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Query No. 6
Subject:
(i) Accounting for foreign exchange differences on
foreign currency loans taken at different times.
(ii) Accounting for foreign exchange gains under
paragraph 4(e) of AS 16.
(iii) Presentation of foreign exchange gains.1
A. Facts of the Case
1. A listed government company is carrying on the business of
operating ships. The company does not have any subsidiary
company. The company has been taking foreign currency loans
for the acquisition of ships which are constructed and delivered
over a period of three to four years.
2. The querist has drawn the attention of the Committee to
‘Instructions in accordance with which assets should be made out’
as contained in Schedule VI to the Companies Act, 1956 which
provides that where the original cost and additions and deductions
thereto, relate to any fixed asset which has been acquired from a
country outside India, and in consequence of a change in the rate
of exchange at any time after the acquisition of such asset, there
has been an increase or reduction in the liability of the company,
as expressed in Indian currency, for making payment towards the
whole or a part of the cost of the asset or for repayment of the
whole or a part of moneys borrowed by the company from any
person, directly or indirectly, in any foreign currency specifically for
the purpose of acquiring the assets (being in either case the liability
existing immediately before the date on which the change in the
rate of exchange takes effect), the amount by which the liability is
so increased or reduced during the year, shall be added to, or, as
the case may be, deducted from the cost, and the amount arrived
at after such addition or deduction shall be taken to be the cost of
the fixed asset.
3. The querist has also drawn the attention of the Committee to
paragraph 13 of Accounting Standard (AS) 11, ‘The Effects of
Changes in Foreign Exchange Rates’ (revised 2003), issued by
the Institute of Chartered Accountants of India, which states that “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, with the exception of exchange differences
dealt with in paragraph 15.” The querist has stated that paragraph
15 of AS 11 (revised 2003) deals with ‘Net Investment in a Nonintegral
Foreign Operation’ which is outside the scope of reference
of this query.
4. The querist has stated that the Ministry of Corporate Affairs
has vide notification no. G.S.R. 739 (E) dated 7th December, 2006
notifying the Companies (Accounting Standards) Rules, 2006, has
stated as a footnote to AS 11 that the accounting treatment of
exchange differences contained in AS 11 (revised 2003) has to be
followed irrespective of the relevant provisions of Schedule VI to
the Companies Act, 1956. Further, the querist has also mentioned
that in consonance with this Notification, the Institute of Chartered
Accountants of India has clarified that the accounting treatment of
exchange differences contained in AS 11 (revised 2003) issued by
the Institute is applicable and not the requirement of Schedule VI
to the Companies Act in respect of accounting periods commencing
on or after 7th December, 2006.
5. The querist has further mentioned that paragraph 4(e) of
Accounting Standard (AS) 16, ’Borrowing Costs’ states that
borrowing costs may include exchange differences arising from
foreign currency borrowings to the extent that they are regarded
as an adjustment to interest costs.
B. Query
6. The querist has sought the opinion of the Expert Advisory
Committee on the following issues arising from the above:
I. Accounting for foreign exchange differences on foreign
currency loans taken at different times.
(a) What should be the accounting treatment of exchange
differences in the financial year 2007-08, arising in
respect of:
(i) loans taken before 1st April, 2004, which is the date
of applicability of Revised AS 11,
(ii) loans taken after 1st April, 2004, but before 7th
December, 2006,
(iii) loans taken since 7th December, 2006, and
(iv) loans taken since 1st April, 2007?
(b) Whether the exchange difference on all the above loans
can be taken to the profit and loss account or
alternatively, be capitalised with the cost of the asset
under construction and assets which are already
completed and put into operation.
(c) Paragraph 9.1 of Accounting Standard (AS) 10,
’Accounting for Fixed Assets’, inter alia, states that the
cost of an item of fixed asset comprises its purchase
price, including import duties and other non–refundable
taxes or levies and any directly attributable cost of
bringing the asset to its working condition for its intended
use. In the light of this paragraph, whether the exchange
difference on loans for ships under construction should
be capitalised or taken to the profit and loss account.
(d) Considering the fact that AS 11 (revised 2003) applies
only to transactions entered into after 01.04.2004,
whether the exchange difference on loans taken before
01.04.2004 can be taken to the profit and loss account
or whether Schedule VI will continue to apply to these
transactions and the exchange difference is to be
capitalised.
II. Accounting for foreign exchange gains under paragraph 4(e)
of AS 16.
7. The querist has drawn the attention of the Committee to
Accounting Standards Interpretation (ASI) 10, dealing with
interpretation of paragraph 4(e) of AS 16 issued by the Institute of
Chartered Accountants of India. The illustration to ASI deals with a
scenario where exchange rate has moved upwards, i.e., devaluation of rupee which results in increase in liability towards the principal
amount. However, the present scenario is that the rupee has
strengthened and there has been a decrease in liability towards
the principal amount. In the light of the above, opinion of the
Expert Advisory Committee has been sought on the following:
(a) The accounting treatment in respect of currency
exchange gains arising out of loans in foreign currency.
(b) For the purpose of comparison of interest on foreign
currency borrowing with interest that could be applicable
had the loan been taken domestically in Rupees, what
is the benchmark for notional rate of interest to be
considered for domestic loan for the purpose of
comparison?
(c) Accounting treatment in relation to foreign exchange
difference on loan in foreign currency in the event interest
rate on foreign currency borrowings is higher than that
of local currency borrowings.
III. Presentation of foreign exchange gains.
8. In the event foreign exchange gain arises, what should be the
method of presentation in financial statements / disclosures required
by SEBI?
(a) Whether it should be disclosed under the head ’Other
Income’.
(b) Whether it should be disclosed under the head ‘Other
Expenditure’ as a reduction to such expenditure.
