1.18 Query: Accounting for exchange rate fluctuations. 1. A government company is engaged mainly in manufacturing of steel products. It has four integrated steel plants with a total ingot production capacity of 11.4 million tonnes. It also has two special steel plants, which are used for producing a wide range of special alloy steel and stainless steel. The company had farmed a modernisation scheme in the year 1982. The replacement of two hot rolling (HR) coilers and run-out table is hot strip mill, in one of the units of the company, was a part of this modernisation scheme. However, due to exigency, this scheme was changed to ‘survival/addition, modification and replacement’ (AMR) scheme in the year 1987.
2. As per the querist, the company had obtained the approval of its board of directors at its meetings held on 20th May, 1987, and 9th June, 1988, for the replacement of two coilers and run-out table. The Government of India, vide its letter dated, August 25, 1987, had approved the replacement of coilers, subject to the condition that for meeting the foreign exchange requirement for the coilers, the company would resort to global tendering and only thereafter it would approach the Department of Economic Affairs (DEA) for the foreign exchange tie-up. The board of directors approved the financing of the coilers through buyer’s credit from a foreign financial institution, in their meeting held in July, 1988. ‘Secretarial for the Industrial Approval’ (SIA) approved the import of HR Coiler etc., vide their letter dated, December 8, 1988, stating that the import licence will be issued only after obtaining approval of the foreign financial institution for financing of the scheme. The foreign financial institution, vide their communication dated, November 2, 1988, agreed in principle to finance replacement of coilers even after becoming part of the survival/AMR scheme, that too retroactively, on finalisation of the financing of the company’s modernisation scheme. The procurement order for the coilers was placed on 25.1.1989. The Ministry of Steel, vide letters dated, 4.1.89 and 28.6.89, approved the release of free foreign exchange for making down payment of 10% and later for 90%, to be reimbursed after approval of the soft loan from the foreign financial institution. On the basis of this, import licence was issued with the condition that the foreign exchange component will be reimbursed by the foreign financial institution.
3. The company signed a loan agreement of DM 260 million in October, 1992, with the foreign financial institution for company’s modernisation scheme and as agreed earlier, the loan agreement provided for retroactive financing of the foreign exchange component for the said coilers also. Accordingly, the foreign financial institution reimbursed on 27.11.92, 4.1.93 and 17.2.93, the foreign exchange expenditure met, through free foreign exchange, by the company amounting to about DM 33.67 millions, equivalent to Rs.63.25 crores. However, the capital work-in–progresses for the foreign exchange expenditure relating to coilers/run-out table had been debited at Rs. 41.05 crores, arrived at by converting the payments at the foreign exchange rates on the respective dates during 1989 to 1992 when the free foreign exchange was released for procurement of coiler. Thus, there is a gap of about Rs. 22.20 crores between the amount received from the foreign financial institution and the amount debited to the work-in-progress account. This is due to the fact that the loan disbursement by the foreign financial institution at a later date has resulted in the variation in the exchange rates.
4. The querist has further stated that the rupee financing of free foreign exchange was made up by the company by taking loans from the Steel Development Fund In India. Till the date of signing of the agreement with the foreign financial institution on 20th October, 1992, interest on the loan from Steel Development Fund was allocated to the Coiler work-in-progress. However, from November, 1992, the interest amount thus fallen due on the DM currency loan obtained from the foreign financial institution upto the date of commissioning of the scheme has to be allocated to the scheme. For working out actual cost of the project, cost of financing is related to the respective projects, and exchange losses/gains arising out of the foreign exchange loans utilised directly/indirectly for acquisition of fixed assets are adjusted in the cost of the relevant fixed assets.
5. The querist is of the view that since the financing of the foreign exchange component for the coiler/run-out table has been ultimately made through the loan from the foreign financial institution, the equivalent rupee amount of the loan reimbursed for this project should form part of the cost of the assets. Debit to the project should not be restricted to the cost of financing done through buying of free foreign exchange which was a stop-gap measure only till the foreign currency loan was made available. Thus, to reflect the cost of assets correctly in the books of account, the work–in-progress needs to be adjusted in line with the loan account. Therefore, in this case, the work-in-progress amount should be increased by Rs.22.20 crores, by giving corresponding credit to ‘Exchange variation – other revenues account’ in the profit and loss account.
