A. Facts of the Case
1. A Government of India enterprise incorporated under the
Companies Act, 1956, is engaged in the business of transmission
of power from the generating units to different State Electricity
Boards (SEBs) through its transmission network. With the growing
investment in power sector, it also undertakes construction of new
transmission systems linked with the generating units as well as
systems strengthening schemes of the existing networks.
2. The company has borrowed foreign currency loans to partly
finance its capital expenditure on construction of new projects.
The principal and interest on the loans are repaid in the agreed
foreign currencies as per the terms of the various loans. According
to the querist, as per the requirements of Accounting Standard
(AS) 11 (pre-revised as well as revised), the outstanding loans are
restated at the year-end on the prevailing exchange rates as on
that date (i.e., 31st March of each year). The resulting foreign
exchange rate variation (FERV) is being accounted for as under:
(i) FERV in respect of loans utilised for import of capital
equipments is adjusted in the carrying cost of various
fixed assets and the same is depreciated over the
remaining useful life of the asset as depreciation in
accordance with the requirements of Accounting Standard
(AS) 6, ‘Depreciation Accounting’, issued by the Institute
of Chartered Accountants of India.
(ii) FERV in respect of loans utilised for capital equipments
(other than imported) is treated as under:
(a) Limited to domestic borrowing cost: FERV limited
to domestic borrowing cost is treated as part of
borrowing cost and the same is accounted for as
per the provisions of Accounting Standard (AS) 16,
‘Borrowing Costs’, issued by the Institute of
Chartered Accountants of India, i.e., capitalised
during construction period and charged to revenue
thereafter.
(b) FERV above the domestic borrowing cost: Such FERV in respect of loans contracted prior to 1/04/
2004 is adjusted in the carrying cost of the related
fixed assets and the same is depreciated over the
residual useful life as per pre-revised AS 11 (1994).
FERV in respect of loans contracted w.e.f. 1/4/2004
is charged to revenue after commissioning of the
project in accordance with AS 11 (revised 2003).
3. The querist has further stated that the tariff for the transmission
systems constructed by the company is governed by the regulatory
authority, i.e., Central Electricity Regulatory Commission (CERC)
in accordance with the tariff norms fixed from time to time. The
tariff is based on the capital cost of the project and it comprises:
(i) Fixed capacity charges, such as, return on equity, interest
on loans, depreciation, O&M charges and interest on
working capital. The fixed capacity charges are billed
once in a month on fixed dates as 1/12th per month of
the annual normative fixed capacity charges.
(ii) Reimbursements: These include income tax and FERV
which are reimbursed on actual basis. The relevant
provisions of tariff norms regarding FERV are given as
below:
“Extra Rupee liability towards interest payment and
loan repayment corresponding to the normative
foreign debt or actual foreign debt, as the case may
be, in the relevant year shall be permissible provided
it directly arises out of Foreign Exchange Rate
Variation and is not attributable to the generating
company or the transmission licenses or its suppliers
or contractors. Every generating company and the
transmission licensee shall recover Foreign
Exchange Rate Variation on a year to year basis as
income or expense in the period in which it arises
and Foreign Exchange Rate Variation shall be
adjusted on a year to year basis.”
As such, the FERV is recovered from the beneficiaries
on actual payment basis and the same is billed as and
when it is incurred (usually once or twice in a year).
4. According to the querist, the above accounting treatment
results in mismatch between the expenditure and revenue since
FERV accrued due to restatement of loans is charged to revenue
either in the form of interest, depreciation or FERV as explained in
paragraph 2 above, whereas FERV recovery is accounted for on
actual payment basis as per the tariff norms. Moreover, the FERV
charged to the profit and loss account in different forms as explained
in paragraph 2 above may not actually materialise since the
exchange rates on the actual repayment dates may be different
from the rates based on which liability has been created. This
leads to fluctuation in the financial results of the company from
year to year whereas the net impact over the tenure of loan is nil.
The above accounting treatment affects the profit and loss account
of the company on year to year basis since the amount debited or
credited in a particular year will be set-off in the subsequent years
as the FERV is passed through to customers as per the regulatory
norms over the total tenure of the loans and should be seen in the
light of paragraph 2.5 of the Guidance Note on Accrual Basis of
Accounting, issued by the Institute of Chartered Accountants of
India, which is reproduced below:
“2.5 The following are the essential features of accrual basis
of accounting:
(i) Revenue is recognised as it is earned.
(ii) Costs are matched either against revenues so
recognised or against the relevant time period to
determine periodic income, and
(iii) Costs which are not charged to income are carried
forward and are kept under continuous review. Any cost
that appears to have lost its utility or its power to generate
future revenue is written-off as a loss.”
5. To overcome the above situation, the querist has suggested
the following treatments:
(i) The foreign currency loan should be translated at the
closing rates.
(ii) The differential debit or credit should be treated as
recoverable/payable in the balance sheet, given the
nature of the transaction and the contractual
reimbursement rights as per the tariff norms of the
regulatory authority.
