1.18  Query:  

Treatment of effects of changes in exchange rates.

1. A public limited company imported plant and machinery which is financed through foreign currency term loans denominated in US Dollars taken from financial institutions, viz., IFCI/IDBI/ICICI. The repayment of these foreign currency term loans is in accordance with the term-loan agreement executed with the financial institutions. The repayment is spread over 5 years after commissioning.

2. The querist has explained by way of an illustration that in accordance with the Guidance Note on Accounting of Foreign Currency Loans issued be the Institute of Chartered Accountants of India, the following accounting practice has been adopted for the said foreign currency loans:

Illustration

            (i)         Cost of machinery is US $ 100.

(ii)        The purchase of plant and machinery is accounted for by debiting fixed assets with the rupee amount actually debited by IFCI/IDBI/ICICI to the company being the amount of rupees utilised by them for remitting the required 100 dollars to the foreign equipment suppliers.

(iii)       At the close of the financial year, the entire foreign currency loan is revalued based on the spot rate prevailing at the close of the financial year and the exchange difference thus arising (a loss in this case) is debited to the plant and machinery account with a corresponding credit to the foreign currency loan account.

(iv)       Accordingly, depreciation for that particular year is worked out on the basis of the enhanced cost of plant and machinery both for the purposes of balance sheet as well as for the purpose of claiming depreciation under the Income-tax Act.

(v)        Based on the above, the following Tables I and II depict hypothetical position of US $ loan account and the fixed assets account in the books of the company for the concerned financial year:

                                                                                               TABLE  I

US DOLLAR LOAN

30.9.90            Actual increase in rupee liability on repayment of instalment of $ 10

 = $ 10 X Rs. 25 Minus $ 10 X Rs. 20 = Rs. 50 (1)

31.3.91            Increase in rupee liability (B-A) = Rs. 770 (2)

                                                                                       TABLE  II

FIXED ASSETS (AS PER THE COMPANY) 

3. The accounting treatments as illustrated above, both for the purpose of balance sheet and for the purpose of claiming depreciation under the Income-tax Act, have not been accepted by the auditors conducting the tax audit of the company. As per the querist, the tax auditors have suggested that the approach adopted by the company may not be acceptable to the income-tax authorities and, consequently, have suggested claiming increase in capital cost arising due to exchange variation only to the extent of loan repayments actually made during the financial year and not on the basis of entire loan outstanding. In the case, the querist explains, the amount of depreciation to be claimed for the purpose of balance sheet as well as for the purpose of tax return would be as shown in Table III below:

                                                                                        TABLE  III

FIXED ASSETS 

4.  The querist has sought the opinion of the Expert Advisory Committee in respect of the following issues emerging from above facts:

(a)        Whether for the purpose of revaluing the dollar liability outstanding as at the end of the financial year the entire loan should be revalued and the difference thus arising added to or subtracted from the fixed assets?

(b)        In case the answer to the above is in the affirmative, whether the same treatment can also be applied for claiming depreciation under Income-tax laws also?

(c)        Whether it is possible to apply, as suggested in Table III, the accounting treatment for the purpose of balance sheet and for the purpose of computation of depreciation under the Income-tax Act.

(d)        If the company follows the accounting treatment as stated in query (c) above, whether the income-tax authorities would be able to challenge the computation of book profits under Section 115J of the Income-tax Act stating that the depreciation as computed for the purpose of preparation of balance sheet should also be charged in line with the depreciation admissible for the purpose of regular assessment as stated in Table III.

                                                                              Opinion*                                 October 7, 1992

1. The Committee notes the instruction inserted in Schedule VI to the Companies Act, 1956, vide Notification No. G.S.R. 129, dated 3.1.1968, which states as follows:

“Where the original cost aforesaid and additions and deductions thereto, relates to any fixed asset which 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, there has been an increase or reduction in the liability of the company, as expressed in Indian currency, for making payment towards the whole or a part of the cost of the asset or for repayment of the whole or a part of monies borrowed by the company from any person, directly  or indirectly in any foreign currency specifically for the purpose of acquiring the asset (being in either case the liability existing immediately before the date on which the change in the rate of exchange takes effect), the amount by which the liability is so increased or reduced during the year, shall be added to, or, as the case may be, 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. The Committee further notes paragraphs 22, 23, and 25(b) of the Accounting Standard (AS) 11 on Accounting for the Effects of Changes in Foreign Exchange Rates, issued by the Institute of Chartered Accountants of India, which state as follows:

“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.

