Query No. 7

Subject:           Applicability of paragraph 46A of AS 11 to buyer’s credit/suppliers’ credit repaid through a long-term liability.[1]

A.        Facts of the Case

1.         A closely held public limited 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 the thermal holding company, 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 and 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 as mentioned therein.

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 risks and rewards get transferred on the date of such 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/ equipment as capital assets.

5.         The company is funding the project by way of long-term rupee term loans for a period of upto 15 years from the Indian Project Lead Lenders. For import of capital assets for the project, Foreign Letter of Credits (FLCs) have been issued in favour of offshore vendors by the lead lenders. Against issuance of FLCs denominated in USDs, equivalent Indian rupee balance to be disbursed by the Project Lead Lenders gets blocked from the total sanctioned rupee loan limit. Further, the company has opted for part funding of the project cost through buyers’/ suppliers’ credit to finance offshore liabilities in case of capital assets. These buyers’/suppliers’ credits from foreign lenders are short-term in nature, i.e., generally for a term of six months to 360 days (i.e., less than one year) and are availed against the Letter of Undertaking (LOUs) given by the Indian Project Lead Lenders who undertake to pay liabilities to the foreign lenders. Generally, LOUs contain following terms of repayment to the buyer’s/ supplier’s credit lenders:

“We Lead Lenders hereby unconditionally agree to pay the principal, interest at applicable interest rate and other under this loan. We undertake to credit your designated account on the due date as per your instructions. We hereby undertake to pay you on demand the loan amount and interest thereon and/or the amount of any losses, cost or damages you may suffer in our failure to credit your designated account on due date”.

In accordance with the terms of LOUs issued by the Indian Project Lead Lenders to the buyers’/suppliers’ credit issuing foreign lender, the amount so availed by the company eventually gets converted into long-term loan upon maturity of these buyers’/suppliers’ credit. Since these buyers’/suppliers’ credits (even though contracted for a period of less than 12 months) are converted into long-term rupee loans upon maturity, in substance, this results in conversion of one liability into another. In the said conversion, no real cash outflows happen which are known to the querist on the date of transaction.

6.         Currently, foreign exchange differences arising on actual repayments of above foreign currency liabilities and buyers’/suppliers’ credit for offshore supplies and restatement of such liabilities as at the balance sheet date are treated as below:

(i) When the company avails buyers’/supplier’ credit, the offshore vendor is paid by the foreign lenders giving such facility. Such buyers’/suppliers’ credit is then accounted as a short term foreign currency liability in the company’s books, as it is repayable in less than 12 months period.

 

(ii) On maturity, the Project Lead Lenders pay foreign lenders for such buyers’/ suppliers’ credit availed and then the basic amount of FLCs get converted into long-term rupee term loan in the books of the company. Any foreign exchange difference between payment by project lead lenders to the foreign lenders and basic amount of FLC availed is recorded as foreign exchange gain/ loss in the statement of profit and loss of the company.

(iii) Further, buyers’/suppliers’ credits outstanding to foreign lenders on the balance sheet date are restated and foreign exchange gain/ loss on account of such restatement, if any, is also recorded in the statement of profit and loss of the company. Thus, the current view being taken is that the buyers’/suppliers’ credits outstanding to foreign lenders are short-term monetary items which are taken from different foreign lenders (other than the long term project lenders) and thus, are not covered under paragraph 46A and accordingly, disclosed as ‘short-term borrowings’ repayable within one year in the financial statements.

7. (i)     The querist has reproduced paragraph 17(b) of Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’ issued by the Institute of Chartered Accountants of India, which states that “The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form.” Further, paragraph 10 of Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’ defines liability as “a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits”. (Emphasis supplied by the querist.)

 

(ii)        Considering the principle of substance over legal form as mentioned above, it can be construed that such short-term buyers’/suppliers’ credits from foreign lenders are a part of long-term rupee term loan as there are no real pay outs at maturity for the company as the liability is undertaken to be paid by the long-term project lead lenders (as per the terms of LOUs as mentioned in paragraph 5 above). In substance, the company has to pay to the Project Lead Lenders against the amount paid by them to these foreign lenders as a part of long-term rupee term loan as per the repayment schedule of rupee term loan agreement which extends up to 15 years and therefore, it is a long-term monetary item in nature.

