4.     According to the querist, the company is adjusting foreign exchange differences arising in respect of the said foreign currency loan sub-lent by the parent company against the cost of fixed assets, and is disclosing the said fact each year in the notes to accounts. The company is also disclosing the financial impact had it charged off the said foreign exchange difference every year to the profit and loss account.

5.     The  auditors,  however,  are  qualifying  the  accounts  each  year  as under:

"Attention is invited to:

Loans sub-lent to the company by X Limited, wherein Accounting Standard 11, relating to "Accounting for the Effects of Changes in Foreign Exchange Rates" has been implemented in the manner and for  the  reasons  stated  in  Note  no.  A  of  schedule  16.  Had  the exchange difference been charged to revenue, the accounts for the year  would  be  affected  to  the  extent  and  manner  as  stated  in  the aforesaid Note no. A."

B .   Query

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

(a)    Whether the accounting policy followed by the company is in line with AS 11.

 

(b)    If the answer to (a) above is in the affirmative, whether it will be necessary to disclose the financial impact of the alternative treatment.

 

(c)    Whether the accounting treatment would have been different had the company taken the ECB for repayment of its high cost rupee loans directly instead of through its parent company.

C.  Points  considered  by  the  Committee

7.  The Committee notes that the basic issue raised in the query relates to the accounting treatment of the first part of the sub-lent loan which is a  foreign  currency  denominated  loan.  The  Committee  has,  therefore, considered  only  this  issue  and  has  not  touched  upon  any  other  issue arising from the facts of the case such as treatment of the second part of the sub-lent loan which is a fixed rupee loan.

8.  The Committee notes that under the facts and circumstances of the query, there are two accounting standards relevant for accounting treatment of foreign currency differences arising in respect of a foreign currency denominated liability, namely, Accounting Standard (AS) 11, ‘Accounting for the Effects of Changes in Foreign Exchange Rates’ and Accounting Standard (AS) 16, ‘Borrowing Costs’.

9.  The Committee notes from the loan agreement between the querist and its parent company in respect of the loan sub-lent that it came into force with effect from 24.02.1998. The Committee also notes that AS 16 came into effect in respect of accounting periods commencing on or after 1.4.2000.  Therefore, the  Committee  is  of the  view  that  prior to  AS  16 coming into force, i.e., 1.4.2000, only AS 11 (revised 1994) will apply in respect of accounting for foreign exchange fluctuations in question.

10.  The Committee notes paragraph 10 of AS 11 (revised 1994), 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."

11.   The  Committee  is  of  the  view  that  since  paragraph  10  of AS  11 (revised 1994) reproduced above requires capitalisation of foreign exchange differences in respect of repayment of foreign currency monies borrowed by an enterprise from any person, directly or indirectly, for acquisition of fixed assets, it does not matter that the sub-lent loan was received from the parent. Further,  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 captialised and that too,  from  the  date  the  company  is  exposed  to  the  foreign  currency fluctuation  risks.  Since  prior  to  1.4.2000,  AS  16  was  not  in  force,  the entire amount of foreign exchange difference should be treated as per the aforesaid  requirements  of  AS  11  (revised  1994).  Subsequent  to  the aforesaid date, the extent to which the exchange differences are considered as borrowing costs is determined by AS 16.

12.   The  Committee  notes  that  in  respect  of  accounting  periods commencing on or after 1.4.2000, clause 4(e) of AS 16 applies, which provides as below:

"4.     Borrowing costs may include:

...

(e)    exchange  differences  arising  from  foreign  currency borrowings  to  the  extent  that  they  are  regarded  as  an adjustment to interest costs."

13.   The Committee also notes Accounting Standards Interpretation (ASI) 10,  ‘Interpretation  of  paragraph  4(e)  of  AS  16’,  as  published  in  ‘The Chartered  Accountant’,  November,  2003  (page  492)  which,  inter  alia, provides as follows:

"3.Paragraph 4(e) of AS 16 covers exchange differences on the amount of principal of the foreign currency borrowings to the extent of  difference  between  interest  on  local  currency  borrowings  and interest on foreign currency borrowings. For this purpose, the interest rate for the local currency borrowings should be considered as that rate at which the enterprise would have raised the borrowings locally had  the  enterprise  not decided  to  raise  the  foreign  currency borrowings. If the difference between the interest on local currency borrowings and the interest on foreign currency borrowings is equal to or more than the exchange difference on the amount of principal of the foreign currency borrowings, the entire amount of exchange difference is covered under paragraph 4(e) of AS 16."

14.   From the  above,  the  Committee  is of  the  view  that  in  the  present case, in respect of accounting periods commencing on or after 1.4.2000, the increase in the liability towards the principal amount due to foreign exchange  fluctuations  representing  the  difference  between  interest  that would have been paid had the company raised the money through local currency  borrowings  and  the  interest  on  foreign  currency  borrowings would be considered as the borrowing cost to be accounted for as per AS 16 and the remaining exchange differences, if any, would be accounted for as per AS 11, as explained in paragraphs 10 and 11 above. Thus, the exchange  differences  covered  by  paragraph  4(e)  of  AS  16  would  be capitalised only if the requirements of that standard are met for capitalisation of borrowing costs.

D.   Opinion

15.   On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 6 above:

(a)    The accounting policy followed by the company is in line with AS 11 only  in  respect  of  accounting  period/periods  upto 31.3.2000. In respect of accounting periods commencing on or after  1.4.2000,  the  company  should  follow  the  accounting treatment as suggested in paragraphs 13 and 14 above.

 

(b) In view of (a) above, this question does not arise. Disclosures should be made in accordance with the requirements of AS 11 and AS 16.

 

(c)    No, the accounting treatment would have been the same had the company itself obtained the ECB for repayment of its high cost rupee loans.