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Query No. 13
Subject:
Accounting for exchange differences in respect of
foreign currency borrowings.1
A. Facts of the Case
1. A Government of India enterprise is engaged in the business
of transmission of power from the generating units in the central
sector to various State Electricity Boards. To meet its expansion
plan, funds are also borrowed in foreign currency from foreign
financial institutions and banks. Its accounting policy regarding
foreign currency transactions is as under:
(a) Transactions in foreign currencies are initially recorded
at the exchange rate prevailing on the date of transaction.
Foreign currency loans/deposits/liabilities are translated/
converted with reference to the rates of exchange ruling
at the year-end.
(b) Exchange Rate Variation (ERV) on loans towards fixed
assets not acquired from outside India is considered as
borrowing cost to the extent it does not exceed domestic
borrowing cost in accordance with Accounting Standard
(AS) 16, ‘Borrowing Costs’.
(c) Exchange Rate Variation (except the amount considered
as ‘borrowing cost’ under paragraph (b) above) arising
on transactions contracted prior to 01/04/2004 is adjusted to the carrying cost of capital work-in-progress/fixed
assets in case of capital assets. For the transactions
contracted after 01/04/2004, the same is charged to the
profit and loss account and is considered incidental
expenditure during construction (IEDC) till the
commissioning of the project in terms of Accounting
Standard (AS) 11 (revised 2003), ‘The Effects of
Changes in Foreign Exchange Rates’.
According to the querist, the above accounting policy is as per the
Accounting Standards Interpretation (ASI) 10, ‘Interpretation of
paragraph 4(e) of AS 16’ and the clarification issued by the
Accounting Standards Board (ASB).
2. The querist has drawn the attention of the Committee to ASI
10 wherein it has been stated that “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”. Further, it has also been stated that “the
likely currency depreciation and resulting exchange loss often offset,
fully or partly, the difference in the interest rates. In such cases,
the exchange difference on the foreign currency borrowings to the
extent of the difference between interest on local currency borrowing
and interest on foreign currency borrowing, is regarded as an
adjustment to the interest costs”.
3. The querist has stated that based on the above, exchange
differences (ERV) whether favourable or unfavourable are
compared with the difference between interest on local currency
borrowings and interest on foreign currency borrowings. ERV limited
to domestic borrowing cost is considered as part of borrowing cost
and accounted for in accordance with the provisions of AS 16.
This comparison is made in respect of each loan agreement
separately. As the favourable ERV in respect of a particular loan
will naturally be less than the difference between the interest on
local currency borrowings and interest on foreign currency
borrowings, such favourable ERV is reduced from the interest
cost. According to the querist, this treatment is based on the fact
that when unfavourable ERV is adjusted to interest cost, the favourable ERV also has to be adjusted to the interest cost [emphasis supplied by the querist]. However, the querist has
contended that it will be illogical that unfavourable ERV is adjusted
to interest cost and charged to revenue, and favourable ERV is
adjusted in the carrying cost of the relevant fixed assets (in case
of transactions prior to 01/04/2004 which are covered under
Accounting Standard (AS) 11(1994), ‘Accounting for the Effects of
Changes in Foreign Exchange Rates’). The querist has explained
this by way of the following illustration:
XYZ Limited has taken a loan of USD 10,000 on April 1, 2004
@ 5% p.a. from the international market. The corresponding
amount of Rs. 4,30,000 (USD 10,000 @ Rs. 43 {assumed
exchange rate on 01/04/2004}) could have been borrowed at
an interest rate of 11% p.a. on the same date in local market.
The exchange rates on different dates are assumed to be as
follows:
I. On April 1, 2004 USD 1 = Rs. 43
II. On March 31, 2005 USD 1 = Rs. 45
III. On March 31, 2006 USD 1 = Rs. 43
Alternatively
IV. On March 31, 2006 USD 1 = Rs. 42
Year 2004-05
(A) Interest cost as per the foreign currency loan agreement
will be Rs. 22,500 (5% of USD 10,000 x Rs. 45)
(B) Interest cost at domestic rate of 11% will be Rs. 47,300
(11% of Rs. 4,30,000)
(C) Difference between interest on local currency borrowings
and foreign currency borrowings = Rs. 47,300 –
Rs. 22,500 = Rs. 24,800
(D) ERV as on 31/03/2005 will be Rs. 20,000 (USD 10,000
x (Rs. 45 – Rs. 43))
Since unfavourable ERV at (D) is less than the difference at
(C) above, Rs. 20,000 will be treated as interest cost which
will become Rs. 42,500 (Rs. 22,500 at (A) above + Rs.20,000
at (D) above).
Year 2005-06
(A) Interest cost as per the foreign currency loan agreement
will be Rs. 21,500 (5% of USD 10,000 x Rs. 43)
(B) Interest cost at domestic rate of 11% will be Rs. 47,300
(11% of Rs. 4,30,000)
(C) Difference between interest on local currency borrowings
and foreign currency borrowings = Rs. 47,300 – Rs.
