraphs 22, 24(b), 25(b) and 26 of the Accounting Standard (AS) 11 on ‘Accounting for the Effects of Changes in Foreign Currency Rates’, which are reproduced below:

 

“22. Gains or losses on settlement of the transactions within the same accounting period should be recognised in the Profit and Loss Statement of the period except in the case of exchange differences relating to amounts incurred for the acquisition of fixed assets, which should be adjusted in the carrying amount of related fixed assets.

 

24(b). In the case of current liabilities incurred for the acquisition of fixed assets, the loss or gain, if material, should be regarded as an adjustment of cost and should be included in the carrying amount of the related assets. If the amount is not material, the loss or gain may be dealt with in the manner described in sub-para (a) above.

 

25(b). In the case of long-term liabilities incurred for the acquisition of fixed assets, the gain or loss, if material, should be regarded as an adjustment of cost and should be included in the carrying amount of the related assets. If the amount is not material, the gain or loss may be dealt with in the manner described in sub-para (a) above.

 

26. Gains or losses on settlement, in a subsequent period, of transactions entered into in an earlier period should be credited or charged to the Profit and Loss Statement, except in the case of exchange differences relating to amounts incurred for the acquisition of fixed assets, which should be adjusted in the carrying amount of related fixed assets.”

 

3. The Committee is of the view that the reimbursement of difference due to exchange rate variation by the SEB is part of the freight earned by the company. The Committee is therefore of the view that it is proper to account for as freight, the amount reimbursable by the SEB towards exchange rate fluctuations as per the terms of the agreement.

 

4. The Committee is of the view that the accounting practice of the company whereby for the instalments repaid during the year, any increase or decrease in the actual rupee outgo as compared to the rate adopted in the previous year’s balance sheet, is debited/credited to profit and loss account, is not correct.

 

5. The Committee is of the opinion that in the facts and circumstances of the case, the correct accounting treatment is as under:

 

(i) Amount reimbursible by the SEB as per the terms of agreement on account of exchange rate variations should be accounted for as freight.

 

(ii) At the balance sheet date, the outstanding foreign currency loan should be converted at the exchange rate prevailing on that date. Any gain or loss arising as a result of such conversion should be adjusted in the carrying amount of the ships.

 

(iii) In respect of the instalments repaid during the year, any increase or decrease in the actual rupee outgo as compared to the rate adopted in the previous year’s balance sheet should also be adjusted in the carrying amount of these ships.

ANNEXURE

 

Comments of the Comptroller and Auditor General of India under Section 619(4) of the Companies Act, 1956, for the year ended 31st March, 1989.

 

COMMENTS

 

Balance Sheet

 

1.     Fixed Assets:

 

A reference is invited to Comment No.1 of the Comptroller and Auditor General of India under Section 619(4) of the Companies Act, 1956, on the accounts for the year ended 31st March, 1987, and 31st March, 1988, to the effect that in view of the understanding with State Electricity Board (SEB) that any increase in liability on foreign exchange rate would be reimbursed by it, no adjustment should have been made in the accounts to reflect any increase in such loans at the end of the year on account of exchange rate fluctuations. The company has, however, continued to carry out adjustment in the accounts in respect of the increase in foreign currency loan liability on account of the exchange rate fluctuations as indicated below:

 

(1)    Increase in liability in respect of foreign currency loans consequent on variation in exchange rate as on date of Balance Sheet amounting to Rs. 1392.70 lakhs (vide Note. 3) is shown as addition to fixed assets.

 

 

(2)   Depreciation amounting to Rs. 445.98 lakhs on account of increase in the value of ships due to difference in exchange rate is reflected in total depreciation amounting to Rs. 1635.48 lakhs charged to the Profit and Loss Account.

 

(3)   Recovery from State Electricity Board on account of exchange rate fluctuations on repayment of instalments of principle amounting to Rs. 1062.69 lakhs is accounted under freight earned on own vessels Rs. 3199.89 lakhs (vide Schedule 11).

 

 

 

 

 

(4)     Expenditure due to fluctuations in exchange rate at the time of actual repayment of instalments amounting to Rs. 128.71 lakhs (Note 3) is included under “Financing charges”-own vessels- Rs. 1,011.99 lakhs (Schedule 17).

 

 

 

Due to these incorrect accounting, the loss for the year has been understated by Rs. 488.00 lakhs.

                                                                                                                  

      REPLIES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

  i)  The liability under the Foreign Currency Loans outstanding as on the Balance Sheet date has been properly arrived at in conformity with the instructions in Schedule VI, Part I-Form of Balance Sheet under ‘FIXED ASSETS’ to the Companies Act, 1956.

 

     ii)   Depreciation has been charged in the accounts on the fixed assets value duly arrived at in accordance with the principles detailed above.

 

 

 

 

    iii)     Reimbursement of difference due to exchange rate variation is a commercial arrangement between SEB  and company towards freight settlement. This method has been adopted to avoid revision of freight rate arising out of change in the capital cost of ships commensurate with changes in foreign currency loan liability. The recovery has accordingly been accounted for as part of freight earnings.

 

     iv) Expenditure attributable to fluctuations in exchange rate prevailing at the time of repayment of instalment is correctly charged to Profit and Loss Account in conformity with the accounting principles and guidelines issued by the Institute of Chartered Accountants of India.

 

    In view of the foregoing, the question of incorrect accounting or understatement of loss does not arise.

 

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