|
A. Facts of the Case
1. A public limited company (hereinafter referred to as the ‘company’), which is a wholly owned subsidiary of a listed government company, is in the business of exploration and production of oil and gas and other hydrocarbon related activities outside India. The company acquired oil and gas properties/blocks, by way of acquisition of property/block, acquisition of Participating Interest therein or through acquisition of the legal entity owning a right in the properties/blocks.
2. A Cyprus based company (hereinafter referred to as ‘ABC’), has been acquired (100% of share capital) by the company. During the same year, ABC acquired the entire issued share capital of a UK based company (hereinafter referred to as ‘XYZ’). XYZ, through its direct/indirect subsidiaries/joint ventures, operates in several oil and gas blocks in Russia. The funds for the acquisition of XYZ amounting to USD 1,922 million equivalent to Rs. 93,664 million were provided by the company to ABC with the intention to treat it as share application money without entering into any formal agreement at the time of remittances. Further, the company has advanced USD 53 million equivalent to Rs. 2,635 million to ABC for XYZ’s business requirements.
3. Subsequently, the company entered into a ‘Shareholders’ Investment Agreement’ with ABC. As per the terms of Shareholders’ Investment Agreement, ABC will issue preference/equity shares at a mutually agreed premium rate. The agreement makes clear the intention to convert the advance of USD 1,922 million given for acquisition of XYZ into preference/equity shares, however, no concrete modalities regarding vital issues of the shares like, nature of shares (i.e., equity/preference shares), number of shares, face value and premium, etc., are firmed up till the balance sheet date. No written agreement is in place regarding settlement of advance of USD 53 million given for meeting XYZ’s business requirements. However, the company intends to convert this advance also into equity/preference shares and the advance is not likely to be refunded in near future.
4. As the shares are yet to be issued, the amount paid by the company to ABC has been shown as ‘Advance to ABC’ in the Schedule, ‘Loans and Advances’ in the stand-alone financial statements of the company.
5. The company intends to convert the advances of USD 1,975 million (USD 1,922 million for financing acquisition of XYZ as well as USD 53 million for financing business requirements of XYZ) into equity/preference shares. Thus, as per the querist, the advance given to ABC, was considered as an extension to the company’s net investment in ABC, which is a non-integral foreign operation and, therefore, the net investments in ABC were revalued and accounted for in accordance with the requirements of paragraphs 15 and 16 of Accounting Standard (AS) 11 (revised 2003), ‘The Effects of Changes in Foreign Exchange Rates’. The company revalued the advance of USD 1,975 million at the foreign exchange rate at the year-end rate, increasing advances by Rs. 442 crore consisting of Rs. 434 crore due to revaluation of advance amounting to USD 1,922 million towards financing acquisition cost of XYZ and Rs. 8 crore due to revaluation of advance amount of USD 53 million towards financing business requirements of XYZ. The credit for the same amount was given to ‘Foreign Exchange Translation Reserve’.
6. The querist has stated that the C&AG auditors, while carrying out their review under section 619(3)(b) of the Companies Act, 1956, objected to the above accounting treatment of showing the amount of USD 1,922 million paid to ABC towards financing acquisition cost of XYZ as ‘Advance’, as, in their view, the amount should be shown as ‘Investment (Share Application Money pending allotment)’ and, therefore, should not be revalued in accordance with Accounting Standard (AS) 13, ‘Accounting for Investments’.
7. Further, as stated by the querist, the C&AG auditors questioned the credit of Rs. 8 crore arising on revaluation of amount of advance of USD 53 million towards financing business requirements of XYZ to ‘Foreign Exchange Translation Reserve’ instead of taking it to the profit and loss account as, in their view, the foreign exchange revaluation gain is of revenue nature.
B. Query
8. In view of the above stated facts, the querist has sought the opinion of the Expert Advisory Committee on the appropriate accounting treatment of advances so paid and treatment of foreign exchange gain/loss arising on revaluation thereof, i.e.,
(a) Whether the accounting treatment followed by the company in treating payment of USD 1,975 million as ‘Advance to ABC’, revaluation of advances and credit of foreign exchange revaluation gains to ‘Foreign Exchange Translation Reserve’ is appropriate; or
(b) Whether views of the C&AG auditors that (i) the advance of USD 1,922 million should be shown as Investment, (ii) it should not be revalued and (iii) that the foreign exchange gain arising on revaluation of advance of USD 53 million given for meeting business requirements of XYZ is a revenue gain, is appropriate; or
(c) Whether there is any other appropriate accounting treatment / disclosure of the sum paid to ABC and revaluation thereof.
