Query No. 11

Subject:         Determination of long-term liability for application of paragraph 46A of AS 11.[1]

A.        Facts of the Case

1. A closely held public limited company (hereinafter referred to as the ‘company’) is engaged in the business of developing a 1200 MW (600 MW*2) coal based thermal power project at Madhya Pradesh. The company is a fully owned subsidiary of a company, which is developing coal based thermal power projects. The group is currently operating in solar, hydro, thermal power and EPC business through various companies. The company is registered under the Companies Act, 1956. The company prepares its annual financial statements as per the provisions of the Companies Act, 1956 and revised Schedule VI to the Companies Act, 1956. The company follows financial year as its accounting year. The holding company through various subsidiaries is planning to expand its operations to different states of India in the near future.

2. The company has awarded an Engineering, Procurement and Construction (EPC) contract to a third party for two units of 600 MW each and other major Non-EPC contracts. The project is under construction stage. EPC related project work got started post December 2010 and the project is expected to start commercial operations by July 2014.

3. One of the major costs of the project includes offshore supply contract with the EPC contractor for Boiler, Turbine and Generator (‘BTG’) denominated in US Dollars. The contract involves a total time period of 35-39 months from supply to commissioning.

4. As a part of the contract between the company and the EPC contractor, the main plant and equipment is being supplied by the contractor by importing it from vendors in China, through their Singapore subsidiary. The equipment is being sold on high sea sale basis to the company and payments are made to the contractor as set out in the contract which are given below:

            Payment terms for supply of BTG

a. 5.00% of BTG contract price as first advance within 5 days of submission of advance bank guarantee;

b. 3.50% of BTG contract price as second advance on execution of this contract and against submission of first corporate guarantee;

c. 5.00% of BTG price as third advance on or before the date of falling 3 months from the date of payment of first advance against submission of second corporate guarantee;

d. 61.50% of the BTG contract price by way of sight letter of credit on despatch of equipment on pro rata basis on issuance of material despatch clearance certificate and submission of satisfactory documentary evidence of shipment and relevant shipping documents (generally paid within two to three months of recording of high sea purchases);

e. 10.00% of BTG contract price on receipt of supplies at site on pro rata basis duly certified and verified by owner’s representative (paid within 5-6 months of recording of high sea purchases);

f. 1.25% of BTG contract price on boiler light of unit 1;

g. 1.25% of BTG contract price on boiler light of unit 2;

h. 1.25% of BTG contract price on turbine and barring gear for unit 1;

i. 1.25% of BTG contract price on turbine and barring gear for unit 2;

j. 2.50% of BTG contract price on issuance of provisional acceptance certificate for unit 1;  

k. 2.50% of BTG contract price on issuance of provisional acceptance certificate for unit 2 and submission of warranty period guarantee by the contractor for an amount equal to 8.5% of the contract price; and

l. 5.00% of BTG contract price on the earlier of (i) issuance of final acceptance certificate or (ii) if the owner refuses to carry out the performance guarantee test within 3 months of issuance of provisional acceptance certificate and contractor has fulfilled all other requirements of final acceptance under the contract, against an unconditional and irrevocable bank guarantee for a period of 6 months.

5. According to the querist, all such offshore supplies are sold by the contractor through high sea sale agreement and risks and rewards get transferred on the date of such high sea sale agreement. Therefore, the date of high sea sale agreement is considered as the date of transaction for recording the foreign currency monetary items. The company accounts for such supplies/ equipments as capital assets (emphasis supplied by the querist).

6. The querist has reproduced paragraph 9 of Accounting Standard (AS) 11 (revised 2003), ‘The Effects of Changes in Foreign Exchange Rates’, issued by the Institute of Chartered Accountants of India (ICAI), which states that “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”.

7. Further, the querist has also stated that the new paragraph 46A inserted in AS 11 by  Companies (Accounting Standards) (Second Amendment) Rules 2011, inter alia, states that “the exchange differences arising on reporting of long-term foreign currency monetary items at rates different from those at which they were initially recorded during the period, or reported in previous financial statements, insofar as they relate to the acquisition of a depreciable capital asset, can be added to or deducted from the cost of asset and shall be depreciated over the balance life of the asset, …”

8. To exercise the option as referred above, as per clause (2) of paragraph 46A of AS 11, “an asset or liability shall be designated as long-term foreign currency monetary item, if the asset or liability is expressed in a foreign currency and has a term of twelve months or more at the date of origination of the asset or the liability. Accordingly, the date of transaction as per paragraph 9 of AS 11 and date of origination of liability as per paragraph 46A can be considered as the same. (Emphasis supplied by the querist.)

9. Presently, foreign exchange differences arising on actual repayments of such foreign currency liabilities for offshore supplies and restatement of such liabilities as at the balance sheet date are accounted in financial statements as below.

10. Exchange differences on payment made as per the terms of payments as mentioned in paragraph 4(a) to (c) above are considered as ‘capital advances’ and are not restated considering the same as non-monetary item as based on earlier opinions of Expert Advisory Committee in the said matter. Such payments are adjusted against the liability booked on account of purchase of capital asset on the respective date of transaction.

11. Exchange differences arising on payment of part liabilities as per terms mentioned in paragraph 4(d) to (e) are recorded in the statement of profit and loss by the company considering them as short-term monetary items as these are paid normally in less than 12 months from the date of transaction.

12. Payment of part liabilities as per terms mentioned in paragraph 4(f) to (k) are considered as ‘retention money’ and as  these liabilities are payable normally in a time period of more than 12 months from the date of transaction, therefore, considered as long-term monetary items and same are accounted for as per paragraph 46A of AS 11. Accordingly, exchange differences arising thereon are added or deducted from the cost of asset.

