Query No. 18

 

Subject:  

Accounting for the effects of changes in

foreign exchange rates.1

 

A. Facts  of  the  Case

 

1. A corporation carrying on life insurance business has been following Accounting Standard (AS) 11, ‘Accounting for the Effects of Changes in Foreign Exchange Rates’, issued by the Institute of Chartered Accountants of India, from the time the Standard was made applicable.  The querist has stated  that  the  corporation  has  been  facing  certain  difficulties  in  the implementation of this Standard and has enumerated below some problems

 

2. The corporation maintains two kinds of funds; one is for ‘Business within India’ and the other is for ‘Business outside India’. Business outside India consists of business from branches in Fiji, Mauritius and U.K., whereas business within India not only represents business in India but also the closed business in Myanmar, Sri Lanka, Uganda, Tanzania and Nepal from the financial year 1999-2000.

 

3. To comply with local legislations, separate funds are set aside in respect of business in UK, Fiji and Mauritius and separate valuations are being conducted on the basis appropriate to the experience of the individual fund and bonus declarations are made accordingly.  The querist has stated that for Fiji,  the  financial  year  is  from 1st   January to  31st   December and  for Mauritius and U.K., the financial year is from 1st  April to 31st  March. As regards the closed funds in respect of Myanmar, Sri Lanka, Uganda, Tanzania and Nepal, the actuarial valuation is carried out along with the valuation of business within India.

 

4. The querist has stated that the results of valuation in accordance with section 13 of the Insurance Act, 1938, and section 26 of the Life Insurance Corporation Act, 1956, are required to be shown in the corporation’s valuation report in respect of its global business. In respect of foreign branches, actuarial valuation has to be conducted for determining the policy liabilities in their respective local currency as required under local laws of the country.  The querist has stated that only for the purpose of preparing global valuation report in Form I of the Fourth Schedule to the Insurance Act, 1938, all policy liabilities in foreign branches are required to be converted at the closing rate, i.e., on the balance sheet date.  Accordingly, for actuarial valuation the closing funds of foreign branches stated in local currency are converted into reporting currency at the closing rate for the purpose of valuation balance sheet.   In other words, the results of these valuations are incorporated in the global report after converting the amounts into Indian rupees at the exchange rate prevalent on the date of valuation, viz., 31st March for UK and Mauritius and 31st December for Fiji.

 

5. The querist has stated that AS 11 was made mandatory with effect from 1.4.1995 and it was implemented by the corporation in the financial year 1996-97 taking into consideration the changes in the exchange rate from 1.4.1995. As per the querist, prior to the implementation of AS 11, the corporation did not encounter any major problems in tallying the within-India- life fund and outside-India-life funds between the audited balance sheet of the corporation and the valuation balance sheet in Form I, since the closing rate used for converting the life fund both for the audited balance sheet and the valuation balance sheet was the same.

 

6. As per the querist, consequent to the implementation of AS 11, in order to give effect to the changes in foreign exchange rates, there have been differences in the balances of within-India-life fund and outside-India-life fund between the audited balance sheet and the valuation balance sheet. The corporation has been facing these problems since the financial year ended 31st  March, 1997.

 

7. As per the querist, with the application of AS 11 from 1st April 1996, all transactions during the year were required to be converted into Indian rupees at the exchange rate prevalent at the time of transactions.   The excess of income over expenditure so arrived at represented the closing fund which was not at any specific rate.   The querist has stated that this gave rise to discrepancies in the fund shown in the valuation balance sheet as given by the actuary and the audited balance sheet of the corporation.  The difference is explained in the following paragraph.

 

8. For presenting the results of valuation in corporation’s global valuation report, the actuary had shown the following figures of life funds converted into Indian rupees at the exchange rate as at 31.3.1997 and 31.3.1998 for U.K. and Mauritius and as at 31.12.1996 and 31.12.1997 for Fiji respectively for business outside India.

 

                                                                                                                  Rs. in crore

9. The querist  has  stated  that  as  the  life  funds  in  respect of  business outside India should be adequate to meet the respective valuation liabilities and cost of new bonus after providing for the Government’s share of surplus, an amount of Rs. 31,35,05,395 was transferred from within-India fund to outside-India fund in the accounts for the year 1997-98. Although, in reality, outside-India funds are on self-supporting basis, such a transfer gives an impression that the outside India business is being subsidised by the within- India business. The shortfall in the outside-India fund has arisen due to application of AS 11.

 

10. The querist has stated that as per the directions of the board, it was decided since inception that the outside-India fund in respect of UK, Fiji and Mauritius should be self-supporting and no money shall be transferred from within-India fund to outside-India fund. The actuarial valuation in respect of these funds is also being carried out on a stand-alone basis, without subsidising one fund from another. In view of these provisions, the Insurance Regulatory and Development Authority directed the corporation to re-transfer the amount of Rs. 31.35 crore from outside-India fund to within-India fund in the year 1998-99.  The re-transfer of the said amount was done in the year 1998-99.