C. Points considered by the Committee
9. The Committee, while answering the query, has considered only the issues raised by the querist in paragraph 8 above and has not touched upon any other issue that may arise from the Facts of the Case, such as, accounting treatment in the books of ABC and XYZ of the funds advanced by the company, etc. Further, the Committee notes from the Facts of the Case that the company in the extant case treats ABC as a ‘non-integral foreign operation’. In the absence of any information to the contrary, the Committee presumes that the company has correctly classified investment in ABC as investment in a non-integral foreign operation in accordance with the provisions of AS 11 (revised 2003).
10. The Committee is of the view that the accounting treatment in the extant case would depend upon whether the funds advanced to ABC for acquisition of shares in XYZ and for meeting XYZ’s business requirements can be regarded as a monetary item or as a non-monetary item. The Committee notes the following paragraphs from Accounting Standard (AS) 11 (revised 2003), ‘The Effects of Changes in Foreign Exchange Rates’:
“7.11 Monetary items are money held and assets and liabilities to be received or paid in fixed or determinable amounts of money.”
“7.14 Non-monetary items are assets and liabilities other than monetary items.”
“12. Cash, receivables, and payables are examples of monetary items. Fixed assets, inventories, and investments in equity shares are examples of non- monetary items. …”
11. The Committee notes from the Facts of the Case that in respect of the advance of USD 1922 million, though the company has entered into a ‘shareholders’ investment agreement’ with ABC, it only contains the intention to convert the said advance into preference/equity shares, and no concrete modalities regarding nature of shares (i.e., equity/preference shares), number of shares, face value, premium, etc. have been decided till the balance sheet date. The Committee notes in respect of advance of USD 53 million made by the company to ABC that the company intends to convert this advance also into equity/preference shares, however, no agreement in respect thereof has been entered into or any modality for such conversion has been decided till the balance sheet date. Accordingly, the Committee is of the view that both the advances are of the nature of monetary items.
12. For determining the treatment of ‘monetary items’, the Committee notes the following paragraphs of AS 11 (revised 2003):
“11. At each balance sheet date:
(a) foreign currency monetary items should be reported using the closing rate. …”
“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, with the exception of exchange differences dealt with in accordance with paragraph 15.”
Net Investment in a Non-integral Foreign Operation
“15. Exchange differences arising on a monetary item that, in substance, forms part of an enterprise’s net investment in a non-integral foreign operation should be accumulated in a foreign currency translation reserve in the enterprise’s financial statements until the disposal of the net investment, at which time they should be recognised as income or as expense in accordance with paragraph 31.
16. An enterprise may have a monetary item that is receivable from, or payable to, a non-integral foreign operation. An item for which settlement is neither planned nor likely to occur in the foreseeable future is, in substance, an extension to, or deduction from, the enterprise’s net investment in that non-integral foreign operation. Such monetary items may include long-term receivables or loans but do not include trade receivables or trade payables.”
From the above, the Committee is of the view that the two advances of USD 1922 million and USD 53 million, should be reported using the closing rate. The Committee presumes that since the intention of the company is to convert both the advances into equity/preference share capital, settlement of the advances is neither planned nor likely to occur in the foreseeable future (as envisaged in paragraph 16 of AS 11 (revised 2003) reproduced above). In such a case, keeping in view that ABC is a non-integral operation of the company, in substance, the advances would be an extension to the company’s net investment in ABC, and therefore, the exchange difference arising on the balance sheet date should be accumulated in a foreign currency translation reserve in accordance with paragraph 15 of AS 11 (revised 2003) reproduced above. However, in case the presumption stated above with respect to the settlement of the advances does not hold good, the advances cannot be treated as an extension of the company’s net investment in ABC. In that case, the exchange difference arising on the balance sheet date should be recognised as income or as expense in the profit and loss account of the company in accordance with paragraph 13 of AS 11 (revised 2003).
13. With respect to the disclosure of the advances in the financial statements of the company, the Committee is of the view that these advances should be disclosed under the head which most appropriately reflects their nature. Accordingly, the advances should be disclosed under the head ‘loans and advances’ with appropriate disclosure regarding their nature.
D. Opinion
14. On the basis of the above, and subject to the presumptions stated in paragraph 9 above, the Committee is of the following opinion on the issues raised in paragraph 8 above:
(a) Accounting treatment followed by the company in treating payment of USD 1975 million as advance to ABC, revaluation of advances and credit of foreign exchange revaluation gains to ‘Foreign Exchange Translation Reserve’ is appropriate subject to the presumption stated in paragraph 12 with respect to the settlement of advances. See paragraph 12 above.
(b) The views of the C&AG auditors that the advance of USD 1922 million should be shown under the head ‘investment’, and should not be revalued, is not appropriate. The view of the C&AG auditors that the foreign exchange gain arising on revaluation of advance of USD 53 million should be treated as a revenue gain, would be appropriate only if the presumption stated in paragraph 12 above with respect to the settlement of advance does not hold good. See paragraph 12 above.
(c) For appropriate accounting treatment/disclosure of the advance of USD 1975 million, see paragraphs 11, 12, and 13 above. |