A. Facts of the Case

 

1. Gas Rehabilitation and Expansion Project (GREP) of a public sector company was approved by the government for laying 505 kms. pipeline system  from Vijaipur  to  Dadri,  and  establishing/upgrading  compressor stations and constructing Gas Processing Unit (GPU) at Auraiya in March 1994. Asian Development Bank (ADB) appraised the GREP in July 1993 for loan  of US$ 430 million  and agreed to  provide a loan of  US$ 260 million  on  its  own  and  also  arrange  co-financing  in Yen  equivalent  to US$  170  million  from  Export  Import  Bank  of  Japan  (J-EXIM)  which was to be administered by ADB in the same way as if the loan was taken from ADB, i.e., all ADB guidelines for procurement, approval of tenders, purchase orders and disbursement were to apply.

 

2. The loan agreement for the loan of US$ 260 million for GREP was signed  by  the  company and  ADB  in  May  1994  and  funds  were  drawn from the year 1994 to June 1998 as per the requirement under their direct payment method and reimbursement method of disbursing the loan. Under direct payment method, payments were directly released to the suppliers and  contractors  after  receipt  of  the  company’s  advice  to  release  such payments. Under the reimbursement method, initial payment was released by the company and necessary documents were deposited with ADB for reimbursement of the payment made by the company to the suppliers and contractors.

 

3. The loan of Japanese Yen equivalent to US$ 170 million from Export Import Bank of Japan was approved in principle by the board of directors of  the  company  in  November  1993.  The  draft  loan  agreement,  after obtaining approval of the board of directors of J-EXIM was submitted by J-Exim in July 1994 on which comments were sent by the company and discussions  were  held.  The  project  scope  of  GREP  as  indicated  in  the loan  agreement  was  505  kms.  pipelines,  compressor  stations  and  gas processing plant of 12.7 MMSCMD capacity at Auraiya. The terms and conditions of loan were discussed and finalised between Export Import Bank of Japan and the representatives of the Ministry of Petroleum and Natural Gas, Ministry of Finance, and the company in December 1994. During loan negotiations, the company requested J-EXIM and ADB for advance  procurement  and  retroactive  financing  for  all  the  components proposed to be financed. In view of the urgency for timely implementation of the project, J-EXIM indicated that after it approved the financing of the  proposed  project,  the aforesaid  arrangement  including procurement actions  already  taken  for  the  requirements  of  the  project  would  be acceptable.

 

4. In view of the above arrangement, even though the loan agreement was  not  signed  by  J-EXIM  and  the  company,  ADB  procedure  for procurement of components for the project was followed by the company from 1994. Wherever tenders had been issued but not finalised, tender conditions were amended incorporating ADB guidelines and evaluation was done as per ADB procedure only. Where the tenders had not been issued, these were issued as per ADB procedure. In cases where purchase orders had already been issued, copies of such purchase orders were sent to ADB  for their  formal approval.  Purchase orders  were placed  by the company during 1993-95 and ADB approval for all such purchase orders was received during 1994-95.

 

5. The company applied to the Government of India for formal approval of  the  loan  in  February  1995.  After  several  rounds  of  discussions  and written  clarifications,  the  approval  of  the  government  was  received  in March 1996. As per the querist, the approval clearly indicated that the loan  was  for  GREP.  However,  this  approval  was  not  sufficient  as  a guarantee by the Government of India for repayment of loan and payment of  interest  due  thereon,  which  was  one  of  the  conditions  of  the  loan agreement, was not provided. Therefore, the matter was again taken up with  the  government  and  government  approval  of  the  guarantee  clause was received in November 1996. As per the requirement, application was made  to  RBI  for  sanction  of  the  loan  which  was  received  in  January 1997. According to the querist, RBI approval also clearly indicated that the  loan  was  for  GREP.  Ministry of  Finance  was  requested  in  January 1997 for signing of the Guarantee Agreement. Ministry of Finance sent the loan documents to Law Ministry. Comments of Law Ministry were received in April 1997. These were discussed with J-EXIM and some of them were agreed to by J-EXIM. The replies to comments of Law Ministry were sent on 17th  May, 1997 and clarified on 27th  May, 1997. Again the comments of Law Ministry were received on 25th  June, 1997 and replied by the company in June itself. The modified loan documents and Guarantee Agreement were again sent in August 1997 and followed up constantly with the  Ministry of Finance. The  government approval to  execute the loan  agreement  was  finally  received  in  November  1997.  Meanwhile  it was  observed  by  the  company  that  requirement  for  funds  would  be approximately  equivalent  to  US$  80  million  only  instead  of  US$  170 million as assessed earlier. Therefore, J-EXIM was approached to reduce the  loan  amount  equivalent  to  US$  80  million.  After  receipt  of  such approval  from  J-EXIM,  Ministry  of  Finance  was  re-approached  for approval  of  the  reduced  amount,  which  was  received  in  January 1998. Loan agreement was executed in February 1998. Letter of guarantee was issued by the government in April 1998.

