Expert Advisory Committee

Query No. 22 

Subject:  

Presentation of exchange losses arising on long-term foreign currency liability

pursuant to the adoption of paragraph 46A of AS 11 in quarterly financial results.1

A.  Facts of the Case

1.A listed company (hereinafter referred to as ‘the company’) is engaged in manufacturing of pharmaceutical products. The company, during the financial years 2008 to 2011, had obtained long-term foreign currency loans from various banks. The loans have been utilised for the purpose of obtaining depreciable capital assets and also for meeting working capital requirements.

2.The querist has stated that the company had not previously opted for the option given under paragraph 46 of Accounting Standard (AS) 11, ‘The Effects of Changes in Foreign Exchange Rates’ (G.S.R 225 (E) dated March 31, 2009). Accordingly, the afore-mentioned long-term foreign currency loans were restated at the end of each reporting quarter during the current year, i.e., June 30, 2011 and September 30, 2011. Pursuant to such restatement, an exchange loss of INR 47.30 million arising on the said loans was recognised in the profit and loss account for the six months ended September 30, 2011.

3.In the quarter ended December 31, 2011, pursuant to the notification dated December 29, 2011 issued by the Ministry of Corporate Affairs amending AS 11, the company has exercised the option as per paragraph 46A inserted in AS 11. Accordingly, the exchange differences arising on long-term foreign currency monetary items (which were earlier being charged or credited to the profit and loss account) insofar as they relate to the acquisition of depreciable capital assets are added to or deducted from the cost of the assets and depreciated over the remaining useful life of the asset and in other cases, are accumulated in a Foreign Currency Monetary Item Translation Difference Account (FCMITDA) and amortised over the balance period of such loan.

4.Pursuant to the application of paragraph 46A of AS 11, the cumulative impact of the charge towards exchange loss for the previous quarters (June and September, 2011 amounting to 47.30 million) has been credited in the quarter ended December 31, 2011.

5.The querist has further stated that the adoption of paragraph 46A of AS 11 would typically imply a change in accounting policy as mentioned in Question 7 of the ‘Frequently Asked Questions on AS 11 Notification – Companies (Accounting Standards) Amendment Rules, 2009 (G.S.R 225(E) dated March 31, 2009) issued by Ministry of Corporate Affairs’, issued by the Accounting Standards Board (ASB) of the Institute of Chartered Accountants of India (ICAI) (hereinafter referred to as FAQs on AS 11 Notification).

6. The main issue is the presentation of change in the above-mentioned accounting policy in the quarterly financial results in the context of the requirements of clause 41 of the listing agreement and those of the relevant Accounting Standards, i.e., Accounting Standard (AS) 25, ‘Interim Financial Reporting’ and Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’. The analysis below discusses two alternative views in this regard, i.e., whether the entire amount of reversal should be presented as a credit for the quarter ending 31st December, 2011 or whether the results of the earlier quarters should be restated:

I. Arguments in favour of reversal of already recognised exchange losses by restating the reported numbers of the respective quarters to which they belong (Alternative I):

 

Clause 41 IV (f) of the Listing Agreement states the following:

“The quarterly and year to date results shall be prepared in accordance with the recognition and measurement principles laid down in Accounting Standard 25 (AS 25 - Interim Financial Reporting) issued by the Institute of Chartered Accountants of India (ICAI)/ company (Accounting Standards) Rules, 2006, whichever is applicable.”

Clause 41 (IV) (i) of the Listing Agreement states as below:

“Changes in accounting policies, if any, shall be disclosed in accordance with Accounting Standard 5 (AS 5 - Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies) issued by ICAI/company (Accounting Standards) Rules, 2006, whichever is applicable.”

As per paragraph 42 of AS 25, “A change in accounting policy, other than one for which the transition is specified by an Accounting Standard, should be reflected by restating the financial statements of prior interim periods of the current financial year.”

 

As per paragraph 43 of AS 25, “One objective of the preceding principle is to ensure that a single accounting policy is applied to a particular class of transactions throughout an entire financial year. The effect of the principle in paragraph 42 is to require that within the current financial year any change in accounting policy be applied retrospectively to the beginning of the financial year.”