Alternatively, if it is considered that the above accounting treatment
is not in line with AS 11,
(i) the amount debited or credited in the profit and loss
account due to FERV in the form of interest, depreciation
and FERV (as explained in paragraph 2 above) should
be depicted as ‘deferred foreign currency fluctuation
asset/liability’ under the current assets or liabilities in
the balance sheet by corresponding debit/credit to the
profit and loss account as ‘deferred income/expenditure
from foreign currency fluctuation’, to the extent the same
is recoverable as per the tariff norms of the Regulatory
Commission.
(ii) The amount billed on year to year basis to the State
Electricity Boards on account of FERV reimbursement
would be adjusted against the balance in the ‘deferred
foreign currency fluctuation asset/liability’.
As per the querist, by following the above practice, the recognition
of foreign exchange differences in the profit and loss account,
arising on account of restatement of foreign currency loans as at
the balance sheet date, will be matched with a corresponding
‘deferred income/expenditure from foreign currency fluctuation’ and
reflected as ‘deferred foreign currency fluctuation asset/liability’ in
the financial statements following the matching principle.
B. Query
6. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
(i) Whether the accounting treatment suggested in
paragraph 5 above would be in accordance with the
provisions of AS 11 and the Guidance Note on Accrual
Basis of Accounting.
(ii) From which year, the proposed accounting treatment is
to be implemented, i.e., whether with effect from (w.e.f.)
the current financial year or w.e.f. 1/04/2000, i.e., the
year from which AS 16 and Accounting Standards
Interpretation (ASI) 10, ‘Interpretation of paragraph 4(e)
of AS 16’ became effective?
(iii) In case the proposed accounting treatment is to be
implemented retrospectively, whether the impact of
previous years is to be considered as prior period item
or to be accounted for under the natural heads of current
financial year.
C. Points considered by the Committee
7. The Committee, while expressing its opinion, has considered
only the issues raised in paragraph 6 above and has not touched
upon any other issue arising from the Facts of the Case, such as,
the appropriateness of the accounting policy of the company in
respect of foreign exchange rate variation as stated in paragraph
2 above.
8. The Committee notes from the ‘Facts of the Case’ that the
electricity tariff comprises two parts, namely, fixed capacity charges
and reimbursements. The Committee is, however, of the view that
from the accounting point of view, there is no distinction between
the two parts since these comprise the sale consideration for the
power supplied to the customer. In the view of the Committee, the
nature of the components of the tariff from the accounting point of
view is such that the amount of certain expenses considered for
the purpose of fixation of tariff is different from the expenses
recognised in accordance with the generally accepted accounting
principles in the financial statements resulting into excess revenue
in certain years and lesser revenue in certain other years.
9. The consequence of the above peculiarities of tariff fixation in
the electricity companies is that there would be a divergence
between the accounting income, i.e., the income computed by
applying the generally accepted accounting principles and the
income computed by applying the tariff fixation requirements. With
a view to reflect a true and fair view of the profit (loss) for the
period, the revenues and expenses need to be matched. The
Committee is of the view that the matching can be achieved in
respect of the situations mentioned in above paragraphs by
recognising a deferred liability in the cases where excess revenue
arises in the initial years because higher costs are considered for
tariff purposes as compared to those recognised in the financial
statements, which gets reversed in the later years when the
expenses for tariff purposes become lower as compared to those
recognised in the financial statements. Similarly, the matching can
be achieved in respect of the situations, where an expense is
recognised earlier in the financial statements as compared to that
for tariff purposes, by recognising a deferred asset subject to the
consideration of prudence, i.e., the realisability of the asset is
reasonably certain or where the company has a history of business
losses, the realisability of the asset is virtually certain, also keeping
in view the contractual reimbursement rights as per the tariff norms
of the regulatory authority. In respect of the situations where the
differences between the expenses/revenue do not get reversed in
the subsequent years, no effect is required to be given.
10. Regarding the issue raised by the querist in the present case
related to accounting for foreign exchange rate variation in respect
of the foreign currency loan, which is recognised in the financial
statements on the balance sheet date for accounting purposes in
one year but is recovered in a later year for tariff purposes, two
situations would arise:
(a) Foreign exchange rate variation which is included in the
cost of fixed assets, keeping in view the requirements
of Schedule VI to the Companies Act, 1956 and
Accounting Standards Interpretation (ASI) 10,
‘Interpretation of paragraph 4 (e) of AS 16’, and
(b) Other FERV which is charged to the profit and loss
account.
11. Under these two situations, the views of the Committee based
on paragraph 9 above as well as the relevant accounting standards
are as follows:
(i) Foreign currency variation on the foreign currency
outstanding loan as on the balance sheet date should
be arrived at by applying the closing rate as per the
requirements of AS 11. The said variation should be
adjusted in the cost of the fixed asset or recognised in
the profit and loss account, as appropriate, keeping in
view the requirements of Schedule VI, ASI 10, AS 11
and AS 16. The other accounting treatments given below
apply in the situation of foreign exchange loss. The
treatment would, accordingly, have to be modified
appropriately in the situation of foreign exchange gain.
(ii) (a) In respect of the situation discussed in paragraph
10(a) above, i.e., where the FERV being a loss is
adjusted in the cost of a fixed asset, the company should
create a ‘deferred foreign currency fluctuation asset’,
subject to the consideration of prudence as discussed
in paragraph 9 above, with a corresponding credit to
‘deferred income from foreign currency fluctuation’ which
should be shown on the assets side and liabilities side
of the balance sheet, respectively.
(b) In respect of the situation discussed in paragraph
10(b) above, i.e., where the FERV being a loss is
charged to the profit and loss account, the company
should create a ‘deferred foreign currency fluctuation
asset’ with a corresponding credit to the profit and loss
account subject to the consideration of prudence as
discussed in paragraph 9 above.
(iii) In the situations discussed in (ii)(a) above, an amount
equivalent to the depreciation on the foreign currency
variation component of the cost of the fixed asset should
be transferred from the ‘deferred income from foreign
currency fluctuation’ to the credit of the profit and loss
account of the relevant year to achieve matching of
cost with the revenue.
(iv) ‘Deferred foreign currency fluctuation asset’ created in
both types of situations, should be credited when amount
in this regard is received from the SEB. Any balance in
the said asset account should be transferred to the
relevant profit and loss account.
12. The Committee is of the view that the above treatment meets
the requirements of accrual basis of accounting including the
matching principle while recognising the peculiarities of the electricity
companies in respect of tariff fixation.
13. The Committee, however, notes that on 7/12/2006, the Ministry
of Company Affairs, Government of India, has notified the
Accounting Standards 1 to 7 and 9 to 29 as recommended by the
Institute of Chartered Accountants of India, which are specified in
the Annexure to the Companies (Accounting Standards) Rules,
2006. Accounting Standard (AS) 11, as contained in the Annexure
to these Rules, while prescribing the accounting treatment in respect
of recognition of exchange differences, states in paragraph 13, “Exchange differences arising on the settlement of monetary
items or on reporting an enterprise’s monetary items at rates
different from those at which they were initially recorded during
the period, or reported in previous financial statements, should
be recognised as income or as expenses in the period in
which they arise…” and also contains a footnote which, inter alia, states that “the accounting treatment of exchange differences
contained in this Standard is required to be followed irrespective
of the relevant provisions of Schedule VI to the Companies Act,
1956”. Accordingly, in the view of the Committee, with effect from
accounting periods commencing on or after 7/12/2006, the foreign
exchange differences arising in respect of fixed assets purchased
from abroad would also have to be recognised in the profit and
loss account, which were hitherto, debited to the cost of fixed
asset in view of the requirements of Schedule VI to the Companies
Act, 1956. Accordingly, the treatment prescribed in paragraph 11
above which relates to recognising FERV in the profit and loss
account would be relevant.
14. As far as the issues raised in paragraph 6(ii) and (iii) are
concerned, the Committee notes that paragraph 4(e) of AS 16
became applicable from the date when AS 16 came into force and
ASI 10 deals only with the interpretation of the same. Accordingly,
paragraph 4(e) of AS 16 should be interpreted in the way stipulated
in ASI 10 from the date the Standard came into force. Therefore,
in the view of the Committee, insofar as the capitalisation of FERV
in respect of foreign currency loan as per the requirements of AS
16 read with ASI 10 is concerned, the accounting treatment
prescribed above in respect thereof should be applied from the
date AS 16 became applicable to the company with retrospective
effect. The adjustments arising from the retrospective
implementation should be treated as ‘prior period items’ and should
be accounted for keeping in view the requirements of Accounting
Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period
Items and Changes in Accounting Policies’, issued by the Institute
of Chartered Accountants of India. The disclosure of the amounts
arising therefrom may be included in the natural heads provided
the nature thereof and the relevant amounts are disclosed in the
notes to accounts, so that their impact on the profit or loss can be
perceived. These can also be reflected as a separate item in the
statement of profit and loss. In this regard, the Committee notes
paragraph 15 of AS 5, which states as follows:
“15. The nature and amount of prior period items should
be separately disclosed in the statement of profit and
loss in a manner that their impact on the current profit or
loss can be perceived.”
D. Opinion
15. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 6 above:
(i) The accounting treatment of foreign exchange rate
variation in respect of foreign currency loans restated at
the balance sheet date but recoverable from the state
electricity boards at a later date on actual payment basis
should be in accordance with the recommendations
contained in paragraphs 10, 11 and 13 above.
(ii) The accounting treatment suggested above in respect
of capitalisation of FERV as per the requirements of AS
16 read with ASI 10 should be implemented from the
date AS 16 became applicable to the company from
retrospective effect as discussed in paragraph 14 above.
(iii) The adjustments arising from the retrospective
implementation of the above-suggested accounting
treatment should be accounted for as ‘prior period items’,
as per the requirements of AS 5. For disclosure
purposes, the amounts may be included in the natural
heads provided the nature thereof and the relevant
amounts are disclosed in the notes to accounts, so that
their impact on the profit or loss can be perceived, or
these can be reflected as a separate item in the
statement of profit and loss as discussed in paragraph
14 above.
1 Opinion finalised by the Committee on 14.5.2007.
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