 

6. For receiving the loan proceeds, it was necessary to appoint a process agent and also open a foreign currency bank account in Tokyo for which the approval of RBI was received in April 1998. The final approval to draw the  loan was  received from RBI on 23.4.1998. To make  the loan effective, it was necessary to obtain a legal opinion, which was arranged in April 1998 itself. The legal opinion sought by J-EXIM and the Indian side  was  debated  and  sorted  out  in  May  1998.  The  loan  was  declared effective  on  12th   June,  1998.  Immediately,  application  for  drawing  the funds under ADB reimbursement procedure was submitted to ADB. Based on the ADB recommendations, reimbursement was made by Export Import Bank of Japan and an amount equivalent to US$ 63.835 million or Rs.276.38  crore was  credited to  the bank account  of the  company on  29th June, 1998.

 

7. Since  purchase  orders  were  placed  during  1993-95  and  supplies started  arriving  from  the  year  1995  and  the  loan  agreement  between Export Import Bank of Japan and the company was not in place due to procedural  delays  as  stated  above,  the  company had  to  use  its  internal temporary working capital surplus funds for taking delivery of the materials which  were  urgently  required  for  the  project  believing  that  the  loan agreement will be executed shortly and the loan proceeds to be received under reimbursement procedure will be utilised for recouping the internal working capital funds. Though the payments to suppliers started as early as  July  1993  and  continued  upto  November  1997,  the  majority  of  the payments were released during 1995-96 and 1996-97.

 

8. While the loan agreement was under approvals/execution, the GREP and  GPU  Projects  for  which  the  loan  was  tied  up,  were  capitalised  in March 1997 and March 1998 respectively.

 

9. The company adjusted the exchange difference arising on account of  loan  taken  in  the  carrying  amount  of  the  respective  fixed  assets  of GREP and GPU as on 31.3.1999 and 31.3.2000. The following disclosure was  made  by  the  company  in  the  ‘Notes  on  Accounts’  for  the  year ending 31.3.2000:

 

Note 9 – Schedule 14  

“The  company  had  tied  up  foreign  currency  loan  for  acquisition/ setting up of GREP Pipeline and GPU plant from J-EXIM (as co- financing  with ADB)  amounting  to  9224  million Yen  (Rs.  276.38 th crore)  in  1994  under  reimbursement  procedure,  signed  on  20 February, 1998, was disbursed on 29.6.1998 due to delay in furnishing of counter guarantee by Government of India. These projects were capitalised on 29.3.1997 and 13.3.1998, respectively. The additional liability  on  account  of  exchange  rate  variation  amounting  to  Rs.51.34 crore for the financial year 1998-99 and Rs. 53.04 crore for the current financial year have been capitalised by the company”.

 

10. As  per  the  querist,  the  above  accounting  treatment  was  followed keeping  in  view  the  requirements  of  Accounting  Standard  (AS)  11, ‘Accounting  For  the  Effects  of  Changes  in  Foreign  Exchange  Rates’, issued by the Institute of Chartered Accountants of India, which provides in  paragraph  10  that  “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” provided “monies are borrowed by the enterprise from any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring those assets”.

 

11. According to the querist, the foreign currency loan had been obtained for acquiring specific fixed assets of the GREP. The company believed that there was direct connection between the loan and specific items of fixed assets of GREP due to the following reasons:

(i)         When the loan was under negotiation, the specific project viz. GREP  including  505  kms  pipeline,  compressor  stations  and gas processing unit at Auraiya were appraised with emphasis on the category of items to be financed by the loan.

 

(ii)        Each  and  every  purchase  order  covering  the  items  under financing by Export Import Bank of Japan were approved by ADB  (loan  administering  agency)  under  their  advance procurement procedure.

