1.6 Query: Accounting treatment for the effects of changes in foreign exchange rates.
1. A public sector company, to meet the foreign exchange requirement of one of its projects, had borrowed in 1981, Kuwaiti Dinar (KD) 30 million. The term of the loan was 7 years with one shot repayment date in 1988. The Bonds were with fixed interest rate. The project was commissioned in 1985. The company desired to prepay the bonds in 1985, but could not as there was no clause to prepay the Bonds before maturity date.
2. The querist has stated that when the Bonds fell due for repayment in 1988, the company was advised by Govt. of India not to repay the loan in view of exchange crisis at that time. Instead, the company had been advised by the Govt. to extend loans to other public sector undertakings. The company renewed the Bonds by issuing fresh bonds, this time with a 5 year term, maturing for repayment in 1993. The agreement also provided a clause for earlier repayment with a premium in 1991.
3. According to the querist, the rate of exchange at the time of original borrowal was 1 KD = Rs. 32.24. In 1988, when the Bonds fell due for repayment, the rate of exchange was 1 KD = Rs. 53.91. As required under Part I of Schedule VI to the Companies Act, 1956, and Section 43A of Income-tax Act, 1961, the exchange difference between 1981 and 1988, i.e., till the maturity date of first Bonds, was capitalised. The depreciation of the Indian rupee against KD continued. As on March 31, 1990, the exchange rate was 1 KD = Rs. 59.70. As per the accounting policy adopted by the company, the long term loan in foreign currency is valued at closing rate of exchange. The exchange difference between March 31, 1989 and March 31, 1990 was charged to profit and loss account. The interest was also charged to profit and loss account from the date of commercial production at the rates at which remittances are made annually.
4. Due to invasion of Kuwait by Iraq, the exchange rate for KD was not available as on March 31, 1991. As per the querist, in the annual accounts for the year ended March 31, 1991, the Bond was exhibited at March 31, 1990, rates with suitable notes to accounts.
5. The exchange parity of Indian Rupee against major currencies was changed twice in early July 1991. The exchange market for KD was opened during early August 1991. Consequent to these, the querist has stated that the exchange rate had shot up from 1 KD = Rs. 59.70 on March 31, 1990 to 1 KD = Rs. 90/- in October 1991. According to the querist, in terms of financial impact, the exchange difference works out to Rs. 100 crores.
6. Accounting Standard (AS) 11 on Accounting for the Effects of Changes in Foreign Exchange Rates has become mandatory with effect from 1st April, 1991. *Para 9.2 (b) of the Standard states as under:
“In the case of long-term liabilities other than those incurred for the acquisition of fixed assets, if the result of conversion at the closing rate is an overall net gain, such gain is not taken into account and the long-term liabilities continue to appear in the books at the rates at which they were originally recorded. On the other hand, if the result is a net loss, the long-term liabilities are restated and the loss is charged in the Profit and Loss Statement. However, such loss can also be deferred and recognised in the Profit and Loss Statement of current and future periods over the remaining term of the liabilities to which they relate. Such deferral is not made if it is reasonable to expect that recurring exchange losses will arise on that item in the future.”
7. The querist has sought the opinion of the Expert Advisory Committee on the following:
(i) Should the exchange difference, after the date when the first Bonds fell due for repayment, be capitalised instead of charging it to revenue?
(ii) If the answer to (i) above is in the affirmative, should the differential depreciation on such exchange difference be also charged to profit and loss account till date?
(iii) If the answer to (i) above is in the negative, should the exchange difference between March 31, 1990 and March 31, 1992 rates be charged to profit and loss account in the year 1991-92?
(iv) Could the exchange difference be deferred over the balance period of loan till 1993-94 as per para 9.2(b) of AS 11?
(v) Will it make any difference in accounting treatment, if the Bonds are prepaid in December, 1991, the earliest date of repayment?
Opinion July 6, 1992
1. The Committee presumes that the entire loan was taken to meet the requirement of funds for acquisition of fixed assets from outside India, since the querist has stated that the company has capitalised the loss on exchange in accordance with the instructions contained in part I of Schedule VI to the Companies Act, 1956. With regard to capitalisation of loss on exchange after 1988, in respect of the renewal of the loan, the Committee is of the view that the fresh bonds have been issued under a financial arrangement with some public sector undertakings on the advice of the Government of India. Therefore, the loan can not be said to have been taken for acquisition of fixed assets. In view of this, the loss of exchange in respect of new bonds should not be capitalised.
2. The Committee notes para 9.2 (b) of Accounting Standard (AS) 11 on Accounting for the Effect of Changes in Foreign Exchange Rates, issued by the Institute of Chartered Accountants of India, reproduced in para 6 of the query.
3. On the basis of above and subject to presumption stated in 1 above the Committee is of the following opinion in respect of queries raised in para 7 of the query:
(i) No.
(ii) Since the answer to (i) above, is in the negative, this question does not arise.
(iii) The Committee is of the opinion that in view of the non-availability of the exchange rate on March 31, 1991, that exchange rate should have been used which was indicative of the exchange rate prevailing on that date, e.g., the last normal exchange rate available before the onset of hostilities. The exchange rate available after the balance sheet date on cessation of war can also provide additional indication of the rate prevailing on March 31, 1991. Since it was not done, the company should estimate, as aforesaid, the rate prevailing as on 31st March, 1991, and charge the difference between that rate and the rate used by the company (i.e., March 31, 1990 rate) as a prior period item in the accounts for the year end March 31, 1992, as per para 5 of Accounting Standard (AS) 5 on Prior Period and Extraordinary Items and Changes in Accounting Policies, issued by the Institute of Chartered Accountants of India. Thus, the loss on exchange for the current year should be arrived at on the basis of the difference between the rate used for the year ended March 31, 1991 and the closing rate on March 31, 1992.
(iv) The loss on exchange can be deferred only in the situation laid down in para 9.2 (b) of AS-11.
(v) The exchange difference to be charged to profit and loss account will be the difference based on the rate used for the year ended March 31, 1991 and the rate prevailing on the date of payment in December, 1991.
_______________________________ * 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.
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