1.12     Query

Accounting treatment of foreign currency translation gain.

1.A public sector company was incorporated in June, 1965 as a joint enterprise of Government of India and a foreign enterprise with equity share capital of Rs. 300 lakh subscribed by them in the ratio of 51:49 respectively. The foreign enterprise paid Rs. 127 lakh in cash towards their share of the equity capital and the remaining shares worth Rs. 20 lakh were issued to them for consideration other than cash. The amount received from them was kept with a foreign bank to be utilised for import of machineries.

2.At the time of receipt of this amount from the foreign enterprise, the foreign bank account was debited and the Equity Share Capital Accounts was credited at the rate of exchange prevailing at that time.

3.The Government of India devalued the Rupee in June, 1966. Subsequently, the company purchased assets out of the aforesaid foreign bank account. The respective assets accounts were debited with the equivalent Indian rupees on the date of their purchase. The net difference due to difference in exchange rates prevailing at the time of deposit and the purchase of assets, amounting of Rs 9.01 lakhs, was credited to Capital Reserve Account for the purpose of adjusting any deficit arising in future due to difference in foreign currency transaction. The company has now been advised that this treatment is not proper.

4. The opinion of the Expert Advisory Committee was sought whether the company could continue to show the gain arising from foreign currency translation in the Capital Reserve Account or should it be credited to the Profit and Loss Account?

Opinion                                                                                                                       April 29, 1983

1.The Committee notes that Paras 21, 22 and 23 of the ‘Statement on Accounting For Foreign Currency Translation’, (1976 edition) issued by the Institute of Chartered Accountants of India, state as under:

“21.      A major problem connected with accounting for foreign currency translation is the appropriate treatment of translation differences. These problems broadly require consideration of (a) whether all translation differences should be adjusted in the profit and loss account (b) whether the adjustment should be in the year of change or deferred and (c) whether any part of the difference can be treated as a capital expenditure.

22. Those who advocate the adjustment of all differences in the profit and loss account argue that changes in exchange rates result in loss or gain, which does not in anyway, affect the cost of the assets. However, while such a practice would have the merit of simplicity there are several reasons why it cannot be adopted in all cases. Firstly, translation adjustments are related to assets and liabilities which will be liquidated over varying periods of time and not necessarily within the accounting periods. Secondly, in respect of certain assets and liabilities though the asset or liability may be liquidated within the accounting periods, the realisation of the gain or the reimbursement of the loss will be deferred beyond the accounting period and will be subject to changes in foreign exchange regulations from time to time. Finally, in an era of fluctuating exchange rates and general exchange instability, the gain or loss may be reversed before it can be realised or reimbursed.

23. At the same time, deferment of the charge to the profit and loss account in all cases till the actual gain or loss is realised on conversion of the foreign currency would result in accounting on a “cash basis” and would be contrary to the “accrual” concept of accounting. It therefore becomes necessary to distinguish between translation differences which arise on translation of non-current assets and long-term liabilities.”

2.The Committee considers that since the amount deposited with the foreign bank on account of equity share capital was for the purpose of purchase of fixed assets and not be used in the day-to-day running of the business, the foreign currency translation gain arising therefrom is of a capital nature. This view is supported by, e.g., CIT Vs Tata Locomotive and Engineering Co. Ltd. (S.C.) [60 I.T.R. 405], and CIT Vs Canara Bank (S.C.)[63 I.T.R. 328].

3. On the basis of the above, the Committee is of the opinion that the transfer of foreign currency translation gain, arising on the translation of a deposit with the foreign bank kept for the purpose of purchase of fixed assets, to the Capital Reserve Account is justified. The Committee is further of the opinion that losses of capital nature arising on subsequent translations can be debited to this reserve.