1.12 Query: Accounting for exchange rate fluctuations.
1. A company has taken a long-term foreign currency loan from a foreign bank for financing the construction of a super thermal power station project in India. The company has also used a part of the said loan for procurement of spare parts. These spare parts received at project were accounted for and shown as ‘Inventories’ under the head ‘Current Assets’ in the balance sheet of the company. The accounting policy followed by the company in respect of foreign exchange fluctuations is as follows:
“Foreign currency loans/deposits/liabilities are translated with reference to the rates of exchange ruling at the year-end. Cumulative difference is transferred to capital work-in-progress/fixed assets in case of capital assets and to revenue in case of current assets.”
2. As per the querist, according to the above policy, the impact of exchange rate fluctuations on fixed assets and current assets would be as follows:
(i) The gain or loss arising due to foreign exchange fluctuations at the year-end on long-term liabilities and current liabilities utilised for acquisition of fixed assets would be adjusted against the cost of fixed assets and capital work-in-progress by giving the corresponding effect to the loan liability relating thereto.
(ii) In case of long-term liabilities and current liabilities utilised for acquisition of current assets, losses would be adjusted in the profit and loss account by giving corresponding effect to the related loan liability on overall basis. In other words, if there is an exchange loss in a particular year, it is transferred to the profit and loss account and loan liability is restated accordingly. Similarly, gains arising on fluctuation of foreign exchange rates in such cases would also be adjusted to profit and loss account by adjusting the amount to the corresponding loan liability in case the gain is lesser than the loss incurred earlier. In other words, the effect of foreign exchange fluctuation is accounted for on overall basis and not on year to year basis. This, as per the querist, is in line with the Accounting Standard (AS) 11 issued by the Institute of Chartered Accountants of India, the relevant para 25 of which is reproduced below:
“25(a) 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 should not be taken into account and the long-term 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 long-term liabilities should be restated and the loss should be charged in the Profit and Loos Statement. However, such losses 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 permitted if it is reasonable to expect that recurring exchange losses will arise on that item in the future.
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.”
3. As per the querist, the treatment given by the company by restating the loan liability and transferring the gain arising during 1992-93 to the profit and loss account from the overall angle as stated above is in order, as the gain arising during 1992-93 is much less than the loss arising in earlier period. The querist has given the following arguments to support his view point:
“The Government Audit and not the company’s auditors had been of view that the favourable foreign exchange variations should have been credited to a reserve account- ‘Foreign Exchange Currency Translation Reserve Account’ instead of treating the way company had done.”
(i) The company, as a policy, had been restating the liabilities relating to foreign currency loan as at the date of the balance sheet to correspond to its value as at that date by debiting/crediting the profit and loss account. The variation in the past has been only negative all along and it is only as at 31.3.93, a positive variation has arisen as compared to the last recording (31.3.92) and not with reference to the original recording as explained hereunder:
(ii) In fact the cumulative effect has been an overall net loss and the liabilities after adjusting for variation to the profit and loss account as at 31.3.93, represent their value as at 31.3.93.
(iii) The gain arising in respect of transactions relating to fixed assets has been adjusted against the value of fixed assets.
(iv) The adverse exchange rate variation in the year ending as on 31st March, 1991, was Rs. 6.37 crores and during the financial year ending 31st March, 1992, it was Rs. 27.95 crores. The total adverse exchange rate variation as at 31.3.92 was Rs.34.32 crores. The loan liability was restated from time to time by debiting the profit and loss account during the respective years. As at 31.3.93, there had been a positive exchange rate variation resulting in a net gain of Rs. 9.95 crores. The same has been dealt with by credit to the profit and loss account in accordance with the recommendations of the Institute of Chartered Accountants of India. As per the querist, as on 31st March, 1993, there is no “net overall gain” but there is still a net overall loss of Rs.24.37 crores compared to the “rates at which the transaction was originally recorded.” As such, as per the querist, the company has not followed a different policy than that recommended by the Institute of Chartered Accountants of India.
(v) Since such exchange rate variation as relating to acquisition of current assets has been consistently charged to revenue in the past, and there being no change in the accounting policy in this regard, the policy being followed by the company is not inconsistent with any of the Accounting Standards issued by the Institute of Chartered Accountants of India.
