Query No. 20

Subject:   

A.  Facts of the Case

1.   A public financial institution registered under the Companies Act, 1956, is engaged in lending operations for power projects in India   In the process of lending operations, it raises domestic as well as foreign currency long term loans.

2.  In July 1997, the company raised US $ 100 million through fixed rate euro note issue having a maturity of 12 years for being lent to various power sector projects.  As per the terms of approval of loan by the ministry of finance, the loan was to be utilised within 12 months from the date of raising.  Accordingly, the entire amount of loan in foreign currency, after paying issue expenditure, was deposited in US dollar denominated bank account abroad on 31^st July, 1997 .  On this date, the company passed an accounting entry by debiting “Bank account abroad” and crediting “Fixed Rate Loan Issue account” by adopting exchange rate of Rs. 35.57/US $ prevalent on the day the amount was raised and so deposited. According to the querist, although, on this date no physical conversion of US dollar into Indian rupees took place, the above entry was passed in accordance with Accounting Standard (AS) 11, ‘Accounting for the Effects of Changes in Foreign Exchange Rates’ which requires a transaction to be recorded on the basis of the exchange rate prevailing on the date of transaction.  The exchange rate as quoted by the banker on that date was adopted as reference rate for this conversion.

3. Subsequently, the company withdrew the money from the bank account abroad by actually converting the US dollar into Indian rupees on various dates depending upon the requirement of rupee funds for lending purposes for the capital expenditure of power projects.  Due to depreciation of Indian rupee vis-a-vis US dollar during this period of withdrawal, the company had an exchange gain of Rs. 21.64 crore.

4. In the subsequent year 1998-99, another foreign debt issue of US $ 100 million was launched by the company and the amount was deposited in a foreign bank account.  The company had an exchange gain of Rs. 2.50 crore on similar transfer of funds to India .  In the year 1999-2000 also, a similar transaction for a further loan issue of US $ 100 million is expected to take place.  All these transactions relate to different loans raised in different years, but the exchange gain arises to the company in the same manner, as the rupee depreciates during the utilisation period of loan.

5.  The company treated the exchange gain as capital receipts but disclosed it in the profit and loss account under the head ‘Capital Appreciation on Foreign Exchange’ as the gain had emerged from the proceeds of a long term loan.  The querist has given the following arguments in support of the accounting treatment followed:

(i)  The loan liability was recorded in the books of account on 31^st July, 1997 on the basis of exchange rate prevailing on the date of transaction of loan in accordance with AS 11 although no physical conversion of foreign currency into Indian currency took place.  The actual conversion took place on different dates in the subsequent 10 months.  Any exchange gain arising on conversion is attributable to the capital liability.  At the time of conversion of loan, the exchange gain was credited to ‘Capital Appreciation on Foreign Exchange’ by debiting the bank account ( India ) where the funds were transferred from bank account abroad.  This credit was neutralized by a debit entry in the profit and loss account in respect of translation loss on loan, equal to difference in the exchange rate at the year end and the exchange rate on the date of transaction (assuming there was no further change in the exchange rate after the withdrawal of the loan).  If, the exchange rate increases beyond the rate on the date of withdrawal, the additional loss on translation of liability will be debited to profit and loss account in accordance with AS 11.

(ii)  Alternatively, this gain could have been accounted for by debiting bank account (in India) and by crediting ‘Foreign Currency Loan (Euro Note issue) account’, thereby increasing the loan liability as this capital gain is directly attributable to the loan raised.  The company’s loan liability actually gets increased as the loan, if to be repaid, will be needing more rupee funds as the Indian rupee has depreciated with respect to US dollar.  At the end of the year, no further debit as translation loss to the extent of revised rupee value of such loan will appear in the profit and loss account, whereas in case of option (i) translation loss equal to capital gain also appears in the profit and loss account thereby nullifying the net impact on the profit and loss account.

B.  Query

6.  The querist has sought the opinion of the Expert Advisory Committee on the correct accounting treatment of gain resulting on account of conversion of funds held in foreign currency into Indian currency.

C.  Points Considered by the Committee

7. The Committee notes that paragraph 5 of Accounting Standard (AS) 11, ‘Accounting for the Effects of Changes in Foreign Exchange Rates’, states the following:

"5.  A transaction in a foreign currency should be recorded in the reporting currency by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction, except as stated in paragraph 4 above in respect of inter-related transactions."

8.  Paragraph 7(a) of the said Standard states the following:

"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 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. Paragraph 9 of the Standard requires that, subject to certain exceptions, "exchange differences arising on foreign currency transactions should be recognised as income or as expense in the period in which they arise".

10. Based on the above, the Committee is of the view that the loan in foreign currency should be initially recorded at the exchange rate prevalent on the date the amount is raised and deposited in bank, e.g., 31^st July, 1997 in the case of loan raised in July 1997.  The withdrawal from the aforesaid bank account should be recorded at the exchange rate prevalent on the date of withdrawal.  This treatment is applicable notwithstanding that any resultant exchange gain is neutralised by a corresponding loss on account of restatement of the loan liability on the date of the withdrawal of money from the bank account.

D. Opinion

11. Based on the above, the Committee is of the opinion that the loan in foreign currency should be initially recorded at the exchange rate prevalent on the date the amount is raised and deposited in bank, e.g., 31^st July, 1997 in the case of loan raised in July 1997.  The withdrawal from the aforesaid bank account should be recorded at the exchange rate prevalent on the date of withdrawal.  The correct accounting treatment of the resultant gain would be to recognise the same as income in the profit and loss account.  Any loss on year end translation of loan liability should be recorded as expense in the profit and loss account.

1Opinion finalised by the Committee on 8.8.2000.