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Query No. 31
Subject: (i) Accounting for short term bridge foreign currency loan taken to invest in an overseas joint venture entity.
(ii) Accounting treatment of investment in overseas company’s shares.
(iii) Treatment of loans (advances) given to the overseas joint venture entity.
A. Facts of the Case
1. A navaratna central public sector undertaking under the administrative control of the Ministry of Petroleum and Natural Gas, Government of India, is engaged in the exploration, development and production of oil and gas in various oil and gas fields and transportation of crude oil to refineries.
2. The company has acquired 40% shares in A Ltd., a company registered in British Virgin Islands. A Ltd. holds 10% participating interest in offshore block Rovuma 1 in Mozambique.
3. The Government of India had approved the above acquisition transaction with a stipulation that the entire foreign exchange required for the transaction be raised through external commercial borrowings (ECBs)/other overseas funding and earnings abroad.
4. The company with the approval of the Reserve Bank of India (RBI), had arranged a short term bridge loan (upto one year) of US$ 1.3 billion from foreign banks for financing the acquisition of 40% stake in A Ltd. and had drawn US$ 1.03 billion on 6th January, 2014 for payment of initial acquisition cost of shares of A Ltd. Since the approval of RBI for short term bridge loan stipulated replacement of the same with long term ECB compliant with all the extant ECB guidelines, the company had issued Foreign Currency Bonds (FCBs) in the international market in two tranches of US$ 500 million each for tenors of 5 years and 10 years respectively in April, 2014. The proceeds of the issue have been utilised for part repayment of the short term bridge loan on 22.04.2014.
5. The querist has stated that the company through A Ltd., will also be required to invest additional US$ 1 billion in the project over a period of next 4–5 years as capital expenditure (capex). For this, the company will be raising additional foreign currency loans and extend the same to A Ltd. in the nature of equity or loans (advances) for meeting capex requirements. As of 31.03.2014, the company has already extended loans (advances) to A Ltd. for this purpose.
6. The company’s accounting policies for the relevant areas are as follows:
1. Foreign Currency Translation
(i) Foreign currency transactions are initially recognised and accounted for at the exchange rates prevailing at the dates of transactions.
(ii) Foreign currency monetary assets and liabilities outstanding at the close of the year, are translated at the rates of exchange prevailing at the date of balance sheet. Resultant gain or loss is accounted for during the year.
(iii) Foreign currency transactions in relation to joint venture (overseas) are treated in the following manner:
(a) Foreign currency transactions are initially recognised and accounted for at the exchange rates prevailing at the dates of transactions. However, the average exchange rate of relevant month is taken for the transactions of that month, where actual rate of transaction is not available or at the rate as agreed otherwise.
(b) Foreign currency monetary assets and liabilities outstanding at the close of the year, are translated at the rates of exchange prevailing at the date of balance sheet. Resultant gain or loss is accounted for during the year.
2. Investments
(i) Non-current investments are valued at cost. However, provision for diminution in value is made to recognise a decline in the value, other than temporary.
(ii) Current investments are valued at lower of cost or fair value.
7. The querist has also stated that application of above accounting policies in the instant case is given below:
1. Standalone accounts
(i) Investment in equity shares of A Ltd. is accounted as under:
(a) as investment in joint venture in the nature of jointly controlled entity under paragraph 26 of Accounting Standard (AS) 27, ‘Financial Reporting of Interests in Joint Ventures’.
(b) a non-current investment under Accounting Standard (AS) 13, ‘Accounting for Investments’.
(ii) Advances to A Ltd. are accounted as under:
(a) as current monetary item under Non-integral Foreign Operation.
2. Consolidated accounts
(i) Investment in A Ltd.:
(a) Using proportionate consolidation method under paragraph 28 of AS 27.
8. Accounting treatment done by the company with regard to foreign currency translation prevailing at the balance sheet date:
The accounting treatment in respect of the subject acquisition and loan transactions is as under:
(a) Initial recognition - Recognised and accounted for at the exchange rates prevailing at the date of acquisition of shares (paragraph 9 of Accounting Standard (AS) 11, ‘The Effects of Changes in Foreign Exchange Rates’).
(b) Restatement at balance sheet date - Continuing at cost and not restated being a non-monetary item (paragraphs 11 and 12 of AS 11).
9. The querist has also stated that for item 8(ii) as above on short term bridge loan, there was a substantial gain on foreign currency translation as on the balance sheet date (i.e., 31.03.2014) which was recorded through profit and loss account. However, the statutory auditors of the company had a reservation on the aforesaid accounting treatment due to the following reasons:
(i) Government of India approved the foreign asset acquisition with a stipulation that entire foreign exchange required for the transaction be raised through external commercial borrowings / other overseas funding and earnings abroad;
(ii) Due to the above stipulation, (as per the statutory auditors) the company is not allowed to repay the borrowings from the Indian sources.