4.The querist has also stated that the exposure draft issued by the Accounting Standards Board of the Institute, published in ‘The Chartered Accountant’ of August, 1993, on Accounting for the Effects of Changes in Foreign Exchange Rates, is being followed by the company. It reads: “Exchange difference arising on foreign currency transactions should be recognised as income or as expense in the period in which they arise except as stated in para 10 dealing with fixed assets.”
5.As per the querist, even the alternative approach recommended by Accounting Standard (AS) 11, to transfer the gain to a foreign currency transaction reserve account requires such gains to be transferred on overall basis after netting off with earlier losses.
6. The querist has sought the opinion of the Expert Advisory Committee as the whether the company’s policy regarding the treatment of such foreign exchange variation is correct or not?
Opinion May 19, 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 is the subject of the above query. However, due to convertibility of rupee and other related developments, 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 that the query primarily pertains to the year ending as on March 31, 1993. 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 para 25 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, as reproduced at para 2 of the query. The Committee also notes paras 23, 24 and 26 of Accounting Standard (AS) 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.”
“24. (a) In case of current assets and current liabilities (other than those related to fixed assets), if the result of conversion at 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.
(b) In the case of current liabilities incurred for the acquisition of fixed assets, the loss or gain, 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 loss or gain may be dealt with in the manner in sub-para (a) above.”
“26. Gains or losses on settlement, in a subsequent period, of transactions entered into in an earlier period should be credited or charged to the Profit and Loss Statement, except in the case of exchange differences relating to amounts incurred for the acquisition of fixed assets, which should be adjusted in the carrying amount of related fixed assets.”
2. The Committee is of the opinion, on the basis of the above, that the company should, at each reporting date, first carry out an exercise to convert all foreign currency items at the closing rate of exchange, as per para 23 of Accounting Standard (AS) 11 as reproduced at para 1 above. The gain or loss arising on such conversion, insofar as the conversion of liabilities relating to acquisition of fixed assets is concerned, should be regarded as an adjustment of cost and should be included in the carrying amount of the related fixed asset. In case of long-term liabilities, other than those relating to fixed assets, the sum of post-conversion amount of such liabilities should be compared with the sum of pre-conversion amounts, i.e., the amounts as recorded during the reporting period or in case of the liabilities, brought forward from previous year (s) as presented in the immediately preceding financial statements. In case the result of such conversion exercise is ‘overall net gain’, i.e., the sum of the post-conversion amount of such liabilities is lesser than the sum of pre-conversion amount, such gain should not be taken into account, and the said long-term liabilities should continue to appear at their pre-conversion amount. On the other hand, if the result is a net loss, all such long-term liabilities should be restated using the closing rate of exchange, and the resulting loss should be charged to the profit and loss account for the period, except where it can be deferred as per para 25(a) of Accounting Standard (AS) 11, as reproduced at para 2 of the query. Similarly, all foreign currency current assets and current liabilities not relating to acquisition of fixed assets, should be separately converted into Indian rupees at the closing rate and the net result such conversion should be determined for the year. In case the net result of conversion of such current assets and current liabilities taken together is a net gain, these should continue to be stated at their pre-conversion amounts. However, in case there is a net loss, such loss should be charged to the profit and loss account for the period and all such current assets and current liabilities should accordingly be restated at the closing rate of exchange. However, any exchange gain or loss arising on settlement of a foreign currency transaction during the year should be credited or charged to the profit and loss account, except in case of transactions relating to acquisition of fixed assets, where it should be adjusted in the carrying amount of related fixed asset.
Part B: Opinion as per the Exposure Draft of revised AS 11, published in the August, 1993 issue of ‘The Chartered Accountant’.
1.The Committee notes paras 7(a) and 9 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 reads as follows:
“7 At each balance sheet date
(a) monetary items denominated in a foreign currency (e.g. foreign currency notes, balances in bank accounts denominated in a foreign currency, and receivables, payables and loans denominated in a foreign currency) should be reported using the closing rate. However, in circumstances where the closing rate does not reflect with reasonable accuracy the amount in reporting currency that is likely to be realised from, or required to disburse, the foreign currency item at the balance sheet date, a rate that reflects approximately the likely realisation or disbursement as aforesaid should be used.”
“9. Exchange differences arising on foreign currency transactions should be recognised as income or as expenses in the period in which they arise…..”
2. On the basis of the above, the Committee is of the opinion that the accounting policy of the company regarding accounting for foreign exchange fluctuations with respect to long-term liabilities and current liabilities, not relating to the acquisition of fixed assets, is not correct. _______________________
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