1.27 Query: Applicability of Accounting Standard 6 on Depreciation Accounting in case of change in cost of an asset due to foreign currency fluctuations.
1. A company purchased two dredgers from abroad, financed by foreign currency loans from a foreign bank. The terms of repayment are that the principal amount is repayable in annual instalments after initial moratorium period of 7 years, interest being payable half-yearly commencing from day one. Accordingly, interest at specified rate is being paid half-yearly and the first instalment payment towards principal is due in January, 1996.
2. The querist has informed that the difference in liability for repayment of loan (full amount is remaining as liability as on 31.3.95 as the first instalment is to be paid in January, 1996) due to foreign exchange rate fluctuations as at the balance sheet date, i.e., 31st March, every year is being adjusted in the carrying amount of the fixed assets, i.e., dredgers.
3. The querist has also informed that as regards depreciation, the company has been following straightline method as per the rates prescribed in Schedule XIV to the Companies Act, i.e., 7% in case of dredgers. The depreciation relatable to the amount capitalised during the year due to exchange rate variation is being charged over the expired life and residual life of the asset. The depreciation on the expired life is treated as arrears of depreciation and charged off in the year of adjustment to the cost. In effect, cumulative effect of depreciation for the expired life for this additional amount capitalised due to foreign exchange variation is being charged from day one. However, as per Accounting Standard 6 on Depreciation Accounting, depreciation on the amount adjusted in the carrying cost of the asset, is to be provided on the residual life of the asset.
4. The querist has further informed that the carrying cost of the asset is adjusted every year based on the foreign exchange rates as on the date of balance sheet. The repayment of principal is spread over a period of 15 to 16 years, with an initial moratorium of 7 years; the repayment of insalments being spread over to a period of 9 years immediately following. As such, the carrying cost of the asset undergoes change every year and this can be an addition or deduction, depending upon the rate of foreign exchange on 31st March of the relevant accounting year. Further, in the instant case, some loan may remain unpaid even after the economic service life of the asset is over. Therefore, the whole amount remaining to be adjusted in the carrying cost of the dredgers, in the last year of the effective service life of the particular dredger, is to be charged to depreciation (plus or minus) in that year. This could have a substantial effect on the working results of the company for that year.
5. Further, the querist has informed that both these dredgers were imported from Holland, whose currency has been appreciating substantially against the Indian Rupee over the last several years. Considering the past trend it can be reasonably anticipated that this trend will be continued in future also. This, in effect, would increase cost of expenditure in future years if depreciation due to exchange rate fluctuations is spread over the residual working life of the asset and this would be most undesirable for the company at a time when it is facing stiff resistance to increases in its dredging rates from customers.
6. Keeping in view the above situation arising out of long repayment schedule of the loan amount peculiar to the company, the querist has sought the opinion of the Expert Advisory Committee whether the company can follow the system of charging depreciation on the amount arising out of foreign exchange rates over the entire period of the life of the asset, or whether it should be depreciated over the residual life of the asset.
Opinion February 6, 1996
1. The Committee notes paragraph 25 of Revised Accounting Standard (AS) 6 on ‘Depreciation Accounting’, issued by the Institute of Chartered Accountants of India, which reads as follows:
2.On the basis of the above, the Committee is of the opinion that the depreciation policy being followed by the company is not correct. The revised unamortised depreciable amount (i.e., unamortised depreciable amount after adding the increase in long term liability on account of exchange fluctuations) should be provided over the remaining life of the asset. The standard does not provide for any exemption from the aforesaid treatment under any circumstances. Thus, where loan remains unpaid even after the economic service life of the asset is over, it should be adjusted in the carrying cost of the dredgers in the last year of the effective service life of the relevant dredger and should be charged to depreciation in that year. ______________________________
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