(iii) A part of the short term bridge loan was replaced by a long term foreign currency loan raised through issue of bonds of 5/10 years tenor after the balance sheet date. Accordingly, statutory auditors are of the view that for such loans, paragraph 11(a) of AS 11 will be applicable as there are restrictions on remittances and, therefore, the borrowings cannot be translated simply at the closing rate.
In view of the above, the statutory auditors are of the opinion that such gain/ loss on foreign exchange fluctuation on the short term borrowing cannot be taken through profit and loss statement and need to be accumulated in a foreign currency translation reserve until the disposal of the investment, at which time this should be recognised as income or expense.
10. The company’s view:
(i) The Government stipulations are with reference to raising of funds only and there are no explicit stipulations on repayment of the loan raised in foreign currency.
(ii) The loan is on the company’s account and for all practical purposes, at some point of time, such loan has to be repaid by the company, which is an Indian company, out of its own resources only.
(iii) The word ‘restrictions’ used in paragraph 11 of AS 11 actually refers to a situation where there is a general restriction on overseas remittances due to which a realistic closing rate of the foreign currency is not available. In such circumstances also, the relevant monetary items should be reported in the reporting currency at the amount which is likely to be realised/disbursed. The provisions in this paragraph 11 of AS 11 only specifies the rate at which the monetary items need to be converted at the balance sheet date and does not restrict the treatment of gain/loss on the foreign exchange fluctuations for monetary items through profit and loss statement.
(iv) The short term bridge loan for which foreign exchange fluctuation gain is being accounted for is a short term loan only. Accordingly, any loss/gain on this account cannot be carried forward as foreign currency translation reserve even after the expiry of the loan period. The requirement of raising 5/10 years bonds from abroad, to repay the short term bridge loan, is only a funding decision taken by the company keeping in view the approvals of Government of India and RBI .
(v) In the instant case, the closing rate is realistically available in the market.
In view of the above, the company has restated the short term bridge loan (being a monetary item) at the closing rate on the balance sheet date and has taken the restatement difference to the profit and loss account.
B. Query
11. In view of the above facts and the divergent stand of the querist and the auditors, the querist has sought the opinion of the Expert Advisory Committee to ascertain the correctness or otherwise of the accounting treatment done by the querist in respect of:
(i) Initial recognition and restatement of short term bridge loan in standalone accounts:
1.Initial recognition - Recognised and accounted for at the exchange rates prevailing at the date of loan.
2. Restatement at balance sheet date - Restated at the closing rate being a monetary item and difference is taken to profit and loss account.
(ii) Investment in the overseas company shares (standalone accounts):
3. Initial recognition - Recognised and accounted for at the exchange rates prevailing at the date of acquisition of shares.
4. Restatement at balance sheet date - Continuing at cost and not restated being a non-monetary item.
(iii) Loans (advances) given to the overseas company for future capex in the project (standalone accounts):
5. Initial recognition - Recognised and accounted for at the exchange rates prevailing at the dates of loans (advances) given to the overseas company.
6. Restatement at balance sheet date - Restated at the closing rate being a monetary item and difference credited to Foreign Currency Translation Reserve (FCTR).
(iv) Goodwill (consolidated accounts): Restated at closing rate in the consolidated accounts and resulting exchange variation taken to FCTR.
C. Points considered by the Committee
12. The Committee, while answering the query, has considered only the issues raised in paragraph 11 above, and has not considered any other issue that may arise from the Facts of the Case, such as, accounting treatment of foreign currency bonds, accounting in the books of A Ltd., accounting for advances in the nature of equity to A Ltd. by the company, correctness of treating the loans (advances) given to A Ltd. by the company for future capital expenditure as a monetary item under AS 11, legal interpretation of the approval of the Government/RBI allowing the transaction of acquisition of shares of A Ltd. through bridge loan/ECB and their repayment, propriety of use of monthly average exchange rate for the transactions of that month as stated in paragraph 6 (iii) above, etc. The Committee has further presumed from the Facts of the Case that A Ltd. is a non-integral foreign operation for the company.
13. With regard to initial recognition and restatement of short-term bridge loan in standalone accounts of the company, the Committee notes the following paragraphs of Accounting Standard (AS) 11, ‘The Effects of Changes in Foreign Exchange Rates’, notified under the Companies (Accounting Standards) Rules, 2006 (hereinafter referred to as the ‘Rules’):
“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.”
“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.”
