1.2 Query: Foreign currency bank account maintained in the foreign currency – accounting for the effect of exchange rate fluctuations.
1. A company was incorporated wherein one promoter (a foreign company) had 61% stake. The company was to bring its equity in foreign currency (Yen). For this purpose and account was opened in the country of foreign promoter (i.e. Japan) with the approval of RBI.
2. The permission of RBI stated that this account is for capital payments only. Once these are over, the account should be closed and the currency in the account can be brought back to India.
3. The company is at the stage of pre-commencement of commercial production. The company kept on paying from the account to the capital suppliers and recorded the transactions at the rate prevailing at the date of payment. No credit was involved. The payments were made in the same currency.
4. As at 31st March, 1996, the company had a balance in the foreign currency account. As per the querist, on a plain reading 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, this balance should be realigned at the rate prevailing at the close of the year and the difference should be charged off/credited to profit and loss account. In the next financial year, the company again makes payments against capital purchases and states the transactions at the current prevailing rate of exchange whereas the loss/gain on capital account has already been taken to profit and loss account.
5. The querist has desired the opinion of the Expert Advisory Committee on the following issues:
(i) Will the accounting treatment followed by the company not result into under/over statement of value of assets, especially when the company treats interest earned/paid during construction period as a capital expenditure/revenue?
(ii) Will it not be proper to keep such losses in pre-operative expenses pending allocation and gains in capital reserve? When the capitalisation is made, the net of the two may be allocated on the basis of foreign currency utilised to purchase them.
Opinion March 17,1998
1. The Committee notes the following relevant extracts of paras 7 and 9 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:
“7. At each balance sheet date:
(a) Monetary items denominated in a foreign currency (e.g. foreign currency notes, balance 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 certain circumstances, the closing rate may not reflect with reasonable accuracy the amount in reporting currency that is likely to be realised from, or required to disburse, a foreign currency monetary item at the balance sheet date, e.g., where there are restrictions on remittances or where the closing rate is unrealistic and it is not possible to effect an exchange of currencies at that rate at the balance sheet date. In such circumstances, the relevant monetary item should be reported in the reporting currency at the amount which is likely to be realised from, or required to disburse, such item at the balance sheet date;
9. Exchange differences arising on foreign currency transactions should be recognised as income or as expense in the period in which they arise….”
2. The Committee notes that the balance in the bank account kept abroad can be remitted to India at any point of time. Thus, the decision to hold the foreign currency aboard was principally a financing decision and, accordingly, the ramification of this decision- the gains or losses arising from holding of this monetary asset- should be reflected in the financial statements of the relevant period. Accordingly, gain or loss from restatement of the balance in the foreign currency account at the closing rate should be recognised in the financial statements for the period.
3. From the above, the Committee is of view that since foreign currency gain/loss from translation of the bank balance is a financing gain/loss, it should be treated in the same manner as other financing gains/losses expenses, such as interest on loans, during the construction period. In this context, the Committee notes para 4.3 of the Guidance Note on Treatment of Expenditure During Construction Period, issued by the Institute of Chartered Accountants of India, which is reproduced below:
“4.3 There is no doubt that interest charges and commitment fees incurred after the date of commencement of commercial production should be treated as revenue expenditure in the normal way. However, during the period of construction, both these charges would represent indirect construction expenditure and should be added to the total capital cost of the project. (This view has already been accepted by the Institute vide paragraph No. 3.25 of the Statement on Auditing Practices). These remarks would apply with particular force in the case of loans which have been taken for the purchase of capital assets or for incurring capital expenditure. It is possible that the accounting treatment suggested in this paragraph may appear to be slightly controversial and unorthodox from a purely theoretical standpoint but, on practical considerations, the suggested treatment is probably fair and is also probably the most appropriate choice out of various alternatives, each of which is bound to be subject to some practical or theoretical objection. This view has now been accepted by the Supreme Court of India in the case of Challapalli Sugars Ltd. V. C.I.T. (1975) 98 ITR-167 (S.C.). With regard to interest charges and commitment fees on loans taken specially and exclusively for the purpose of providing working capital, the treatment suggested above may not be proper and, in this case, it will be more appropriate to transfer the interest charges and commitment fees during the period of construction to a separate account which is carried forward in the balance sheet under the group heading of “Miscellaneous Expenditure” until it is subsequently written-off to profit and loss account after the commencement of commercial production, over a period not exceeding 3 to 5 years.”
4. The Committee notes that the bank account opened in the foreign country with the approval of RBI is for capital payments only. Accordingly, any gain/loss arising on translation of the account should be disclosed in the Statement on Incidental Expenditure During Construction Period (prepared in lieu of profit and loss account) and capitalised.
5. Based on the above, the Committee is of the following opinion for issues raised at para 4 of the query:
(i) Please see para 4 above.
(ii) No. The treatment should be as suggested in para 4 above. _____________________________ |