Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.6   Query:    

Accounting for estimated roll-over charges payable in future.

 

1. A company imports raw materials from various countries. These imports are made under usance letter of credits (L/Cs) where the payment is to be made 180 or 360 days after the shipment date.

 

2. The accounting treatment followed by the company for recording purchase of imported raw materials is as follows:

 

(a)        On the date of preparation of the materials inwards note (MIN), the materials received is valued in accordance with paras 20 and 21 of AS 11, as follows:

 

-           if a forward cover has been taken by that time, at the forward rate;

 

-           if a forward cover has not been taken by that time, at the exchange rate prevailing on the date of MIN.

 

(b)        On the date of payment, i.e., 180 or 360 days later, the payments are made as follows:

 

-           If a forward cover of the transaction had been taken- at the forward rate. In this case, there could be no exchange fluctuation in this account. However, company may incur roll-over charges which would need to be treated in the accounts.

 

-           If no forward cover had been taken- at the spot rate on the date of payment. This may be different from the rate at which transaction was originally recorded and may result in exchange fluctuation.

 

3. The exchange fluctuation whether by way of roll-over charges or otherwise is normally substantial, i.e., between 10 to 16% p.a. due to the considerable time gap of 180 or 360 days. Till such time the exchange fluctuation is actually incurred, i.e., payment made or roll-over charges incurred, the exchange difference is not recognised in the books of account. Also, there is problem of relating the exchange fluctuation to the materials consumed and those in stock.

 

4. The querist has suggested the following alternative accounting treatments to overcome above said problems:

 

(a)        On the date of preparation of MIN, the material may be valued in the following manner:

 

-           If a forward cover has been taken, the forward rate may be adjusted for estimated roll-over charges to be paid. The resultant rate should be applied for valuing the materials.

 

-           If no forward contract has been taken, the rate on the date of MIN should be applied.

 

(b)        On the date on which the last roll-over up to the due date of L/C is done, the exact amount of roll-over charges would be known. The difference between the roll-over charges estimated and roll-over charges actually incurred would then be charged off to profit and loss account.

 

If this treatment of estimation of roll-over charges is followed, it may still lead to exchange fluctuation. However, the amount will be considerably less as compared to the present practice being followed, depending upon how accurately can roll-over charges be predicted, because, premiums in the exchange market are relatively stable as compared to the spot rate movements. For example, premiums in the last 5 months have been in the range of 13-16% p.a.

 

5. The querist contemplates that this treatment would be against Accounting Standard (AS) 11, which states that in case a forward cover has been taken, the material should be valued at the forward rate. It does not provide any flexibility for providing roll-over charges. Morever, it is not certain that the company shall incur roll-over charges. This is specially so after the recent changes in the RBI policies, allowing cancellation of forward contracts. The company may cancel the contract before the roll-over date and may not end up paying any roll-over charges. Nonetheless, if roll-over charges are not provided, it will give a wrong picture of profitability of the company. Even if it is an estimate, it has to be provided. Also, though the forward contracts can be cancelled, it cannot be so presumed. Till such time the contracts can be cancelled, the company is always exposed to liability on account of roll-over charges.

 

6. The querist has sought the opinion of the Expert Advisory Committee whether the treatment proposed at para 4 of the query is in accordance with the Accounting Standard (AS) 11 generally, and with paras 20 and 21 of the standard in particular.

 

                  Opinion                                       March 2, 1994

 

The Committee notes that the Institute of Chartered Accountants of India had, in 1989, issued Accounting Standard (AS) 11 (hereinafter referred to as old AS–11) on Accounting for the Effects of Changes in Foreign Exchange Rates, which the subject of the above query. However, due to convertibility of rupee and other related development, the Council of the Institute decided to revise the old AS-11 in June, 1992. Accordingly, in August 1993, the old AS-11 was withdrawn and an exposure draft of the revised AS-11 was issued. The Committee also notes the query primarily pertains to the year ending as on March 31, 1992.  The Committee has decided to give its opinion in two parts. The first part (Part A) contains the opinion as per old AS-11 and is relevant for the accounts closing before the withdrawal of old AS-11. The second part (PART B) contains the opinion as per the Exposure Draft of Revised AS-11 and is applicable to the accounting period ending on or after August 1993. However, in the view of the Committee, in cases where accounts for any accounting period closing before August 1993 are finalised after August, 1993, the opinion in Part B may be followed for such accounts also.

 

PART A:         Opinion as per Accounting Standard (AS) 11, issued by the Institute of Chartered Accountants of India in 1989.

 

1. The Committee notes paragraphs nos. 20, 21 and 24(a) of 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 read as follows:

 

“20.      A transaction in a foreign currency should, except as provided in paragraph 21, be recorded in rupee by applying to the foreign currency amount the exchange rate existing at the time of the transaction or a standard rate.

 

21.       When forward exchange contracts are entered into to establish the amount of rupees required or available at the settlement dates of the foreign currency transactions, the forward rates specified in the related foreign exchange contracts may be used as the basis for measuring and reporting the transactions.”

 

“24.      (a) In case of current assets and current liabilities (other than those related to fixed assets), the results of conversion of the closing rate is an overall net gain, such gain should not be taken into account and the assets and liabilities should 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 current assets and current liabilities should be restated and the loss should be charged in the Profit and Loss Statement.”

 

2. On the basis of the above, the Committee is of the opinion that the accounting treatment suggested by the querist in para 4 of the query is not correct. The company should account for the purchases of raw materials at the rates prevailing at the relevant transaction date. However, if the company has taken a forward cover in this regard, the company should account for such purchases at the contracted forward rate. Any roll-over charges paid/credits received subsequently with regard to such forward contract should be charged to the profit loss account of the period in which such roll-over charges become due.

 

PART B:         Opinion as per Exposure Draft of Revised Accounting Standard (AS) 11, issued by the Accounting Standards Board of the Institute of Chartered Accountants of India in August, 1993.*

 

1. The Committee notes paras 5 and 12 of Exposure Draft of Revised Accounting Standard (AS) 11, on ‘Accounting for the Effects of Changes in Foreign Exchange Rates’, issued by the Accounting Standards Board of the Institute of Chartered Accountants of India which read as follows:

 

“5.        A transaction in a foreign currency should be recorded in the reporting currency by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction, except as stated in para 4 above in respect of inter-related transactions.”

 

“12.      An enterprise may enter into a forward exchange contract, or another financial instrument that is in substance a forward exchange contract, to establish the amount of the reporting currency required or available at the settlement date of a transaction. The difference between the forward rate and the exchange rate at inception of the forward exchange contract should be recognised as interest income or expense over the life of the contract, except in respect of liabilities incurred for acquiring fixed assets in which case, such difference should be adjusted in the carrying amount of the respective fixed assets.”

 

2. On the basis of the above, the Committee is of the opinion that the accounting treatment suggested by the querist in para 4 of the query is not correct. The company should account for the purchases of raw materials at the rate prevailing at the relevant transaction date. In case any forward cover has been taken in this regard, the difference between the forward rate and the exchange rate at the inception of the forward contract, or at the time of its roll-over, as the case may be, should be recognised as interest income or expense over the life of the contract on accrual basis.

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* The Committee wishes to draw attention to the fact that the opinion is based on the recommendations made in Exposure Draft of Revised Accounting Standard (AS) 11, issued by the Accounting Standards Board of the Institute of Chartered Accountants of India, published in ‘The Chartered Accountant’, August, 1993. It is, thus, possible that this opinion may change upon issuance of revised Accounting Standard (AS) 11.