21,500 = Rs. 25,800
(D) ERV as on 31/03/2006 will be Rs. (-) 20,000 (USD
10,000 x (Rs. 43 – Rs.45)) (being the exchange rate
difference between 31.03.2006 and 01.04.2005)
Since favourable ERV of Rs. (-) 20,000 at (D) is less than the
difference at (C) above, Rs. (-) 20,000 will be treated as
interest cost and interest charged to profit and loss account
will become Rs. 1,500 (Rs.21,500 at (A) above – Rs. 20,000
at (D) above)
Since the unfavourable ERV of Rs. 20,000 in case of year
2004-05 is treated as interest cost and charged to revenue, it
will be logical that same treatment is given to favourable ERV
of Rs. 20,000 in case of year 2005-06.
The querist further states that if the exchange rate as on 31/03/
2006 is Rs. 42 or below, the favourable ERV will increase and
accordingly interest expenditure will become negative which is
explained below:
Year 2005-06
(A) Interest cost as per the foreign currency loan agreement
will be Rs. 21,000 (5% of USD 10,000 x Rs. 42)
(B) Interest cost at domestic rate of 11% will be Rs. 47,300
(11% of Rs. 4,30,000)
(C) Difference between interest on local currency borrowings
and foreign currency borrowings = Rs. 47,300 – Rs.
21,000 = Rs. 26,300
(D) ERV as on 31/03/2006 will be Rs. (-) 30,000 (USD
10,000 x (Rs. 42 – Rs. 45) (being the exchange rate
difference between 31.03.2006 and 01.04.2005)
Since ERV of Rs. (-) 30,000 at (D) is less than the difference
at (C) above, Rs. (-) 30,000 will be treated as interest cost
and interest charged to profit and loss account will become
Rs. (-) 9,000 (Rs. 21,000 at (A) above – Rs. 30,000 at (D)
above ), i.e., interest cost will become negative which seems
to be illogical.
4. The querist has further drawn the attention of the Committee
to a letter dated April 4, 2005 of the Accounting Standards Board
wherein a clarification has been given that “pending the revision to
Schedule VI to the Companies Act, 1956, Schedule VI would prevail
over ASI 10. Accordingly, for accounting for foreign exchange
differences, the provisions of Schedule VI should be followed by
the companies to the extent the provisions in AS 11/ASI 10 (relating
to AS 16) are inconsistent with the provisions of Schedule VI”. The
querist has mentioned that in accordance with the above
clarification, ERV in respect of loans utilised for acquisition of
assets from outside India is capitalised irrespective of whether it is
more or less than the difference between interest on local currency
borrowings and interest on foreign currency borrowings. Further,
the querist has stated that the Ministry of Corporate Affairs (MCA)
has notified Accounting Standards vide Notification dated December
7, 2006. In the footnote to AS 11 (2003), notified by MCA, it has
been stated that “It may be noted 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”. The querist has mentioned that it is
observed that provisions of AS 11 (2003) will prevail over Schedule
VI. However, since no such clarification has been issued for AS 16 and AS 11 (1994), provisions of Schedule VI will prevail over ASI
10 (relating to AS 16) and AS 11 (1994). As per the querist, the
above will have the following implications:
(a) ERV to the extent regarded as an adjustment to interest
cost (portion pertaining to AS 16) in respect of loans
utilised for acquisition of assets from outside India will
continue to be capitalised whether the loan is contracted
after 01/04/2004 or before 01/04/2004 (applicability of
Schedule VI over AS 16).
(b) ERV above the amount mentioned in (i) above, will be
capitalised with cost irrespective of whether or not the
loan is utilised for acquisition of assets from outside
India in respect of loans contracted prior to 01/04/2004
(Applicability of AS 11 ( 1994)).
(c) ERV above the amount mentioned in (i) above will be
charged to revenue irrespective of whether or not the
loan is utilised for acquisition of assets from outside
India in respect of loans contracted after 01/04/2004
(Applicability of AS 11, Revised 2003).
B. Query
5. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
(i) The accounting treatment in respect of favourable
exchange variation in case of foreign currency
borrowings as given in paragraph 3 above. If the
Committee does not agree with the said accounting
treatment, then the correct accounting treatment.
(ii) The accounting treatment of exchange rate variations
as given in paragraph 4 above.
C. Points considered by the Committee
6. The Committee notes that the query basically pertains to two
issues viz., (i) accounting treatment of favourable exchange variation
in case of foreign currency borrowings and (ii) clarification regarding applicability of AS 16, Schedule VI to the Companies Act, 1956
and AS 11 (pre-revised) inter-se with regard to exchange rate
variations in case of foreign currency borrowings towards fixed
assets acquired from outside India, pursuant to the notification of
the Accounting Standards. Accordingly, the Committee has
considered only these issues and has not considered any other
issue(s) contained in the Facts of the Case.
