Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.15     Query

 

Treatment of exchange rate fluctuations in respect of a long-term liability.

 

1. A public limited company had set up a plant for which it had availed of a foreign currency loan from ICICI. In view of the depreciation in the value of Indian Rupee against the German DM and the Japanese Yen in the past few years, the liability on account of the loan has increased considerably as compared to the amount converted at the point of time of taking the loan. In other words, the outstanding loan as on 30.6.1987 converted at the rate of exchange prevailing when the loan was accepted is Rupees one crore approximately, while the additional liability computed by converting the loans into the relevant currencies at the rate prevailing as on 30.6.1987, which is the year ending of the company, is Rupees seventy one lakhs.

 

2. The auditors of the company are of the view that the situation calls for a note explaining this position and the report would have to be qualified as a result of this additional liability not having been provided for. The auditors have relied on Para 23 of the Statement on Accounting for Foreign Currency Translation, issued by the Institute of Chartered Accountants of India. The company is however of the view that the liability is contingent. It does not consider a qualification necessary in the Auditors’ Report, but feels that an explanatory note would suffice. The auditors have also relied on Para 10 of Accounting Standard 4 (AS-4) on ‘Contingencies and Events Occurring After the Balance Sheet Date, issued by the Institute of Chartered Accountants of India, in support of the view that even assuming that the loss is contingent, it is probable that the loss will arise and should, therefore, be provided for.

 

3.The querist has accordingly sought the opinion of the Expert Advisory Committee on the correctness, or otherwise, of the views expressed by the auditors of the company.

   

                                                                      Opinion                                            June 27, 1988

 

1. The Committee notes that paragraphs no. 23 and 25 of the Statement on Accounting for Foreign Currency Translation, issued by the Institute of Chartered Accountants of India, state as below:

 

“23. At the same time, deferment of the charge to the profit and loss account in all cases till the actual gain or loss is realized on conversion of the foreign currency would result in accounting on a ‘cash basis’ and would be contrary to the “accrual” concept of accounting. It therefore becomes necessary to distinguish between translation differences which arise in translation of current assets and short-term liabilities and translation on differences which arise on translation of non-current assets and long-term liabilities.”

 

“25. The translation difference arising on the translation of long-term liabilities should be dealt with as under:

 

(i) If the funds represented by the long-term liability have been used for the purchase of assets which continue to appear in the balance sheet at the date of translation, the amount of the difference can be dealt with as suggested in sub-paragraphs (ii) and (iii) below or can be added to or deducted from the cost of the assets to the extent considered appropriate.

 

(ii) If the translation results in a profit, the difference (to the extent not adjusted wholly or partly against the cost of assets) should be transferred to a reserve account and a loss arising on a subsequent translation can be debited to this reserve.

 

(iii) If the translation results in a loss, the difference (to the extent not adjusted wholly or partly against the cost of assets) should be written off in the profit and loss account. If the amount of the difference is substantial, it can be written off in annual instalments over a period of years in proportion to the repayment of the liability in each of the subsequent years.”

 

2. The Committee also notes that Part I of Schedule VI to the Companies Act, 1956, contains “Instructions in accordance with which assets should be made out”. The instruction, related to the matter in the query, is as below:

 

“Where the original cost aforesaid and additions and deductions thereto, relates to any fixed asset which has been acquired from a country outside India and in consequence of a change in the rate of exchange at any time after the acquisition of such asset, there has been an increase or reduction in the liability of the company, as expressed in Indian currency, for making payment towards the whole or a part of the cost of the asset or for repayment of the whole or a part of monies borrowed by the company from any person, directly or indirectly in any foreign currency specifically for the purpose of acquiring the asset (being in either case the liability existing immediately before the date on which the change in the rate of exchange takes effect), the amount by which the liability is so increased or reduced during the year, shall be added to, or, as the case may be, deducted from the cost, and the amount arrived at after such addition or deduction shall be taken to be the cost of the fixed asset.”

 

3. The Committee is, therefore, of the opinion that in view of the aforesaid requirements of Schedule VI, if set-up of the plant involves purchase of fixed assets from a country outside India in respect of which the company has specifically taken foreign currency loan from ICICI, the amount of increase in the said liability in consequence of a change in the rate of exchange, shall be added to the cost of the fixed asset, and the amount arrived at after such addition shall be taken to be the cost of the fixed asset. However, in case the set-up of the plant does not involve purchase of fixed assets from a country outside India or the company has not taken foreign currency loan specifically for the said purpose, the increase in liability should be written-off as a loss in the profit and loss account. Where the company considers the said loss to be a substantial amount, it can be written-off in annual instalments over a period of years in proportion to the repayment of the liability in each of the subsequent years.

 

4.Thus, in the opinion of the Committee, the auditors will have to qualify their report if the accounting treatment of exchange rate fluctuations of a long-term liability is not in accordance with para 3 above.

 

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