 

(iii)   Loan agreement stipulates the specific items to be financed by Export Import Bank of Japan for GREP, i.e.,:

 

Line Materials               US$     6.00 million

Cathodic Protection      US$     4.00 million

Terminals                      US$     0.70 million

Telecom/SCADA         US$     3.10 million

Pressure Upgradation   US$     0.20 million

Gas Processing Plant    US$     66.00 million

 

Total    US$ 80.00 million

 

(iv)   All  government/RBI  approvals  state  that  the  loan  is  for acquiring  fixed  assets  for  Gas  Rehabilitation  and  Expansion Project including Gas Processing Unit.

 

(v)        Loan  funds  have  been  released  by  Export  Import  Bank  of Japan after verification of invoices by ADB that material has actually  been  dispatched  to  the  projects  and  that  against  the invoices,  money  has  actually been  disbursed  to  the  vendors/ contractors.

 

(vi)   The querist has also referred to an earlier opinion of the Expert Advisory Committee of the Institute of Chartered Accountants of India published in Compendium of Opinions – Volume XIII (pages 56-61).

   

12. The  statutory auditors  of  the  company  observed  in  their  report  to the shareholders on accounts of the company for the year ending 31.3.2000

as below:  

“The  company  has  not  charged  off  to  revenue  exchange  rate difference on foreign currency loan which was disbursed after the acquisition  of  assets  which  has  resulted  in  increase  in  profits  and fixed assets by Rs. 94.85 crore (refer note no. 9 Schedule 14)”.

 

13. The  statutory  auditors  further  made  the  following  observation  in their report under section 619(3)(a) of the Companies Act, 1956, submitted to the Principal Director of Commercial Audit:

 

“The  company  had  tied  up  foreign  currency  loan  for  acquisition/setting up  of  GREP  pipeline  and  GPU  plant  from J-EXIM,  Japan (as co-financier with ADB) amounting to 9224 million Yen in 1994. Due to various reasons, the loan was finally disbursed on 29.6.1998. In the meanwhile, the projects for which loan was taken were already completed,  i.e.,  GREP  pipeline,  was  capitalised  on  29.3.1997 (financial  Year  1996-97)  and  GPU  was  capitalised  on  13.3.1998 (financial year 1997-98) respectively. These projects were completed out  of  own  resources  (internal  generation)  of  the  company  and without taking any bridge loan. Thus the company acquired/installed all  these  assets  out  of  its  own  internal  resources  which  were accordingly capitalised. The loan which was disbursed on 29.6.1998 was  never utilised  in the  acquisition of  the fixed  assets. The  loan amount of 9224 million Yen (Rs. 276 crore) was credited to current account  with  Bank  of  India  on  29.6.1998.  The  entire  money  was used  as  working  capital  and  for  acquisition  of  fixed  deposits  on account  of  which  company  earned  interest  income  credited  to  its profit  and  loss  account  for  the  current  year.  The  company  has capitalised  the  additional  liability  on  account  of  exchange  rate variation amounting to Rs. 51.34 crore for the financial year 1998-99  and  Rs.  53.04  crore  for  the  financial  year  1999-2000.  As  per paragraph 10 of Accounting Standard 11 issued by the Institute of Chartered Accountants of India, the 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, therefore, only the exchange difference relating to loans acquired and utilised for acquisition of fixed  assets should be capitalised.  In this particular case though the loan was tied up for the acquisition of that particular asset, the same was never used for the acquisition of these assets. Itis evident that loan proceeds have been used to acquire fixed deposits and for the working capital.

 

Your kind attention is also invited to the provisions of Accounting Standard (AS) 10, ‘Fixed Assets’, which provide that the financing cost (including interest on fixed assets purchased on deferred credit basis)  or  on  money  borrowed  for  construction  or  acquisition  of fixed assets should not be capitalised to the extent it relates to the period after such assets are ready to be put to use.

 

Thus,  from the  combined  reading  of AS  10  and AS  11,  it  is  very clear that since the loan proceeds were not utilised for the acquisition of fixed assets, exchange rate variation relating to this loan cannot be capitalised along with the cost of plant and machinery.”

 

14. The company had given the following clarifications on the statutory auditor’s comments:

(i)         According to the provisions of AS 10, interest or other financing costs  relating  to  the  monies  borrowed  for  construction  or acquisition of fixed assets are not capitalised if they relate to the period after relevant fixed assets are ready to be put to use. The  company  has  not  capitalised  any  portion  of  the  interest relating to money borrowed from J-EXIM Bank because loan was received after the assets were ready to put to use. As such AS  10  has  no  relevance  in  this  case.  Further,  unlike AS  10 which prohibits capitalisation of interest after the date when the assets are put to use, AS 11 requires exchange rate variations to be adjusted in the cost of the relevant fixed assets till the relevant borrowings are totally paid off. In other words, foreign exchange variations (unlike interest) should be capitalised even after  the  asset  has  been  put  to  use,  provided  the  related borrowings still exist.