Thus, as per AS 25, if there is a change in an accounting policy, the financial statements of the prior interim periods of the current financial year should be restated.

 

As per the querist, the above is not in consonance with paragraph 32 of AS 5 which states as follows:

“Any change in an accounting policy which has a material effect should be disclosed. The impact of, and the adjustments resulting from, such change, if material, should be shown in the financial statements of the period in which such change is made, to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact should be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.”

As per this view, the term ‘period of change’ in AS 5 should be construed to mean the current annual period rather than an interim period. Thus, AS 5 requires that the effect of a change in an accounting policy in respect of previous financial year(s) should be accounted for in the year of change only (in other words the financial statements of the previous financial year should not be restated).

 

The querist has stated that as far as interim periods are concerned, AS 25 should be followed. The language of above-mentioned paragraphs of AS 25 is plain and clear and raises no ambiguity and accordingly, the company, when declaring the results for the quarter ended December 31, 2011, should segregate the impact of the exchange differences that pertain to the previous quarters of the current year and should account for them in the respective quarters. Thus, the financial statements of prior interim periods should be restated as per the revised policy (but corresponding previous year interim periods presented as comparatives would not be restated). Such restatement would enable a reader to have a meaningful understanding of the last quarter performance/position as well as make a comparison of different interim periods.

 

The above conclusion is also supported by sub-clause (I) (a) of Clause 41 of the Listing Agreement which requires that:

“The financial results filed and published in compliance with this clause shall be prepared on the basis of accrual accounting policy and in accordance with uniform accounting practices adopted for all the periods.” (Emphasis supplied by the querist)

The requirement to prepare quarterly results on the basis of "uniform accounting practices adopted for all the periods" clearly implies that the figures for each of the interim periods of the current year presented in the quarterly results (viz., current quarter, previous quarter, year-to-date figures for current period) should be on the basis of uniform accounting policies. It follows that if an accounting policy is changed in the third quarter of the current financial year; figures for the first two interim periods of the current year will also have to be on the basis of the changed accounting policy. Accordingly, the figures relating to the immediately preceding previous quarter (which are now also required to be published in the statement of quarterly results) would be restated.

The proponents of this view also argue that paragraphs 42 and 43 of AS 25 deal with recognition and measurement in the financial statements of each interim period e.g. restatement of earlier quarters would have an impact on the reported net profit of each interim period.

Compliance with the above requirement of the Listing Agreement read with AS 5 would require disclosure of (a) the nature of the change, (b) the fact that the figures for the previous interim periods of the current year presented are based on the revised accounting policy, and (c) for each such periods presented after adjustment (except the current quarter), the amount of adjustment to each line items presented in the quarterly results, net impact on profit or loss for each period presented and net impact on EPS figures for each period presented

II. Arguments for giving the cumulative impact of such reversal in the quarter ended December 31, 2011 (Alternative II):     

 

It is to be noted that Clause 41 of the Listing Agreement has a reference to AS 25. The reference in clause 41 (IV)(f) is reproduced as below:

“(f)  The quarterly and year to date results shall be prepared in accordance with the recognition and measurement principles (emphasis supplied by the querist) laid down in Accounting Standard 25 (AS 25 – Interim Financial Reporting) issued by the Institute of Chartered Accountants of India (ICAI)/Company (Accounting Standards) Rules, 2006, whichever is applicable.”

It is to be noted that under AS 25, the recognition and measurement principles appear to be contained under paragraphs 27 to 41 of the said Standard. The requirement to restate the previous interim financial statements for any change in accounting policy is contained separately in paragraphs 42 and 43 of AS 25, titled as ‘Restatement of Previously Reported Interim Periods’.

 

Based on the above, it can be argued that paragraphs 42 and 43 containing provisions on the restatement of previously reported interim financial statements are not recognition and measurement paragraphs as the recognition and measurement principles are contained only in paragraphs 27 to 41 of AS

 

25. Accordingly, it is argued that paragraph 42 on restatement is only a presentation paragraph. It is also to be noted that paragraph 2 of AS 25 states that “A statute governing an enterprise or a regulator may require an enterprise to prepare and present certain information at an interim date which may be different in form and/or content as required by this Standard. In such a case, the recognition and measurement principles as laid down in this Standard are applied in respect of such information, unless otherwise specified in the statute or by the regulator.”

