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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 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.
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