 

(ii)        As a matter of policy, the company keeps its temporary internal working capital funds in short term deposits ranging from 15 to 90 days with banks as keeping the funds in current account does not earn any revenue.

B. Queries

 

15. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

 

(a)        Whether the loan received from Export Import Bank of Japan is  directly  or  indirectly  connected  with  the  acquisition  of specific assets of GREP.

 

(b)        Whether  the  company  was  right  in  adjusting  exchange  ratest difference, as on 31st March, 1999 and 31 March, 2000, in the carrying amount of specific fixed assets.

C.  Points considered by the Committee

 

16. The Committee notes from the facts of the case that it is not clear as to whether the loan was taken by the company for the GREP or the GPU or both. The Committee has, therefore, not touched upon the issue as to the project to which the loan pertains as that is a question of fact. The opinion of the Committee, given hereafter, is in respect of capitalisation of differences in the foreign exchange rates related to the acquisition of the specific fixed assets for which the loan was raised.

 

17. The Committee notes paragraph 10 of AS 11 which states as below:

 

“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” (emphasis added).

 

18. The Committee notes from the above that the exchange differences are required to be capitalised as a part of the cost of fixed assets if the liabilities were incurred for the purpose of acquiring the fixed assets. The Committee notes that it is the purpose for which the loan was raised that is  of  prime  significance,  i.e.,  whether  the  purpose  of  the  loan  was  to finance the fixed assets or not.

 

19. In order to determine whether the loan from J-EXIM can be said to be for the purpose of acquiring the relevant fixed assets, the Committee notes from the facts of the query that the negotiations for obtaining the loan were initiated by the company before the acquisition of the concerned fixed  assets.  However,  due  to  various  procedural  delays  with  the governmental authorities as stated in the facts of the case, the loan could not be executed till the time the project was over. The Committee also notes from the facts of the case that two modes of payment were permitted to the company, viz., the direct payment method and the reimbursement method  under  the  loan  agreement  with  ADB.  The  Committee  further notes that all ADB guidelines for procurement, reimbursement, etc., were to apply to the loan from J-EXIM also. J-EXIM had also indicated that after it approved the financing of the proposed project, J-EXIM would finance retroactively all the components already procured by the company. Subsequently, after the necessary approvals of the loan, funds were drawn under  the  reimbursement  method  of  disbursement  of  loan.  Keeping  in view the above facts, the Committee is of the view that the loan from J- EXIM was for the purpose of acquiring the relevant fixed assets, although the  company  utilised  its  working  capital  funds  for  the  acquisition  of related fixed assets in the interim.

 

20. In respect of capitalisation of the foreign exchange differences on the  loan  amount,  the  Committee  is  of  the  view  that  only  the  foreign exchange differences related to the loan equivalent to the actual amount spent in Rupees on the relevant fixed assets should be capitalised. Thus, in  case  the  loan  amount  is  equal  to  the  amount  actually  spent  on  the relevant fixed assets, the entire amount of foreign exchange differences in this regard should be capitalised. On the other hand, if the loan received is in excess of the actual amount spent the foreign exchange differences arising in repayment of such excess loan amount should not be capitalised, since  the  said  excess  cannot  be  considered  to  be  for  the  purpose  of acquisition of the relevant fixed assets. The Committee is further of the view that only those foreign exchange differences should be capitalised which  relate to  the period  after  the drawing of  the loan  since, prior  to that,  the  company  was  not  exposed  to  the  risk  of  changes  in  foreign currency rates.

 

D. Opinion

 

21. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 15:

(a)        The loan received from the Export-Import Bank of Japan should be treated as directly connected with the acquisition of those fixed assets that are acquired in accordance with the terms of loan agreement for the purpose of AS 11. The Committee has not touched upon the issue as to the project to which the loan actually pertains since that is a question of fact, as stated in paragraph 16 above.

(b)        The company is right in capitalising the exchange differences to the extent stated in paragraph 20 above, provided the same relates  to  the  specific  fixed  assets  for  which  the  loan  was acquired.

1Opinion finalised by the Committee on 19.8.2001.