6. The querist has given the following reasons in support of her view as stated at para 5 above:
(i) The board of the company had approved the replacement of the equipments (coilers 1 and 2) in May, 1982. Later, in mid-1982, replacement of the coilers became part of the company’s modernisation proposals. Due to exigency, the board had approved, in its meeting in May, 1987, the replacement of coilers as a part of the replacement scheme to be financed from Steel Development Fund loan. The board had also approved replacement of run-out table scheme in June, 1988. It also approved at its meeting in July, 1988, financing of coilers through buyer’s credit from the foreign financial institution. The foreign financing agency had agreed in November, 1988, in principle, to finance the purchase of coilers etc. retroactively. The procurement order was placed in January, 1989. Ministry of Steel, in its letters of 4th January, 1989 and 28th June, 1989, while approving the release of free foreign exchange for procurement of the equipment, mentioned that the foreign exchange will have to be reimbursed from the loan obtained from the foreign financial Institution.
(ii) The company finalised the loan agreement with the foreign institution in October, 1992. The expenditure incurred on procurement of the equipment during 1989 to 1992 was DM 33.67 million equivalent to Rs. 41.05 crores, at the foreign exchange rates prevalent during that period. After finalisation of the foreign currency loan in October, 1992, the total amount of DM 33.67 million, spent by the company from free foreign exchange, was reimbursed by the foreign institution in November, 1992, January, 1993 and February, 1993. The equivalent amount credited in company’s account in this regard was Rs. 63.25 crores.
(iii) The gap between Rs. 41.05 crores and the reimbursed amount of Rs. 63.25 crores amounting to Rs. 22.20 crores is proposed to be adjusted to work-in-progress, as this equipment was specifically financed with the stipulation from the Government of India for reimbursement of this foreign exchange amount from the foreign currency loan. Hence, this amount of Rs. 22.20 crores should be debited to the work-in-progress for this equipment. Since the reimbursed amount of the loan of DM 33.67 million (i.e., Rs. 63.25 crores) had already been accounted by crediting the loan account and debiting the cash, it is necessary that this excess amount of Rs. 22.20 crores received in rupees on account of variation in DM rate should be credited to the profit and loss account under the head ‘Exchange variation – Other revenues account’, with a corresponding debit to capital work-in-progress account.
7. The querist has sought the opinion of the Expert Advisory Committee as to whether the accounting treatment proposed in para 5 above, in respect of the exchange rate fluctuations, is correct.
Opinion February 28, 1994
1. The Committee notes from the facts of the query, that –
(a) the company had placed order for the purchase of two HR coilers and a run-out table, worth DM 33.67 million, in the year 1989;
(b) the payments for the said equipments were made during 1989 to 1992, by purchasing foreign exchange out of the rupees loan obtained from the Steel Development Fund. Total amount thus paid in rupees terms was Rs. 41.05 crores, and was debited to ‘Capital work-in-progress account’;
(c) the abovesaid foreign exchange however was made available to the company subject to the condition that the company will replenish the same out of the foreign currency loan to be received by the company later;
(d) the company, accordingly, on getting foreign currency loan from a foreign institution during 1992-93, sold DM 33.67 million to the Government for Rs. 63.25 crores, and substituted the rupee loan by the foreign currency loan. The corresponding foreign currency loan was accordingly recorded at Rs. 63.25 crores;
(e) the company wishes to capitalise the difference of Rs. 22.20 crores (Rs. 63.25 crores – Rs. 41.05 crores), by crediting the profit and loss account for the period ending as on March 31, 1993.
2. On the basis of the above, the Committee is of the view that the liability of the company to the Steel Development Fund is denominated in rupees, i.e., 41.05 crores, and hence not exposed to any exchange-rate risk. The company substituted this loan, by the foreign currency loan equivalent to Rs. 63.25 crores obtained from the foreign institution. Thus, the foreign currency loan of Rs. 63.25 crores, would be represented by two components – Rs. 41.05 crores worth of capital assets, and Rs.22.20 crores in cash. Therefore, any question of loss or gain due to exchange rate fluctuations does not arise in this case.
3. The Committee is also of the view that since the Government had released the required foreign exchange for acquisition of the said equipments subject to the condition that the company would replenish the amount of foreign exchange so obtained, by taking foreign currency loan from the foreign institution, the foreign currency loan obtained from the foreign institution, to the extent of foreign currency equivalent to Rs. 41.05 crores, is related to the acquisition of the said equipment. Any subsequent increase or decrease in this portion of the foreign currency liability should, therefore, be adjusted in the carrying amount of the relevant assets. Any change in the equivalent foreign currency liability for the balance amount of Rs. 22.20 crores should be recognised in the relevant profit and loss account.
4. The Committee is accordingly of the opinion that the accounting treatment proposed by the querist in para 5 of the query is not correct. _________________________ |