A. Facts of the Case
1. A public limited company (hereinafter referred to as ‘the company’), which is 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 acquires 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 right in the properties/blocks.
2. A Cyprus based company (hereinafter referred as ‘ABC’) was acquired (100% of share capital) during the financial year 2008-09 by the company. During the same year, ABC acquired 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 an intention to treat these as share application money in the quarter ended 31.03.2009 without entering into any formal agreement at the time of remittances. The querist has mentioned that the advances were made on several dates and each such advance was ab-initio recorded at the exchange rate applicable on the respective advance date.
3. Subsequently, the company entered into a ‘Shareholders’ Investment Agreement’ with ABC on 11th June, 2009. As per the terms of Shareholders’ Investment Agreement, ABC agreed to issue equity/preference shares on or before 31.12.2009 at mutually agreed terms and conditions. The agreement made 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 like, the nature of shares (i.e., equity/preference shares), number of shares, face value and premium, etc. were firmed up till the accounts were finalised and approved.
4. Pending allotment of the shares, the amount was accounted for as ‘Advance to ABC’ and disclosed as ‘Loans and Advances’ in the accounts of the company for the year ended 31st March, 2009.
5. The company intended to convert the advances of USD 1,922 million into equity/preference shares. Thus, the advance given to ABC was considered an extension to the company’s net investment in ABC, which is a non-integral foreign operation. Accordingly, the advance was treated as ‘Net Investment in ABC’, revalued at closing exchange rate and accounted for in accordance with the requirements of paragraphs 15 and 16 of Accounting Standard (AS) 11 (revised 2003), ‘Accounting for the Effects of Changes in Exchange Rates’, issued by the Institute of Chartered Accountants of India, as on 31.03.2009. Accordingly, the resulting exchange difference was taken to ‘foreign currency translation reserve’.
6. During the year 2009-10, the company and ABC continued the discussions and finalised the terms and conditions of the shares leading to signing of share subscription agreement (‘SSA’) dated 31.03.2010. The SSA provided, inter alia, that (a) ABC will issue 1,92,210 optionally convertible redeemable preference shares (OCRPS) of face value USD 1 per share at issue price of USD 10,000 per share, (b) ABC will have the right to redeem at its option 80% of the OCRPS by payment of pre-agreed premium, (c) the company has the right to convert 20% of the OCRPS into equity shares of face value USD 1 per share at issue price of USD 10,000 per share ( i.e., 1 equity share for 1 preference share). Accordingly, ABC allotted shares for USD 1922 million as on 31.03.2010. The company accounted for the amount as investment in shares of wholly owned subsidiary in the financial statements for the year ended 31.03.2010. The investment in shares was measured at exchange rate on the date of issue/allotment (31.03.2010) and the resulting exchange difference was taken to foreign currency translation reserve. The company proposes to treat the shares post-issuance as non-monetary item and not to revalue it.
B. Query
7. On the basis of the above, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) For the financial year 2008-09 and interim periods upto the shares issue date (i.e., 31.03.2010), appropriate accounting treatment of advances so paid and treatment of foreign exchange gain/loss arising on revaluation thereof, i.e., whether the advance as described above is covered within the scope of paragraphs 15 and 16 of AS 11 such that it is revalued on balance sheet date and resulting difference taken to foreign currency translation reserve;
(ii) For the financial year 2008-09 and interim periods upto the shares issue date (i.e., 31.03.2010), whether the advance should be disclosed as ‘loans and advances’ or as ‘investments’, specially till the nature and applicable terms and conditions of the underlying shares are decided; and
(iii) Whether during the financial year 2009-10 in which the shares were issued (i.e., on 31.03.2010), the investment in shares in foreign exchange should be recorded in the company’s financial statements (prepared in Indian Rupees) at (i) the exchange rate applicable on share issue date (31.03.2010), being the transaction date, or (ii) at the ab initio recorded amounts of advance, i.e., at the exchange rates applicable on the dates when the respective advances were initially given.
C. Points considered by the Committee
8. The Committee, while expressing its opinion, has considered only the issues raised in paragraph 7 above and has not considered 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, treatment of shares post-issuance as non-monetary item, 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, notified under the Companies (Accounting Standards) Rules, 2006 (hereinafter referred to as ‘the Rules’).
9. The Committee notes that on the same issue, the querist had earlier sought an opinion from the Expert Advisory Committee, which has been published as Query No. 14 of Volume XXX of the Compendium of Opinions. The Committee notes that in the earlier opinion which pertained to the year 2008-09, in respect of the advance of USD 1922 million, the Committee had opined that 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, and, therefore, the advance is of the nature of ‘monetary item’ as per the definition provided in AS 11, notified under the Rules. Accordingly, it should be reported using the closing rate. Further, on the presumption that since the intention of the company is to convert the said advance into equity/preference share capital and settlement of such advance is neither planned nor likely to occur in the foreseeable future as envisaged in paragraph 16 of AS 11, notified under the Rules, the Committee, keeping in view that ABC is a non-integral foreign operation of the company, had opined that in substance, the advance 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, notified under the Rules. 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, notified under the Rules. With respect to the disclosure of the advances in the financial statements of the company, the Committee had opined that the advance should be disclosed under the head ‘Loans and Advances’ with appropriate disclosure regarding their nature.
10. The Committee notes from the Facts of the Case that the company has advanced money at different dates during the quarter ending March 31, 2009 and the same have been accounted for as ‘Loans and Advances’ in the financial statements of the company for the year ending March 31, 2009 as no modalities in respect of the monies advanced were final by the balance sheet date or till finalisation/approval of the accounts. Further, the exchange difference arising on revaluation at the closing rate as on the balance sheet date, i.e., March 31, 2009 was taken to ‘Foreign Currency Translation Reserve’ treating the advance as extension to ‘Net Investment in ABC’. Subsequent to this, share subscription agreement dated 31.03.2010 has been signed and the shares have been allotted to the company as per the agreement on 31.03.2010.