“Reporting at Subsequent Balance Sheet Dates
11. At each balance sheet date:
(a) foreign currency monetary items should be reported using the closing rate. However, in certain circumstances, the closing rate may not reflect with reasonable accuracy the amount in reporting currency that is likely to be realised from, or required to disburse, a foreign currency monetary item at the balance sheet date, e.g., where there are restrictions on remittances or where the closing rate is unrealistic and it is not possible to effect an exchange of currencies at that rate at the balance sheet date. In such circumstances, the relevant monetary item should be reported in the reporting currency at the amount which is likely to be realised from, or required to disburse, such item at the balance sheet date;
(b) non-monetary items which are carried in terms of historical cost denominated in a foreign currency should be reported using the exchange rate at the date of the transaction; and
(c) non-monetary items which are carried at fair value or other similar valuation denominated in a foreign currency should be reported using the exchange rates that existed when the values were determined.
12. Cash, receivables, and payables are examples of monetary items. Fixed assets, inventories, and investments in equity shares are examples of non-monetary items. The carrying amount of an item is determined in accordance with the relevant Accounting Standards. For example, certain assets may be measured at fair value or other similar valuation (e.g., net realisable value) or at historical cost. Whether the carrying amount is determined based on fair value or other similar valuation or at historical cost, the amounts so determined for foreign currency items are then reported in the reporting currency in accordance with this Standard. ...”
“Recognition of Exchange Differences
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 expenses in accordance with paragraph 31.”
From the above, the Committee is of the view that short-term bridge loan in foreign currency should be recognised initially by applying the rate of exchange as prevailing on the date of the loan. As regards reporting of short-term bridge loan at the subsequent balance sheet date, the Committee is of the view that the same will depend on whether the item is monetary or non-monetary. In the extant case, the Committee is of the view that the short-term bridge loan in foreign currency, being a monetary item, should be reported using the closing rate of foreign currency at subsequent balance sheet dates. With regard to the stipulations of the auditor regarding restrictions on remittances and that considering paragraph 11(a) of AS 11, the gain or loss arising on reporting at subsequent reporting date should be accumulated in foreign currency translation reserve account, the Committee notes that paragraph 11(a) deals with the situation where closing rate may not reflect with reasonable accuracy the amount in the reporting currency that is likely to be realised from or required to disburse a foreign currency monetary item at the balance sheet date, for example, in certain situations where there are restrictions on remittances and it is not possible to effect an exchange of currencies. In those situations, paragraph 11 of AS 11 prescribes to report the monetary item at the amount which is likely to be realised from or required to disburse that item at the balance sheet date. Without commenting on the issue whether there are any restrictions on remittances of the foreign currency in the extant case or not, the Committee is of the view that AS 11 does not cover such type of restrictions on remittances and covers only those restrictions where the closing rate of foreign currency will not reflect realistic exchange rate. Further, paragraph 11 of AS 11 nowhere states to accumulate the gains or losses arising on reporting the monetary items at subsequent reporting date in foreign currency translation reserve account. Accordingly, the Committee is of the view that the short-term bridge loan should be reported using the closing rate of foreign currency at subsequent balance sheet date in the standalone accounts of the company and exchange differences arising, if any, should be recognised in the statement of profit and loss of the company.
14. As regards recognition of investment in the shares of joint venture entity and subsequent reporting at the balance sheet date in the standalone financial statements of the company, the Committee notes the following paragraphs of Accounting Standard (AS) 27, ‘Financial Reporting of Interests in Joint Ventures’ and Accounting Standard (AS) 13, ‘Accounting for Investments’, notified under the Rules:
AS 27
“26. In a venturer's separate financial statements, interest in a jointly controlled entity should be accounted for as an investment in accordance with Accounting Standard (AS) 13, Accounting for Investments.
27. Each venturer usually contributes cash or other resources to the jointly controlled entity. These contributions are included in the accounting records of the venturer and are recognised in its separate financial statements as an investment in the jointly controlled entity.
AS 13
“3.2 A current investment is an investment that is by its nature readily realisable and is intended to be held for not more than one year from the date on which such investment is made.
3.3 A long term investment is an investment other than a current investment.”
“17. Long-term investments are usually carried at cost. However, when there is a decline, other than temporary, in the value of a long term investment, the carrying amount is reduced to recognise the decline. Indicators of the value of an investment are obtained by reference to its market value, the investee’s assets and results and the expected cash flows from the investment. The type and extent of the investor’s stake in the investee are also taken into account. Restrictions on distributions by the investee or on disposal by the investor may affect the value attributed to the investment.”
“19. Where there is a decline, other than temporary, in the carrying amounts of long term investments, the resultant reduction in the carrying amount is charged to the profit and loss statement. The reduction in carrying amount is reversed when there is a rise in the value of the investment, or if the reasons for the reduction no longer exist.”