23.       At each balance sheet date, there may be items of foreign currency assets and liabilities, i.e., items to be received or paid in foreign currency, in respect of transactions not settled within the same accounting period. An exercise should be carried out to perceive the impact of converting such items at the closing rate. This conversion process should be carried out separately for the following two categories of items – (a) Current assets and current liabilities and (b) Long-term liabilities. The results of the conversion should be dealt with in the manner described in paragraphs 24 and 25.

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 fixed assets. If the amount is not material, the gain or loss may be dealt with in the manner described in sub-para (a) above.”

3. The Committee also notes section 43A(1) of the Income-tax Act, 1961, which, inter alia, provides as follows:

“43A.   (1) Notwithstanding anything contained in any other provision of this Act, where an assessee has acquired any asset from a country outside India for the purposes of his business or profession and, in consequence of a change in the rate of exchange at any time after the acquisition of such asset, there is an increase or reduction in the liability of the assessee as expressed in Indian currency for making payment towards the whole or a part of the cost of the asset or for repayment of the whole or a part of the moneys borrowed by him from any person, directly or indirectly, in any foreign currency specifically for the purpose of acquiring the asset (being in either case the liability existing immediately before the date on which the change in the rate of exchange takes effect), the amount by which the liability aforesaid is so increased or reduced during the previous year shall be added to, or, as the case may be, deducted from, the actual cost of the asset as defined in clause (1) of section 43 or the amount of expenditure of a capital nature referred to in clause (iv) of sub-section (1) of section 35 or in section 35A or in clause (ix) of sub-section (1) of section 36, or, in the case of a capital asset (not being a capital asset referred to in section 50), the cost of acquisition thereof for the purposes of section 48, and the amount arrived at after such addition or deduction shall be taken to be the actual cost of the asset or the amount of expenditure of a capital nature or, as the case may be, the cost of acquisition of the capital asset as aforesaid.”

4. The Committee is of the view that there is nothing in either Schedule VI to the Companies Act, 1956 or section 43A of Income-tax Act, 1961, which would suggest that the cost of asset should be adjusted for the difference arising due to exchange variation only to the extent of loan repayments actually made during the financial year and not on the basis of entire loan outstanding. Moreover, Accounting Standard 11 recommends in unambiguous terms that the company should carry out an exercise to perceive the impact of converting foreign exchange liabilities, as outstanding on the balance sheet date, and any loss arising from such conversion should be regarded as an adjustment to the cost of the related fixed asset.

5. The Committee wishes to draw the attention of the querist to the fact that the Institute of Chartered Accountants of India has not issued any Guidance Note on Accounting of Foreign Currency Loans, as stated by the querist. The Institute’s current pronouncement on the subject is AS 11 as mentioned above.

6. The Committee further wishes to draw the attention of the querist to the recommendation made in para 26 of Accounting Standard (AS) 6 on Accounting for Depreciation and para 27 of AS 11, according to which in case the historical cost of a depreciable asset undergoes any change on account of exchange rate fluctuations, the depreciation on the revised unamortised depreciable amount should be provided prospectively over the residual useful life of the assets. The rates of depreciation in this circumstance would be required to be adjusted in such a way that the full unamortised depreciable amount of the asset is written off over the remaining useful life of the assets. Hence the computation of depreciation, as made by the querist in Table II and III above, is not correct.

7. On the basis of above, the Committee is of the following opinion in respect of issues raised in para 4 of the query above:

                       (a)        Yes.

                       (b)        Yes.

(c)        Treatment suggested in Table III is not correct from the accounting as well as the tax point of view.

(d)        Since the answer to (c) above is in the negative, this question does not arise.

*It may be mentioned, that in view of the partial convertibility of the rupee and other related developments in the changed economic environment, the Council of the Institute of Chartered Accountants of India decided to revise Accounting Standard 11. Accordingly, the Council resolved that the mandatory application of this Accounting Standard shall stand postponed to accounts for period commencing on or after 1^st April, 1993. Since the recommendatory status of the Standard was in existence at the time of the issuance of the opinion, it formed the basis of the opinion. Subsequently, in August, 1993, the Standard was withdrawn on the issuance of the Exposure Draft of the revised AS 11.