(c) Whether it should be disclosed as a separate line item.
If so, what is the criteria for warranting such separate
disclosure?
(d) Whether it requires disclosure in the Notes to Accounts,
if the amount involved is less than 10% of ’total
expenditure’ as per SEBI Guidelines.
C. Points considered by the Committee
9. The Committee notes from the Facts of the Case that the
company is acquiring ships which are constructed and delivered to
it over a period of 3–4 years. The Committee presumes that the
loans were obtained by the company before or during the
construction of the ships and, therefore, the ships are considered
‘qualifying assets’ for the purposes of AS 16.
10. 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.”
11. 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.”
12. The Committee also notes the footnote to notified AS 11,
regarding the applicability of AS 11 (Revised) instead of Schedule
VI to the Companies Act, 1956, and the ICAI’s clarification that AS
11 would apply in respect of accounting periods commencing on or after December 7, 2006 and not Schedule VI, as mentioned by
the querist in paragraph 4 of the Facts of the Case.
13. The Committee further notes that in respect of accounting
periods commencing on or after 1-4-2004, the Institute had issued
an Announcement on ‘Treatment of exchange differences under
Accounting Standard (AS) 11 (revised 2003), The Effects of
Changes in Foreign Exchange Rates vis-a-vis Schedule VI to the
Companies Act, 1956’ stating that a company adopting treatment
prescribed in Schedule VI will be considered to be complying with
AS 11 for the purposes of section 211 of the Act. Thus, in respect
of the exchange differences arising during the period 1.4.2004 to
1.4.2007 on the foreign currency loans taken during that period,
Schedule VI would be applicable.
14.The Committee also notes that AS 16 came into effect in
respect of accounting periods commencing on or after April 1,
2000 and became mandatory in nature from that date. The
Committee further notes that paragraph 4(e) of AS 16 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 said clause applies to
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 borrowing 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.
15. With respect to the foreign exchange gains 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 was 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.
16. As regards the presentation of foreign exchange gains, the
Committee notes that paragraph 40(a) of AS 11 requires an
enterprise to disclose “the amount of exchange differences
included in the net profit or loss for the period”. The Committee
further notes that it is not clear as to which SEBI Guidelines have
been referred to by the querist in paragraph 8(d) above. In case
the query is in the context of the format of quarterly financial
results under clause 41 of the Listing Agreement, the Committee
notes that the relevant requirement in respect of Expenditure is
that “Any item exceeding 10% of the total expenditure to be shown
separately” on the face of the results itself. Thus, if the amount of
gains is less than 10%, it is not required to be shown separately,
either on the face or in the notes.
D. Opinion
17. On the basis of the above, the opinion of the Committee on
the issues raised by the querist in paragraphs 6 , 7 and 8 is as
follows:
I. Accounting for foreign exchange differences on foreign
currency loans taken at different times
(a) In the financial year 2007-08,
(i) in respect of loans taken before April 1, 2004, the
pre-revised AS 11 applies subject to applicability of
paragraph 4 (e) of AS 16 as discussed in paragraph
14 above;
(ii) and (iii) as per the footnotes to AS 11 notified by the
Central Government (see paragraphs 11 and 12
above), AS 11 applies in respect of loans taken on
or after April 1, 2004 but before April 1, 2007. In
respect of such loans also, consideration would have to be given to paragraph 4(e) of AS 16. It is
presumed that the accounting year of the company
commences on 1st April, 2007.
(iv) in respect of loans taken on or after 1st April, 2007,
the notified AS 11, i.e., AS 11 (revised 2003) applies,
which means that Schedule VI is not applicable.
Consideration would have to be given to paragraph
4(e) of AS 16.
(b) in the financial year 2007-08, recognition of exchange
differences in the profit and loss account and
capitalisation thereof would depend upon the following:
(i) Applicability of pre-revised AS 11 and revised AS
11 to the loans as per the recommendations
contained in (a) above.
(ii) The exchange differences covered by paragraph
4(e) of AS 16.
(c) In view of the specific requirements of AS 11 and AS 16
issued by the ICAI and these being subsequently notified
by the Central Government, the requirements of
paragraph 9.1 of AS 10 are not applicable as this
paragraph prescribes a general treatment. A general
treatment contained in an Accounting Standard does
not apply when the requirements contained in a specific
accounting standard is applicable.
(d) In respect of transactions entered into before April 1,
2004, the exchange differences can not be recognised in
the profit and loss account in case the loans were
obtained for the purposes of construction of ships. In
such cases, foreign exchange differences would continue
to be capiltalised as per the requirements of pre-revised
AS 11.
II. Accounting for foreign exchange gains under paragraph 4(e)
of AS 16
(a) 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.
(b) As per the Explanation to paragraph 4 (e) of AS 16
notified under the Companies (Accounting Standards)
Rules, 2006, the company will have to determine the
rate of interest had these loans been raised in the
domestic market. It is a company-specific situation,
therefore, no specific benchmark can be prescribed.
(c) The querist has separately informed the Committee that
the company does not have any such foreign currency
loans. The Committee, thus, notes that it is a hypothetical
issue, which it can not answer as per Rule 3 of its
Advisory Service Rules.
III. Presentation of foreign exchange gains
(a) To the extent the exchange gains are not adjusted in
the cost of the asset as suggested in paragraph 15
above, the same should be disclosed as a separate line
item. This may or may not be disclosed under the head
“Other Income”.
(b) Such exchange gains can not be disclosed under the
head ‘Other Expenditure’, as a reduction of such
expenditure.
(c) Refer to (a) above.
(d) No, if the amount involved is less than 10%, it is not
required to be shown in the notes to accounts as
discussed in paragraph 16 above.
1Opinion finalised by the Committee on 30.4.2008
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