On the basis of the above, presuming the investment in the shares of A Ltd., a jointly controlled entity, as a long-term investment and considering paragraphs 11 (b) and 12 of AS 11, the Committee is of the view that the same is a non-monetary item and, therefore, should be initially recognised at the exchange rates prevailing at the date of acquisition of shares and should be carried at historical cost at the subsequent balance sheet date, subject to provisions contained in paragraphs 17 and 19 of AS 13.
15. With regard to loans (advances) given to A Ltd. for future capital expenditure in the project in the standalone accounts of the company, the Committee is of the view that as per paragraph 9 of AS 11 reproduced above, same should be initially recognised at the exchange rate prevailing on the date of loans and advances. Further, with regard to subsequent reporting at the balance sheet date, the Committee notes paragraphs 13 and 15 of AS 11 as reproduced above and paragraph 16 of AS 11, notified under the Rules, as stated below:
“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.”
The Committee notes from the above that in order to determine accounting treatment of exchange differences on a monetary item on subsequent reporting, there is a need to determine whether the loans advanced to the joint venture, in substance, form part of the company’s net investment in the non-integral foreign operation. In this regard, the Committee notes from ‘Note No. 21 – short-term loans and advances’ under ‘current assets’ to the financial statements of the company for the financial year 2013-14 that the loan to A Ltd. is disclosed under ‘Unsecured, considered good’ category of short-term loans and advances. From this, it can be inferred that the advances given to A Ltd. are short-term loans and advances, which will be repaid within short period of time. Accordingly, it can be said that the repayment of loans is planned and is foreseeable. Thus, such loans are not of the nature of net investment in foreign operation (joint venture). Temporary advances in any case are not of the nature of net investment in foreign operation. The Committee is, thus, of the view that the loan advanced is not covered by the treatment prescribed in paragraph 15 of AS 11. Accordingly, exchange differences arising on the loan advanced should be recognised as income or as expense as per paragraph 13 of AS 11. Therefore, the accounting treatment of the company to recognise the exchange difference on reporting the advances at subsequent reporting date in foreign currency translation reserve as per the paragraph 15 of AS 11 is not correct.
16. With regard to treatment of goodwill in consolidated accounts of the company, the Committee notes the following paragraphs of AS 11, notified under the Rules:
“Non-integral Foreign Operations
24. In translating the financial statements of a non-integral foreign operation for incorporation in its financial statements, the reporting enterprise should use the following procedures:
(a) the assets and liabilities, both monetary and non-monetary, of the non-integral foreign operation should be translated at the closing rate;
(b) income and expense items of the non-integral foreign operation should be translated at exchange rates at the dates of the transactions; and
(c) all resulting exchange differences should be accumulated in a foreign currency translation reserve until the disposal of the net investment.”
“27. Any goodwill or capital reserve arising on the acquisition of a non-integral foreign operation is translated at the closing rate in accordance with paragraph 24.”
From the above, the Committee is of the view that the goodwill arising on the acquisition of shares in A Ltd. in the consolidated accounts of the company should be translated using closing rate prevailing on the balance sheet date and the exchange differences should be transferred to foreign currency translation reserve.
D. Opinion
17. On the basis of the above, the Committee is of the following opinion on the issues raised by the querist in paragraph 11 above:
(i) Initial recognition and restatement of short term bridge loan in standalone accounts: The accounting treatment made by the company in this regard is correct, as discussed in paragraph 13 above.
(ii) Investment in the overseas company’s shares in standalone accounts: The accounting treatment made by the company for its initial recognition as well as restatement at the balance sheet date is correct, as discussed in paragraph 14 above.
(iii) Loans (advances) given to the overseas company for future capex in the project in standalone accounts:
(a) Initial Recognition: It should be recognised at the exchange rates prevailing at the dates of loans (advances) and therefore, the treatment made by the company is correct as discussed in paragraph 15 above.
(b) Restatement at balance sheet date: The loans (advances), being a monetary item but not of the nature of net investment in non-integral foreign operation (joint venture), should be restated at the closing rate and the exchange differences arising should be recognised as income or as expense as per paragraph 13 of AS 11. Therefore, the treatment made by the company to recognise the exchange difference on reporting the advances at subsequent reporting date in foreign currency translation reserve is not correct, as discussed in paragraph 15 above,
(iv) Goodwill in consolidated accounts: The treatment made by the company to restate the goodwill at closing rate in the consolidated accounts and resulting exchange variation being taken to FCTR is correct, as discussed in paragraph 16 above.
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[1]Opinion finalised by the Committee on 7.11.2014.
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