Based on the aforesaid paragraphs, it can be argued that paragraph 42 is a presentation paragraph and is outside the purview of the recognition and measurement principles as contained under AS 25 and hence, if the regulator requires the interim financial statements to be prepared and presented in a form that is different in form or content as required by AS 25, then the presentation of interim financial information should be in accordance with the formats and guidelines issued by the regulator.

 

In this context, it is important to draw reference to Clause 41 IV (i) which states that “Changes in accounting policies, if any, shall be disclosed in accordance with Accounting Standard 5 (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 (ICAI)/Company (Accounting Standards) Rules, 2006, whichever is applicable.”

Paragraph 32 of AS 5 states that “Any change in an accounting policy which has a material effect should be disclosed. The impact of, and the adjustments resulting from, such change, if material, should be shown in the financial statements of the period in which such change is made, to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact should be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted". (Emphasis supplied by the querist)

On the basis that paragraph 42 of AS 25 relating to restatement of previously reported interim financial statements is a presentation paragraph and hence if the regulator requires interim financial statements presented in a form that is different in form or content as required by AS 25 then the presentation of such financial statements shall be in accordance with the formats and guidelines issued by the regulator. Accordingly, it is appropriate that any change in accounting policy is presented in accordance with clause 41 IV(i) of the Listing Agreement which has a reference to AS 5.

As per AS 5, the impact of any change in accounting policy has to be disclosed in the period in which such change in accounting policy is made

Since the choice of change in accounting policy has been made in the quarter ended December 31, 2011, the quarter of December 2011 is the period in which the change has been made (as opposed to the period of change being the period from April 1, 2011 i.e., beginning of the financial year) and accordingly, the entire impact of the change in accounting policy with effect from April 1, 2011 should be given effect in the quarter ended December 31, 2011 as required by AS 5. In view of this, no restatement of previously reported interim financial statements will be necessary or even permitted.

 

It is also to be noted that previously reported interim numbers have been published and also been submitted to SEBI. Accordingly, it would not be appropriate to restate those numbers and instead the entire impact of the adoption of paragraph 46A of AS 11 should be given in the quarter of October to December, 2011 without restating the previously reported figures.

B. Query

7.The querist has sought the opinion of the Expert Advisory Committee of the Institute of Chartered Accountants of India on the issue as to what is the appropriate approach for a change in accounting policy in an interim financial period for a listed company for preparation and presentation of quarterly financial results under clause 41 of the Listing Agreement?

C. Points considered by the Committee

8. The Committee notes from the Facts of the Case that the company has exercised the option as per paragraph 46A of AS 11 in the quarter ending on December 31, 2011 and had not applied it in the earlier quarters of the financial year 2011-12. Accordingly, the basic issue raised in the query relates to the presentation and disclosure of such a change in its interim financial reports. The Committee has, therefore, considered only this issue and has not examined any other issue that may arise from the Facts of the Case, such as, propriety of application of paragraph 46A of AS 11 by the company, recognition of foreign exchange gain/loss as per paragraph 46A, other disclosure requirements as per clause 41 of the Listing Agreement, etc.

9. The Committee notes Question No. 7 of FAQs on AS 11 Notification, issued by ASB of the ICAI, as reproduced below:

“(7) Will exercising the option under the Companies (Accounting Standards) Amendment Rules, 2009 be a change in the accounting policy?

Response

As the notification involves the adoption of an option available (a different accounting policy), it will be treated as change in accounting policy and it should be disclosed in accordance with Para 32 of AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies.”

From the above, the Committee is of the view that the adoption of option as per paragraph 46A of AS 11 in the quarter ending on 31st December, 2011 is a change in accounting policy. The Committee further notes sub-clauses I (a), IV (f) and IV (i) of clause 41 of the Listing Agreement, paragraphs 16 (a), 17, 42 and 43 of AS 25 and paragraph 32 of AS 5, as follows:

Listing Agreement

“I (a) The financial results filed and published in compliance with this clause shall be prepared on the basis of accrual accounting policy and in accordance with uniform accounting practices adopted for all the periods.”