13. As per the querist, in case of these capital imports (offshore supplies contract, as stated above), the liability against such imports of depreciable capital assets originates at the date of transaction (i.e., at the time of high sea sales to the company) as mentioned in paragraph 5 above and will finally get discharged at the time of balance 5% payment of the contract on issuance of final acceptance certificate from the contractor to the company as mentioned in paragraph 4(l) above. Therefore, complete settlement of the liability will be after a period of 12 months from the date of transaction/date of origination of liability.

14. Also, according to the querist, the terms of payment as mentioned in paragraph 4 above are merely payment terms against a single liability and classification of long-term monetary nature of a liability for paragraph 46A of AS 11 should be determined in accordance with the complete tenure from the date of transaction till final payment and not in parts as per part payment terms. Hence, such single liabilities should not be bifurcated into two different classification of long-term and short-term monetary items and should be treated as long-term and accordingly, the impact is to be recorded in the books of account. (Emphasis supplied by the querist.)

B.        Query

15. The querist has sought the opinion of the Expert Advisory Committee that since the time between the date of origination of the liability as per clause 2 of paragraph 46A and final payment/settlement of liability is more than 12 months, as per the terms of contract, whether the entire liability recorded as at the date of origination/transaction should be considered as a long-term monetary item and hence, whether the foreign exchange differences arising on such transaction should be allowed to be adjusted to the cost of capital assets.

C.        Points considered by the Committee

16.       The Committee notes that the basic issue raised by the querist is that since final payment/settlement of liability is after 12 months from the date of its origination whether the entire liability arising on the date of transaction should be considered as long-term foreign currency monetary item for the purpose of capitalisation of foreign exchange differences under paragraph 46A of AS 11 irrespective of the fact that a part of the liability is repaid/settled within a period of 12 months. Therefore, the Committee has examined only this issue and has not examined any other issue that may arise from the Facts of the Case, such as, timing of recognition of liability in case of high sea sale, timing of transfer of risks and rewards related to ownership of asset, accounting for EPC contract, whether liability is monetary liability as per AS 11, etc.  Further, the Committee’s opinion is not in respect of determination of nature of individual payments, as mentioned in paragraph 4 above rather on the criteria for determination of nature of liability, i.e., long-term or short-term. The Committee also presumes from the Facts of the Case that the timing of recognition of liability in the extant case is in accordance with the Indian GAAPs.

17.       The Committee notes paragraph 46A of AS 11, notified under the Companies (Accounting Standards) Rules, 2006 which, inter alia, provides as follows:

“46A.  …

(2) To exercise the option referred to in sub-paragraph (1), an asset or liability shall be designated as a long-term foreign currency monetary item, if the asset or liability is expressed in a foreign currency and has a term of twelve months or more at the date of origination of the asset or the liability:
            …”

18.       The Committee further notes the following definition of ‘Long-term Liability’, as given in the Guidance Note on Terms used in Financial Statements, issued by the Research Committee of the ICAI:

“9.04   Long-term Liability
Liability which does not fall due for payment in relatively short period, i.e., normally a period not more than twelve months.”

The Committee also notes FAQ No. 13 of ‘Frequently Asked Questions on AS 11 notification’, issued by Accounting Standards Board of the ICAI, which is reproduced as below:

“(13) If the long term foreign currency monetary item is received in instalments whether the installment received within a period of 12 months should be treated as short term in nature?

Response
Yes, each loan installment should be treated as a separate monetary item. The principle should be to amortise the exchange difference proportionately over the period of the monetary item and not to carry forward any unamortised amount beyond the settlement of the monetary item to which the exchange difference relates. Treating the entire loan as a single monetary item would result in the exchange difference relating to the loan instalment which is settled being amortised in accounting periods even after such settlement.”

19.       From the above, the Committee is of the view that the nature of a liability, i.e., short-term or long-term would depend upon its term from the date of origination (i.e., the date of the initial recognition) till the date it falls due for payment, whether partly or fully, as per the terms of payment.  In the extant case, although the entire liability may originate on the date of transaction which is the date of its initial recognition, but its nature, i.e., long-term or short-term would depend on the terms of its payment, i.e., when it falls due for payment.  Thus, the portion of the liability which falls due within twelve months from the date of its origination would be short-term and the portion of the liability which falls due after twelve months from the date of its origination would be long-term. Moreover, in the context of application of paragraph 46A also, the Committee is of the view that to the extent a liability is discharged within a period of twelve months from the date of its origination, there is no long-term foreign exchange fluctuation exposure on that part of the liability and, accordingly, the foreign exchange gains and losses on that part of liability, i.e., short-term liability should be recognised in the statement of profit and loss.  The part of liability which is discharged after twelve months has long-term exposure towards foreign exchange fluctuations, and accordingly, the foreign exchange gains and losses arising on that part of the liability, i.e., long-term liability can be treated in accordance with paragraph 46A of AS 11. 

D.        Opinion

On the             basis of the above, the Committee is of the opinion that for the purpose of paragraph 46A of AS 11, the term of a monetary liability as long-term or short-term should be assessed on the basis of terms of the payment. Therefore, the portion of the liability which falls due within twelve months from the date of its origination is short-term and the portion of the liability which falls due after twelve months from the date of its origination is long-term liability. The exchange differences related to the liability which qualifies to be long-term monetary liability can be treated in accordance with requirements of paragraph 46A of AS 11.

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[1]Opinion finalised by the Committee on 1.5.2014.