7. The Committee notes that the querist in paragraph 3 above,
has discussed the issue of favourable exchange variation for
transactions entered into prior to 1.4.2004. However, in the
illustration given by the querist, the loan is assumed to have been
taken on 1.4.2004. Therefore, the Committee has considered the
issue of favourable exchange variation for both types of
transactions, that is, the transactions entered into prior to 1.4.2004
and the transactions entered into on or after 1.4.2004.
8. The Committee notes that AS 11, as notified by the Central
Government under the Companies (Accounting Standards) Rules,
2006, carries, inter alia, the following footnote:
“In respect of accounting for transactions in foreign currencies
entered into by the reporting enterprise itself or through its
branches before the effective date of the notification prescribing
this Standard under Section 211 of the Companies Act, 1956,
the applicability of this Standard would be determined on the
basis of the Accounting Standard (AS) 11 revised by the ICAI
in 2003.”
9. The Committee notes that the preamble to AS 11 (revised
2003) states as follows:
“Accounting Standard (AS) 11, The Effects of Changes in
Foreign Exchange Rates (revised 2003), issued by the Council
of the Institute of Chartered Accountants of India, comes into
effect in respect of accounting periods commencing on or
after 1-4-2004 and is mandatory in nature from that date. The
revised Standard supersedes Accounting Standard (AS) 11,
Accounting for the Effects of Changes in Foreign Exchange
Rates (1994), except that in respect of accounting for
transactions in foreign currencies entered into by the reporting enterprise itself or through its branches before the date this
Standard comes into effect, AS 11 (1994) will continue to be
applicable.”
10 From the above, the Committee is of the view that in the year
2007-08, for the transactions entered into prior to 1.4.2004, the
pre-revised AS 11 continues to apply, and for transactions entered
into on or after 1.4.2004, the revised AS 11 (2003) applies even in
respect of the exchange differences mentioned in Schedule VI to
the Companies Act, 1956.
11. The Committee also notes that Accounting Standard (AS) 16,
‘Borrowing Costs,’ came into effect in respect of accounting periods
commencing on or after April 1, 2000 and was mandatory in nature
from that date. The Committee further notes that this implies that
AS 16 applies to all loans whether raised before April 1, 2000, or
on or after April 1, 2000. The Committee also notes that paragraph
4(e) of AS 16, as notified by the Central Government under
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 notes that with the
notification of the Accounting Standards, Accounting Standards
Interpretation (ASI) 10, Interpretation of paragraph 4(e) of AS 16,
has been incorporated in the notified AS 16 by way of ‘Explanation’
which states 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.”
12. From the above, the Committee notes that as per paragraph
4(e) of notified AS 16, exchange loss on foreign currency loan is
capitalised to the extent it amounts to adjustment towards interest
costs. However, 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 decapitalisation can be done only during the period over
which the fixed asset towards which the foreign currency loan has
been taken continues to be a qualifying asset. With respect to
transactions entered into prior to 1.4.2004, to which AS 11 (prerevised)
is applicable, the exchange gains will be adjusted to the
cost of the fixed assets.
13. The Committee further notes that with regard to the applicability
of Schedule VI to the Companies Act, 1956, the notified AS 11 by
way of a footnote provides that the accounting treatment of
exchange differences as contained in the notified AS 11 would
apply irrespective of the relevant provisions of Schedule VI to the
Companies Act, 1956. This implies that in respect of accounting
periods commencing on or after December 7, 2006, the date from
which the Accounting Standards have been notified, the
requirements of notified AS 11 would prevail over Schedule VI
with regard to the treatment of exchange differences. The
Committee also notes that the ‘Scope’ paragraph of the notified
AS 11 (as well as AS 11 (revised 2003)) provides the following
with regard to exchange differences:
“6. This Standard does not deal with exchange differences
arising from foreign currency borrowings to the extent that
they are regarded as an adjustment to interest costs [see
paragraph 4(e) of AS 16, Borrowing Costs.]”
Thus, the Committee is of the view that in the year 2007-08,
without regard to the treatment of exchange differences contained
in Schedule VI to the Companies Act, 1956, with respect to
capitalisation of exchange differences that are of the nature of
borrowing costs, paragraph 4(e) of AS 16 applies. With respect to
other exchange differences, AS 11 (revised 2003) applies for
transactions entered into on or after 1.4.2004. With respect to
exchange differences arising on transactions entered into prior to
1.4.2004, AS 11 (pre-revised) will continue to apply subject to the
consideration of paragraph 4(e) of AS 16.
D. Opinion
14. On the basis of the above, the Committee is of the following
opinion on the issues raised by the querist in paragraph 5 above:
(i) The Committee does not agree with the accounting
treatment as given in paragraph 3 above. The correct
accounting treatment is contained in paragraph 12 above.
(ii) The Committee does not agree with the accounting
treatment as given in paragraph 4 above. The correct
accounting treatment is contained in paragraph 13 above.
1 Opinion finalised by the Committee on 30.5.2008 |