1.26 Query: Exchange rate to be adopted for conversion of foreign currency loan.
1. A company is required to provide for the loss, arising on conversion of the foreign exchange loans, obtained for the purpose of investment in the capital assets. Till now, the loss due to exchange rate fluctuations is being calculated, using the official exchange rate, quoted by the RBI. Accounting Standard (AS) 11 on Accounting for Effects of Changes in Exchange Rates, issued by the Institute of Chartered Accountants of India, also approves this practice. However, the querist is of the view that, it was not foreseen, while drafting Accounting Standard 11 that there may be two rates of exchange prevailing at the same time, viz., the official rate and the market rate. Hence, the accounting standard does not deal with the situation where two rates of exchanges are prevailing at the same time.
2. Further, according to the querist, the opinion of the Expert Advisory Committee on the subject (published in the Chartered Accountant, March 1992 issue) read with Accounting Standard (AS) 10, imply that market rates are not the standard rates, hence only official exchange rates should be considered for the purpose of conversion of foreign currency loans.
3. The company, as stated above, is using official rates for the purpose of conversion, till now. However, if the provision made on the basis of conversion at official rates is not found to be sufficient, suitable adjustments are made at the time of actual payment.
4. The querist has further stated that any foreign exchange fluctuation provided towards capital assets will have a direct impact over the provision for depreciation. Thus, if a lower rate of exchange is adopted, the depreciation will be lower and vice versa.
5. The querist has also stated that in his view, it is preferable to make provision for loss on exchange, using the official rates.
6. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(a) Which of the two foreign exchange rates, namely, the market rate and the official rate, is to be adopted for creating the provision for loss on account of foreign exchange fluctuations on the balance of foreign exchange loans, as at the end of the financial year, which are obtained for the purpose of capital assets?
(b) Whether the company has to disclose in its balance sheet, the rate of exchange adopted even if there is no change in its accounting policy from that of the last year?
(c) As the depreciation arrived at based on market rate may be higher, whether provision for depreciation based on official rate of exchange can be adopted in order to provide depreciation at a reasonable rate (since the depreciation itself is a notional expenditure)?
Opinion* October 7, 1992
1. The Committee notes the definition of ‘exchange rate’, given in para 2 of Accounting Standard (AS) 11 on ‘Accounting for the Effects of Changes in Foreign Exchange Rates’, as reproduced below:
“The rate quoted by the bank or other authorised dealer in foreign exchange at which the Rupee may be exchanged for a unit of a foreign currency or foreign currency may be exchanged for a unit of the rupee.”
2. The Committee further notes paras 23, 25(b), 27 and para 34 of Accounting Standard 11, which read as follows:
“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.
27. Where the historical cost of a depreciable asset has undergone a change due to increase or decrease in liability on account of exchange fluctuations, the depreciation on the revised unamortised depreciable amount should be provided prospectively over the residual useful life of the asset.
34. The following disclosures should be made with regard to accounting of foreign currency transactions or translation of financial statements of foreign branches:
(a) The methods used in (i) converting closing balances of assets and liabilities related to foreign currency transactions remaining unsettled at the end of the accounting period and (ii) translating financial statements of foreign branches.
(b) The accounting treatment of exchange difference, showing separately (i) the amount of loss recognised in the Profit and Loss Statement (ii) the amount of loss or gain included in the carrying amount of fixed assets and (iii) the amount deferred in respect of loss related to long-term liabilities.”
3. The Committee is of the view that exchange rate as defined in the Accounting Standard 11 covers the exchange rates whether quoted by the Reserve Bank of India (called ‘official rate’) or the authorised dealers in foreign exchange (referred to as ‘market rates’), at which one can exchange the rupee for a unit of a foreign currency in India. Hence, for the purpose of the conversion of the foreign exchange loans obtained by the company for acquiring the capital asset, the exchange rate would be the rate at which it can acquire foreign currency as on the date of balance sheet for repaying the foreign currency loans.
4. The Committee further notes that as per clause (1) of the Memorandum on Liberalised Exchange Rate Management System (LERMS), in respect of certain specified priority imports and transactions, foreign exchange will be made available at the official rates. The same is reproduced hereunder:
“Rupee convertibility:
Effective from 1.3.1992, the rupee will become convertible for all approved external transactions. The exchange control regulations are being further liberalised. Under the new Liberalised Exchange Rate Management System, exporters of goods and services and those who are in receipt of remittances will be able to sell the bulk of their foreign exchange receipts at market determined rates. Similarly, those who need to import goods and services or undertake travel abroad will be able to buy foreign exchange at market-determined rates from the authorised dealers subject to the transactions being eligible under the liberalised trade and exchange control regime. However, in respect of certain specified priority imports and transactions, provision has been made in the scheme for making available foreign exchange at the official rate.”
5. On the basis of the above, the Committee is of the following opinion in respect of the issues raised by the querist in para 5 of the query:
(a) The company should adopt that exchange rate for conversion of the foreign currency loans at which foreign exchange can be obtained by the company for repaying the loans at the date of the balance sheet. In case the liability of the company is in respect of priority imports covered under above-referred memorandum, it should adopt the rate quoted by the Reserve Bank of India, i.e., official rate, otherwise it should adopt the rate quoted by the Foreign Exchange Dealers Association of India (FEDAI), i.e., market rate, for the purpose.
(b) Yes.
(c) No, the depreciation is to be provided, in accordance with the recommendation made in para 27 of Accounting Standard (AS) 11, read with para 23 and 25(b), as reproduced in para 1 above. ___________________________________________________________________________________ * 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 1st 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. |