 

“IV (f) The quarterly and year to date results shall be prepared in accordance with  the recognition and measurement principles laid down in Accounting Standard 25 (AS 25 -Interim Financial Reporting) issued by the Institute of Chartered Accountants of India (ICAI)/company (Accounting Standards) Rules, 2006, whichever is applicable.”

“IV (i) Changes in accounting policies, if any, shall be disclosed in accordance with Accounting Standard 5 (AS 5 - Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies) issued by ICAI/company (Accounting Standards) Rules, 2006, whichever is applicable.”

AS 25

“16. An enterprise should include the following information, as a minimum, in the notes to its interim financial statements, if material and if not disclosed elsewhere in the interim financial report:

(a) a statement that the same accounting policies are followed in the interim financial statements as those followed in the most recent annual financial statements or, if those policies have been changed, a description of the nature and effect of the change;

…”

“17.Other Accounting Standards specify disclosures that should be made in financial statements. In that context, financial statements mean complete set of financial statements normally included in an annual financial report and sometimes included in other reports. The disclosures required by those other Accounting Standards are not required if an enterprise's interim financial report includes only condensed financial statements and selected explanatory notes rather than a complete set of financial statements.”

 

“42. A change in accounting policy, other than one for which the transition is specified by an Accounting Standard, should be reflected by restating the financial statements of prior interim periods of the current financial year.

 

43. One objective of the preceding principle is to ensure that a single accounting policy is applied to a particular class of transactions throughout an entire financial year. The effect of the principle in paragraph 42 is to require that within the current financial year any change in accounting policy be applied retrospectively to the beginning of the financial year.”

 

AS 5

 

“32. Any change in an accounting policy which has a material effect should be disclosed. The impact of, and the adjustments resulting from, such change, if material, should be shown in the financial statements of the period in which such change is made, to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact should be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.”

From the above, the Committee notes that as per clause 41 of the Listing Agreement, the financial results should be prepared in accordance with uniform accounting practices adopted for all the periods. Further, clause 41 also provides that quarterly and year to date results should be prepared in accordance with the recognition and measurement principles laid down in AS 25. The Committee is of the view that in case any change in accounting policy is not effected from the beginning of the current financial year, the year-to-date figures reported in the interim financial report would not be correct and the reader would not be able to have a meaningful understanding of the last quarter performance/position as well as make a comparison of different interim periods, as also argued by the querist in the first alternative above. Further, the Committee is of the view that for preparation and presentation of interim financial reports, AS 25 is the specific Standard rather than AS 5. Therefore, in case of change in accounting policy during one of the interim periods, as per the requirements of paragraph 42 of AS 25, financial statements of prior interim periods of the current financial year should be restated. However, since the restated figures will not be comparable with the comparative figures of the last financial year, a description of the nature and effect of change in accounting policy as per paragraph 16 (a) of AS 25 should also be given in current interim financial report.

The Committee is further of the view that paragraphs 42 and 43 of AS 25 in providing for restatement of previously reported interim financial statements require that the entire amount should not be recognised in the period in which the change is made.  Accordingly, recognition principles are, in a way, not restricted only to paragraphs 27 to 41 of AS 25.

10.As far as application of requirements of AS 5, as required under Question No. 7 of FAQs on AS 11 Notification is concerned, the Committee is of the view that the said FAQ has considered the situation from the angle of the financial statements relating to entire financial year and not from the angle of interim financial report for an interim period. For interim financial reports, AS 25 contains specific requirements which should be applied while preparing and presenting thereof.

D. Opinion

11.On the basis of the above, the Committee is of the opinion that for the reasons mentioned above it would not be proper to reflect, as mentioned by the querist in Alternative II, the entire impact of the change in accounting policy in “the financial statements of the period in which such change in made”, where the period being referred to is not a financial year but a quarter (under interim financial statements) (Refer to paragraphs 9 and 10 above). Instead, in the opinion of the Committee, in the extant case, the company should restate financial statements relating to prior interim periods of the current financial year with an appropriate disclosure of the nature and effect of the change in accounting policy as per the requirements of AS 25 and clause 41 of the Listing Agreement, as discussed in paragraph 9 above.

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