1.8   Query:    

Treatment of profit arising on cancellation of a roll-over contract.

1. A company entered into a forward roll-over contract in respect of installments payable on foreign currency loans, to reduce the impact of fluctuations in foreign currencies. The instalments would be paid at the contracted rate. The liability outstanding as at the end of the respective year is valued at the lock-in-rate. The company has to pay swap charges for the loan amount rolled-over at the end of each year. At present, the swap charges net of interest outflows are being capitalised and depreciation on such addition is provided over the residual life of the asset.

2. The company, in view of the RBI’s liberalised economic policies, wishes to cancel the roll-over contracts. This will result in a substantial cash inflow to the company at the beginning of the financial year. Subsequent to the cancellation, the company can again take fresh roll-over contract at the prevailing rate.

3. The querist has sought the opinion of the Expert Advisory Committee on the following points:

(a)        Can the inflows resulting from the cancellation of roll-over contract be treated as revenue?

(b)        Can the company set-off the foreign exchange fluctuations and the swap charges, to be incurred in the current financial year, against the inflows and take the net amount to the asset account and provide depreciation on the above net amount over the residual life of the asset?

(c)        Can the company treat both the inflow and swap charges as revenue and capitalise only the foreign currency fluctuations, whereas during the earlier periods the swap charges together with exchange fluctuations were being capitalised?

(d)        Can the cash flows realised on account of cancellation be treated as adjustments (credits) to the fixed assets and excess depreciation charged from the date of capitalisation of the assets till date be written back to profit and loss account?

(e)        From tax point of view if it is adjusted to gross block as per (d) above, would the tax authorities concur with the view taken by the company?

(f)         Will the tax authorities treat the inflows as income in the hands of the company?

(g)        Can the amount of inflow be credited to a reserve account in the nature of capital reserve?

(h)        In the past, the company had not operated any exchange fluctuation reserve account. Whether, the company can create an exchange fluctuation reserve for the current year and credit the cash inflows to the exchange reserve account. Whether the difference on account of foreign exchange in future can be set-off against the exchange reserve account so created?

  Opinion*                                         November 11, 1993

1. The Committee notes that the foreign currency loans taken by the company is long term financing arrangement for acquisition of fixed assets. The Committee notes, in this context, paras 10, 12, 14 and 15 of Exposure Draft of Revised Accounting Standard (AS) 11 ‘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 state as follows:

“10.      The carrying amount of fixed assets should, to the extent not already so adjusted or otherwise accounted for, be adjusted to account for any increase or decrease in the liability of the enterprise, as expressed in the reporting currency by applying the closing rate, for making payment towards the whole or a part of the cost of the assets or for repayment of the whole or a part of the monies borrowed by the enterprise from any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring those assets.”

“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.”

“14.      Any profit or loss arising on cancellation of a forward exchange contract should be recognised as income or as expense for the period, except in case of a forward exchange contract relating to liabilities incurred for acquiring fixed assets, in which case, such profit or loss should be adjusted in the cost of the respective fixed asset.”

“15.      Where the cost of a depreciable asset has undergone a change in accordance with paragraph 10 or paragraph 12 or paragraph 14 of this Statement, the depreciation on the revised unamortised depreciable amount should be provided in accordance with Accounting Standard (AS) 6, Depreciation Accounting.”

2. The Committee notes that the swap charges paid in respect of rolling over of a forward contract are indicative of increase or decrease in the liability of the company. This, in the view of the Committee, represents the differences in the foreign exchange rates. Therefore, the swap charges paid/received by the company shall also be treated in accounts as per para 1 above.

3. In view of Rule 2 of the Advisory Service Rules, the Committee does not offer any opinion on taxation matters involving interpretation of law.

4. On the basis of the above, the Committee is of the following opinion in respect of the issues raised in para 3 of the query:

(a)        The profit on cancellation of roll-over contract should be adjusted in the cost of the relevant fixed assets where the roll-over contract is in respect of liability for purchase of fixed assets. In case of other liabilities, such profit should be recognised as income for the period.

(b)        Yes.

(c)        The company should continue to follow the accounting policy pursued in earlier years, i.e., it should capitalise swap charges together with exchange fluctuations where the same are related to acquisition of fixed assets. The inflow arising on cancellation of roll-over contract should be treated as suggested in (a) above.

(d)        Cash flow realised on account of cancellation of the forward contract related to acquisition of fixed assets should be treated as adjustment to the cost of the fixed assets, and the revised unamortised amount of the assets should be depreciated over the residual useful life of the asset. Depreciation charged in earlier years should not be written-back under such circumstances.

(e)        No opinion offered in view of para 3 above.

(f)         No opinion offered in view of para 3 above.

(g)        No.

(h)        No.

* 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.