Expert Advisory Committee

1.35 Query:

Accounting for income or expense on forward cover

taken against a foreign currency loan.

1. A company is planning to raise a foreign currency loan (FCL) not earmarked for any specific purpose. As per the querist, in June, 1996, the Government had announced comprehensive guidelines on ECB Policies and Procedures Press Release [vide F.No. 4(1)/97-ECB dated 31^st March, 1997 ]. According to the querist, as per the ECB guidelines, the amount raised can be utilised for the under mentioned purposes:

(i) Purchases of imported/indigenous assets. Corporate borrowers who have raised ECB for import of capital goods and services will be permitted to remit funds into India and deploy the same, except investment in stock market or in real estate, till the actual import of capital goods and services takes place or upto one year, whichever is less.

(ii) Holding companies/promoters will be permitted to raise ECB upto a maximum of USD 50 million equivalent to finance equity investment in a subsidiary company implementing infrastructure projects.

(iii) General restructuring purposes.

2. The queriest has further stated that the recent amendments to the Exchange Control Manual (ECM) (April 15, 1997) have allowed the corporates to book forward covers based on business projections subject to the fact that the forward contract booked should in the aggregate not exceed the average of the actual export/import figures of the applicant for the preceding 2 years. The amendments in the ECM also stated that several corporates having foreign exchange exposure arising out of overseas borrowings/import commitments and those expecting to receive foreign exchange on account of long term commitments, given the market constraints, are now not in a position to obtain forward cover for longer terms and have to hedge their risks by rolling over forward cover for shorter term, which besides being inefficient, is expensive. The authorised dealers have been authorised to enter into foreign currency-rupee swaps to assist the exchange of liabilities between the corporates. Under a swap, a corporate can switch from a foreign currency floating liability to a Rupee fixed liability or vice versa as the case may be. A currency swap is a legal arrangement to exchange payments (interest and principal) denominated in one currency for those denominated in another currency for a defined period of time.

3. The company plans to take a blanket foreign currency loan (FCL) which will be utilised for purchase of imported fixed assets. It has further decided to take a forward cover for the duration of the loan which may be divided as follows:

(a) From the sanctioned date of the FCL to the actual drawdown of the loan.

(b) From actual drawdown till the actual utilisation of it.

4. The queriest has sought the opinion of the Expert Advisory Committee on the following:

(i) The treatment in the books for profit/loss made on the forward cover taken as per para 3 above.

(ii) Will the treatment be different if the above loan is used for the following purposes:

(a) Purchase of indigenous fixed assets.

(b) Investment in a subsidiary company implementing infrastructure projects.

5. The company further plans to hedge itself against the interest fluctuation risk on the foreign currency loan by taking an interest rate derivative which will cap the interest liability. The querist has also sought advice on the treatment in the books for this derivative product.

Opinion December 2, 1997

1. The Committee notes paras 10, 13 and 15 of Accounting Standard (AS) 11, on ‘Accounting for the Effects of Changes in Foreign Exchange Rates’, which require as follows:

“10. Exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which are carried in terms of historical cost, should be adjusted in the carrying amount of the respective fixed assets. The carrying amount of such fixed assets should, to the extent not already so adjusted or otherwise accounted for, also 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.”

“13. 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 date of the transaction should be recognised as 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”.

“15. Any profit or loss arising on cancellation or renewal 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 carrying amount of the respective fixed assets.”

2. The Committee notes that the company in question intends to take a blanket foreign currency loan which can be used for certain specified purposes. It can be theoretically conceived that such a foreign currency loan is acquired, converted into Indian Rupees and then used at the discretion of the management to make various payments- some payments may be for purchase of local fixed assets in rupee terms. In such a case, the loan is a monetary liability denominated in a foreign currency, and, therefore, should be valued at the closing rate with the foreign exchange difference to be taken to the profit and loss account. Accordingly, where a forward cover is taken in respect of such a loan, the difference between the forward rate and the exchange rate on the date of the transaction should be recognised as income or expense over the life of the forward contract and recognised in the profit and loss account. On the other hand, if the foreign currency loan is taken, specifically for the purpose of acquiring fixed assets in foreign currency, the foreign exchange difference should be adjusted in the carrying value of those fixed assets. Similarly, where a forward cover is taken against such a loan, the difference between the forward rate and the exchange rate on the date of the transaction pertaining to the acquisition of fixed assets, should be adjusted in the carrying value of those fixed assets.

3. On the basis of the above, the opinion of the Committee on issues raised in para 4 of the query is as follows:

(i) The accounting treatment of income or expense arising from the forward cover transaction depends upon the purpose for which the loan has been taken irrespective of the periods to which it may relate, i.e., the periods indicated at para 3 (a), (b) and (c) of the query.

(ii) (a) Where the foreign currency loan has been taken specifically for the purpose of purchase of indigenous fixed assets for payment in respect of the fixed assets to be made in foreign currency, the difference between the forward rate and the exchange rate on the date of transaction of the relevant fixed assets should be adjusted in the carrying amount of the respective fixed assets.

(b) & (c) The difference between the forward rate and the exchange rate at the date of the transaction should be recognised as income or expense over the life of the contract and recognised in the relevant profit and loss account.

4. The question regarding treatment of interest rate derivative is a separate question, the answer to which would depend upon the nature of the costs/revenues involved.

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