(iii)       Accordingly, the querist is of the view, based on practices of some sections of the industry, that such buyers’/suppliers’ credit taken against FLCs are an integral part of the long-term loans and thus, should be treated as long-term monetary items. Also, in accordance with paragraph 10 of AS 29 as mentioned above, actual settlement of liability against such buyers’/suppliers’ credit is not taking place at the time of payment by the Project Lead Lenders to buyers’/suppliers’ credit foreign lender, rather actual event of settlement of liability is occurring at the time of payment by the company to the Project Lead Lenders as per the pre-decided repayment schedule for the long-term rupee loans.

(iv)       For long-term monetary items, the querist has also reproduced new paragraph 46A inserted in Accounting Standard (AS) 11, ‘The Effects of Changes in Foreign Exchange Rates’, by Companies (Accounting Standards) (Second Amendment) Rules 2011 which, inter alia, states, “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 the asset and shall be depreciated over the balance life of the asset”. 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 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 liability”.
(Emphasis supplied by the querist.)

8.         As per the querist, in substance, term of the buyers’/suppliers’ credit to the company on the date of transaction is more than twelve months as per the terms of LOUs mentioned in paragraph 5 above and the view taken in paragraph 7(ii) and (iii) above.  Hence, such liabilities should be treated as long-term and accordingly, the impact should be recorded in the books of account as per paragraph 46A of AS 11.

B.        Query

9.         The querist has sought the opinion of the Expert Advisory Committee that, since the short-term buyers’/suppliers’ credit taken from foreign lenders is settled by the long-term Project Lead Lenders and the company is required to settle such liability as a part of long-term rupee term loan availed from the Project Lead Lenders, foreign exchange differences on settlement of foreign lenders’ liabilities during the year as well as restatement of such buyers’/suppliers’ credit at balance sheet date should be treated as against long-term foreign currency monetary items and hence, should be allowed to be adjusted to the cost of capital assets instead of charging them to the statement of profit and loss in the books of the company.

C.        Points considered by the Committee

10.       The Committee notes that the basic issue raised in the query relates to whether repayment of short term foreign currency liability by availing Indian currency long-term liability can be treated in substance as a long term foreign currency monetary liability for the purpose of application of paragraph 46A of AS 11. 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, accounting for EPC contract including the contract for supply of BTG/capital asset, accounting for long-term Rupee term loan from the Project Lead Lenders, accounting for foreign letter of credits issued by the Project Lead Lenders in favour of offshore vendors for import of capital assets, etc.

11.       The Committee notes from the Facts of the Case that the company has availed buyers’ credit/suppliers’ credit  in foreign currency from foreign lenders  to partly finance the offshore liabilities in respect of capital assets, which is short-term in nature, i.e., less than twelve months. Accordingly, on availing of such facilities, the company records a short-term foreign currency liability in its financial statements. On maturity of such short-term liabilities, these are repaid through an existing Rupee long-term fund arrangement entered into with another lender, viz., Project Lead Lenders. Further, at the time of maturity of such short-term liability, the repayment is made at the foreign exchange rate prevailing on the date, which may result into foreign exchange gains or losses. Thus, one short-term foreign currency liability is being extinguished and settled by availing another long-term Indian currency liability.

12.       From the above, in the context of application of paragraph 46A, the Committee is of the view that since buyers’ credit/ suppliers’ credit is settled within a period of twelve months from the date of its origination and thereafter, there would be no foreign exchange fluctuation exposure, the question of recording it as a long-term foreign currency liability as per paragraph 46A of AS 11 does not arise. Accordingly, foreign exchange differences on short-term buyers’/suppliers’ credit arising on either restatement at balance sheet date or on settlement should be recognised as income or as expense in the period in which they arise and should not be allowed to be adjusted to the cost of the capital assets in the books of the company. The reason being that a short-term liability cannot be considered to be converted into a long-term liability just because it is being settled by a long-term liability.

D.        Opinion

13.       On the basis of the above, the Committee is of the opinion that foreign exchange differences on short-term buyers’/suppliers’ credit arising on either restatement at balance sheet date or on settlement should be recognised as income or as expense in the period in which they arise and should not be allowed to be adjusted to the cost of capital assets in the books of the company. The reason being that a short-term liability cannot be considered to be converted into a long-term liability just because it is being settled by a long-term liability.

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[1] Opinion finalised by the Committee on 11.4.2014.