 

11. The querist has stated that this anomaly was discussed at length with the central statutory auditors of the corporation who were then of the opinion that the life fund being a monetary item and as per paragraph 20 of AS 11, should be translated using the closing rate.   This method was not being followed for the financial years ended 31st March, 1996 to 31st March, 1999. The closing fund arrived at during these years after applying AS 11 to the various items reflected an arbitrary rate and not the closing rate, which in fact is the real rate as per the querist.  Besides, policy liabilities also cannot be converted at a rate, which is not real as at the balance sheet date.  This can be seen from the table given below:

 

 

1998-99  Closing         37,321,003    59.39           68.25       2,216,549,015             2,547,158,454

Fund

 

 

12. The querist  has  stated  that as  per  section  28  of  the  Life  Insurance Corporation Act, 1956, 5% of the valuation surplus has to be remitted to the government and this surplus is identified only at the year end. Accordingly, 5% of the valuation surplus of the foreign branches also will stand remitted to the Central Government.  The valuation surplus calculated as per AS 11 will be different from the amount calculated by applying the closing rate and these figures in turn will further vary when compared with the amount when the actuarial surplus is actually remitted by the foreign branch. Thus, according to the querist, the presentation of accounts gets distorted by applying AS 11. The querist has given the following illustration to explain the above:

 

 

  13. As per the querist, in order to remove this anomaly and as per the advice of the central statutory auditors, the closing fund from financial year 1999-2000 was converted at the closing rate in each of the respective countries. While preparing the Revenue Account for the financial year 1999-2000 for the outside-India business, AS 11 was applied to the various items and the closing fund as per the local currency of each country was translated at the closing rate. This resulted in an imbalance in the debit and credit side of the Revenue Account and as a result of which balancing figure had to be credited to the exchange account by debiting sundry debtors to the extent of Rs. 54.33 crore.  The querist has stated that by passing this entry, a fictitious asset was created in the books, which created distortions while valuing the outside-India fund by the actuary as per the actuarial principles.  This aspect has also been brought out by the actuary in his valuation report. By following the same procedure for the financial year 2000-2001, a fictitious liability to the extent of Rs. 10.04 crore has been created.  This fictitious asset/liability appearing in the books in fact is neither a receivable nor a payable to any person and the only alternative is to adjust this amount to the outside-India- life fund. If this is done then the amount due to the outside-India policyholders will show a different figure than that shown in the valuation report and the returns filed with the local authorities.  As per the querist, there is no way in which these fictitious entries can be adjusted nor can they be justified.  The querist has stated that it would be appreciated that creating such fictitious assets and exchange differences does not form part of prudent accounting policies and does not reflect true and fair view of the outside-India business of the corporation.

 

14. The querist has stated that the main purpose of applying AS 11 is to account for the effects of changes in foreign exchange rates and the net exchange difference resulting from the translation is reflected in the profit and loss account of the concern.  However, in insurance business, the net resultant amount in the Revenue Account represented by excess of income over expenditure is the closing fund which is the policyholders liability and this liability which is reflected in Indian rupees has to necessarily match up with the liability in local currency as shown by the countries.

 

B. Query

 

15. The querist has sought the opinion of the Expert Advisory Committee as to whether AS 11 will enable the correct presentation of accounts and if the answer is in the affirmative then how distortion shown in funds can be corrected or alternatively, the corporation may be permitted to follow the basis as adopted by the actuary for valuing the liabilities.

 

C. Points  considered  by  the  Committee

 

16. The Committee notes that for life insurance business, the Revenue Account is prepared in accordance with Form D of Third Schedule to the Insurance Act, 1938, wherein the items of revenue and expense relating to life insurance business and the opening balance of life insurance fund are included. The Committee further notes from Form D of Third Schedule that the resultant  figure  of  the Revenue  Account  represents  only the closing balance of Life Insurance Fund.

 

17. The Committee notes from the facts of the case that while converting the Revenue Account for the financial years 1999-2000 and 2000-01 in respect of outside-India business, the corporation has stated the closing balance of life insurance fund at closing rate in the Revenue Account.  In this context, the Committee notes paragraph 19 of AS 11 which inter alia provides as below:  

“19.  Revenue items, except opening and closing inventories and depreciation, should be translated into reporting currency of the reporting  enterprise  at  average  rate.  ...”

 

On the above basis, the Committee is of the view that since the closing balance of life insurance fund is the difference between the items of revenue and  expense  and  includes  the  opening  balance  of  life  insurance  fund, restatement of closing balance of life insurance fund at closing rate in the Revenue Account would, in effect, result in restatement of all items of revenue and expense at closing rate which is not in accordance with the requirements

of AS 11.

 

18. The Committee notes that to determine the surplus or deficiency of the business, a separate Valuation Balance Sheet is prepared in addition to the Revenue Account as prescribed in Form I of Fourth Schedule to the Insurance Act, 1938, which is reproduced below: