A. Facts of the Case
1. A public sector company is owned by the Government of
India coming under the administrative control of the Ministry of
Coal. The company is engaged in the business of production of
lignite and generation of power. The present capacity of the mine
is 24 million tonnes per annum and 2490 MW of thermal power
generation. The company is in the phase of expansion from 24
million tonnes to 30.6 million tonnes of lignite and from 2490 MW
to 3240 MW of power generation.
2. The company has entered into an agreement for a foreign
currency loan, in respect of its expansion projects requirements
for 50 million Euros under the External Commercial Borrowing
route with XYZ Bank, Singapore. During the year 2006-07, the
company has drawn 34.58 million Euros in two trenches on various
dates. The loan balance has been reinstated with the exchange
rate prevailing on 31st March, 2007. As on 31st March, 2007 there
was a reduction in the exchange rate for Euro, thereby the liability
of the loan has been reduced by Rs. 2.76 crore. The credit effect
has been given in the profit and loss account under the head
‘other income’ and the same has been transferred to the expenditure
during construction as an abatement since the projects for which
the loan has been drawn are in the construction stage.
3. The querist has informed that the entries made in the
company’s books of account in this regard are as follows:
Dr. Cr.
Foreign Currency Loan Account xxxx
Other Income - Exchange Rate
Variation (P&L A/c) xxxx
(Income accounted for on account of
exchange rate variation on foreign
currency loan)
Expenditure Transferred to Capital
Account (P&L A/c) xxxx
Capital Work-in-Progress xxxx
(Foreign Exchange rate variations abated
to Capital
Work-in-Progress during the
period of construction)
4. The querist has stated that as per the pre-revised Accounting
Standard (AS) 11, ‘Accounting for the Effects of Changes in Foreign
Exchange Rates’ (1994), the foreign exchange rate variation of
the nature described above has been identified with the respective
assets to which the loan pertains and capitalised or abated as the
case may be. Further, according to the querist, this treatment is in
line with Accounting Standard (AS) 10, ‘Accounting for Fixed
Assets’. The querist has referred to paragraph 9.3 of AS 10, issued
by the Institute of Chartered Accountants of India, which states as
follows:
“Administration and other general overhead expenses are
usually excluded from the cost of fixed assets because they
do not relate to a specific fixed asset. However, in some
circumstances, such expenses as are specifically attributable
to construction of a project or to the acquisition of a fixed
asset or bringing it to its working condition, may be included
as part of the cost of the construction project or as a part of
the cost of the fixed asset”.
5. The querist has drawn the attention of the Committee to
paragraph 5.1 of the Guidance Note on Treatment of Expenditure
During Construction Period2 issued by the Institute of Chartered
Accountants of India, which states as follows:
“5. Indirect Expenditure Incidental and Related to
Construction
5.1 … expenditure is that, for a running concern, it would be
of a revenue nature. However, because the expenditure is
incurred during the construction period and because during
that period, the expenditure is indirectly related to construction
and is incidental thereto, it should be capitalised as part of the
construction cost.”
The querist has stated that it may be noted that all revenue
expenditures, such as, salary and wages of the employees engaged
in the construction, depreciation of the machinery used in the
construction, interest on the loan taken for the project, stores &
spares and other administrative expenditure incurred during the
period of construction is being capitalised. Likewise any income,
such as, interest on short term investment of the fund raised for
the project, test and trial run revenue and other miscellaneous
receipts are abated to the capital cost of the project.
6. The querist has stated that as per paragraph 13 of Accounting
Standard (AS) 11, ‘The Effects of Changes in Foreign Exchange
Rates’ (revised 2003),
“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. ...”.
Hence,
the exchange rate variance is an item of income or expenditure as
the case may be. Since this has been incurred during the period of
construction, this should be either added or abated to the capital
cost as the case may be.
7. The querist has further informed that the joint statutory auditors
of the company in their audit report have commented upon the
non-compliance of AS 11 stating that the non-recognition of the
exchange fluctuation on foreign currency loan in the profit and
loss account as per revised AS 11, has resulted in the
understatement of current year’s profit by Rs. 2.76 crore and the
understatement of capital work-in-progress by the same amount.
The auditors’ observation is based on the premise that AS 11
specifically states that foreign exchange rate variations should be
recognised as income or as expenses in the period in which they
arise and it is not concerned with capitalisation of the same during
the construction period as in the case of borrowing cost as per
Accounting Standard (AS) 16, ‘Borrowing Costs’, where the interest
during the construction period is capitalised. The querist contends
that the considered view of the company is that expenditure or
income attributable to capital projects still in the construction stage
should be added or abated to capital cost as incidental expenditure
during construction. AS 11 should not be read in isolation and
instead it should be read with AS 10 as well as with the Guidance
Note on Treatment of Expenditure During Construction Period.
B. Query
8. The querist has sought the opinion of the Expert Advisory
Committee on the issue as to whether the exchange rate variations
on the foreign currency loan taken/foreign currency liability incurred
for the project, during the period of construction should be
capitalised or abated, as the case may be, as incidental expenditure
during construction.
C. Points considered by the Committee
9. The Committee wishes to state at the outset that the opinion
given hereinafter is on the facts of the query as stated above.
10. The Committee notes paragraph 9.3 of AS 10 as reproduced
by the querist in paragraph 4 above and paragraph 21 of AS 10,
which states that
“the cost of a self-constructed fixed asset
should comprise those costs that relate directly to the specific
asset and those that are attributable to the construction activity
in general and can be allocated to the specific asset”.
The
Committee notes that in the context of interest, AS 16 lays down
the principles with regard to which borrowing costs should be
considered as attributable to the construction activity3. With regard
to the issue raised by the querist, the Committee notes that
paragraph 4(e) of AS 16 considers that the exchange differences
arising from foreign currency borrowings to the extent that they
are regarded as an adjustment to interest costs, are regarded as
the borrowing costs for the purpose of that Standard.
11. In the context of the issue raised by the querist, the Committee
also notes from paragraph 6 of AS 11 (revised 2003), that exchange
differences arising under paragraph 4(e) of AS 16 are excluded
from AS 11 (revised 2003).
12. The Committee notes that paragraph 4(e) of AS 16, as notified
by the Central Government under the Companies (Accounting
Standards) Rules, 2006, provides that borrowing costs include
exchange differences arising from foreign currency borrowings to
the extent that they are regarded as an adjustment to interest
costs. The Committee further notes that the ‘Explanation’ to the
said paragraph provides as below:
“Exchange differences arising from foreign currency borrowings
and considered as borrowing costs are those exchange
differences which arise on the amount of principal of the foreign
currency borrowings to the extent of the difference between
interest on local currency borrowings and interest on foreign
currency borrowings. Thus, the amount of exchange difference
not exceeding the difference between interest on local currency
borrowings and interest on foreign currency borrowings is
considered as borrowings costs to be accounted for under
this Standard and the remaining exchange difference, if any,
is accounted for under AS 11, The Effects of Changes in
Foreign Exchange Rates. For this purpose, the interest rate
for the local currency borrowings is 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.”
Thus, the Committee notes that exchange loss on foreign currency
borrowings is capitalised to the extent described above.
13. With respect to the foreign exchange gain arising on the
foreign currency borrowings, the Committee is of the view that the
same should be reduced from the cost of the fixed asset to the
extent the exchange loss has been capitalised as per the provisions
of paragraph 4(e) of AS 16. Any excess exchange gain should be
accounted for as income for the year in which the same arises.
Since borrowing costs can be capitalised only with respect to a
qualifying asset as per AS 16, the Committee is further of the view
that the decapitalisation can be done only during the period of
construction of the asset, i.e., only with respect to a qualifying
asset as per AS 16. D. Opinion
14. On the basis of the above, the Committee is of the opinion
that foreign exchange loss on the foreign currency loan can be
capitalised only to the extent as envisaged under paragraph 4(e)
of AS 16. Any excess exchange loss should be expensed in the
profit and loss account. The exchange gain with respect to a
qualifying asset under AS 16 can be adjusted to the cost of the
fixed asset only to the extent exchange loss was capitalised under
paragraph 4(e) of AS 16. The exchange gain in excess of such
adjustment should be treated as income in the profit and loss
account of the year in which the same arises.
1Opinion finalised by the Committee on 30.1.2008.
2The Guidance Note has since been withdrawn pursuant to the decision of the
Council at its 280th meeting held on August 7-9, 2008.
3The Committee notes that the portion of paragraph 20 of AS 10 related to
capitalisation of borrowing costs was withdrawn on AS 16 coming into force. |