11. As regards the accounting treatment for the money advanced and the exchange differences arising thereon at the balance sheet date (31.03.2009), the Committee notes paragraphs 3.2, 8.1 and 8.2 of Accounting Standard (AS) 4, ‘Contingencies and Events Occurring After the Balance Sheet Date’, notified under the Rules as follows:
“3.2 Events occurring after the balance sheet date are those significant events, both favourable and unfavourable, that occur between the balance sheet date and the date on which the financial statements are approved by the Board of Directors in the case of a company, and, by the corresponding approving authority in the case of any other entity.
Two types of events can be identified:
(a) those which provide further evidence of conditions that existed at the balance sheet date; and
(b) those which are indicative of conditions that arose subsequent to the balance sheet date.”
“8.1 Events which occur between the balance sheet date and the date on which the financial statements are approved, may indicate the need for adjustments to assets and liabilities as at the balance sheet date or may require disclosure.
8.2 Adjustments to assets and liabilities are required for events occurring after the balance sheet date that provide additional information materially affecting the determination of the amounts relating to conditions existing at the balance sheet date. For example, an adjustment may be made for a loss on a trade receivable account which is confirmed by the insolvency of a customer which occurs after the balance sheet date.”
From the above, the Committee is of the view that the financial statements are prepared upto the balance sheet date considering the events occurring between the balance sheet date and the date of approval of the financial statements by the approving authority (Board of Directors in case of company). Any event occurring after the approval of financial statements is irrelevant for preparation of the financial statements. In the extant case, the Committee notes that even till the approval of financial statements for the financial year ended March 31, 2009, since the modalities in respect of issuance of shares were not final, the Committee reiterates its earlier opinion that the advance is of the nature of ‘monetary item’. Accordingly, it was appropriate to report and disclose as ‘Loans and Advances’ using the closing rate at the balance sheet date, viz., 31st March, 2009. Further, since during that period, the intention of the company was to convert the advance into equity/preference share capital and settlement of the advance was neither planned nor likely to occur in the foreseeable future as envisaged in paragraph 16 of AS 11, notified under the Rules, keeping in view that ABC is a non-integral foreign operation of the company, it was appropriate to treat the advance as an extension to the company’s net investment in ABC, and to transfer the exchange difference arising on the balance sheet date in the foreign currency translation reserve in accordance with paragraph 15 of AS 11, notified under the Rules. As regards the interim financial reporting, the Committee is of the view that the same accounting principles and policies should be applied as applied for annual financial reporting and accordingly, if the said modalities are not final till the reporting date of every quarter during the financial year 2009-10, the above treatment should be followed.
12. As regards the treatment of the advance post-issuance of shares, the Committee notes the definition of the term ‘Investments’, as defined in paragraph 3.1 of Accounting Standard (AS) 13, ‘Accounting for Investments’, which, inter alia, provides that “Investments are assets held by an enterprise for earning income by way of dividends, interest, and rentals, for capital appreciation, or for other benefits to the investing enterprise”. Since the shares acquired by the company fall into the above definition, the Committee is of the view that the same should be accounted for as ‘Investment’ in the books of the company. As regards the value at which the shares should be recorded, the Committee notes paragraph 9 of AS 11, which provides as follows:
"9. A foreign currency transaction should be recorded, on initial recognition in the reporting currency, by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction.”
The Committee is of the view that the date of transaction in the instant case would be the date when the modalities in respect of shares have been finally concluded. Accordingly, investment acquired should be recorded by applying the exchange rate between the reporting currency and the foreign currency as on the date of final conclusion of modalities in respect of issuance of shares to foreign currency amount of advances. Further, since the investment in ABC has been treated as non-integral foreign operation and by such conclusion of modalities in respect of issuance of shares, there would be an extension to the company’s net investment in ABC, the resulting exchange differences should be transferred to ‘Foreign Currency Translation Reserve’.
D. Opinion
13. On the basis of the above, subject to paragraph 8 above, the Committee is of the following opinion on the issues raised in paragraph 7 above:
(i) and (ii) For the financial year 2008-09, since even till the approval of financial statements, the modalities in respect of issuance of shares were not final, the Committee reiterates its earlier opinion that the advance is of the nature of ‘monetary item’. Accordingly, it was appropriate to report and disclose as ‘Loans and Advances’ using the closing rate at the balance sheet date, viz., 31st March, 2009. Further, since during that period, the intention of the company was to convert the advance into equity/preference share capital and settlement of the advance was neither planned nor likely to occur in the foreseeable future as envisaged in paragraph 16 of AS 11, notified under the Rules, keeping in view that ABC is a non-integral foreign operation of the company, it was appropriate to treat the advance as an extension to the company’s net investment in ABC, and to transfer the exchange difference arising on the balance sheet date in a foreign currency translation reserve in accordance with paragraph 15 of AS 11, notified under the Rules. As regards the interim financial reporting, the Committee is of the view that the same accounting principles and policies should be applied as applied for annual financial reporting and accordingly, if the said modalities are not final till the reporting date of every quarter during financial year 2009-10, the above treatment should be followed.
(iii) Investment in shares should be recorded in the financial statements of the company at the exchange rate applicable on the date of final conclusion of modalities in respect of issuance of shares, which should be considered as the transaction date, as discussed in paragraph 12 above.
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