1.19     Query 

Treatment of roll-over cost paid for a forward cover

for a loan in foreign currency.

1.A public limited company is engaged in the manufacture of Polyester Filament Yarn. The unit was set up in 1985 and it imported 3,000 TPA Spinning Plant from Germany in 1985. The plant was commissioned on 31.3.86 and went into commercial production from 1.4.86.

2.To part finance the imported plant, the company had taken foreign currency loan from IFCI aggregating to DM 26,47,600. The repayment of this foreign currency loan is spread over 7 years commencing June 1988.

3.On the date of capitalization, i.e., 31.3.86, the foreign currency loan of DM 26,47,600 was revalued at the rate prevailing on 31.3.86 and increase in rupee liability was capitalized to Plant & Machinery with a corresponding increase in the loan liability.

4.Similarly, the rupee liability as on 31.3.87 was again calculated based on the exchange rate prevailing on the balance sheet date and adjustments were made in the Plant & Machinery A/c and in Rupee liability of Foreign Currency Loan A/c.

5.Seeing to the constant decline in rupee vis-à-vis foreign currency, it was decided in January, 1988 that the company should take a forward cover with the bank to cover all the future instalments of this particular DM loan. Consequently, a cover was taken with SBT on 18.1.88 which booked the entire DM 26,47,600 @ Rs. 8.11 per DM. The querist has supplied a copy of the forward contract note. The contract note states that the contracted rate of Rs. 8.11 per DM shall be revised after every six months depending upon the cost of roll-over.

6. As per the existing RBI regulations, a forward cover cannot be taken for more than six months in one go, and hence any forward cover extending beyond six months needs to be rolled over every six months. This roll over involves cost at the time of every roll-over, which is basically the difference between the spot rate on the date of roll-over and six months forward rate on the date of roll-over. Normally, the foreign currency forward rates are quoted at a premium, hence, there is always a cost to be incurred at the time of such roll-overs, but in the event the forward rates on the date of roll-over are at a discount, income can also accrue at the time of such roll-overs.

7.Having taken the forward cover in January, 1988, the company at the time of preparation of its balance sheet as on 31.3.88, valued the rupee liability of this loan at the forward contracted rate of Rs. 8.11 per DM with corresponding adjustment in the Plant & Machinery A/c.

8.In June, 1988, the first instalment of this loan amounting to DM 189,200 was paid by the company to IFCI at the contracted rate of Rs. 8.11 per DM. It has been mentioned by the querist that on the date of payment spot rate of DM was lower than Rs. 8.11 per DM as a result of which the company did not gain anything by taking this forward cover, at least for this first instalment. On the contrary, the company lost Rs. 0.30 thousand because the forward rate being higher than the spot rate on the date of payment of the instalment. No financial entry was passed for this notional loss since rupee liability in the books of account of the company has already been covered at the rate of Rs. 8.11 per DM. on the date of provisional balance sheet. However, the roll-over cost amounting to Rs. 5.21 lakhs was incurred by the company on roll-over forward cover for the next 6 months for the full amount of loan DM 26,47,600 minus the instalment paid of DM 189,200.

9.The second instalment of DM 189,200 was due in December, 1988 and was again paid to IFCI at the contracted rate of Rs. 8.11 per DM. On this date, the spot rate of DM was higher than the contracted rate as a result of which the company had notional gain of Rs. 1.12 lakhs in this repayment for which again no entry was passed in the books of account. The forward premium for six months was, however, quite high on this particular date as a result of which the company had to pay Rs. 10.92 lakhs as roll-over cost for the balance amount of loan to be rolled over.

10.The querist has referred the following queries to the Expert Advisory Committee for its opinion:

a) Whether this roll-over cost paid by the company which roughly aggregates to Rs. 15 lakhs, needs to be charged off to revenue in the year 1988-89?

b) Whether it will not be proper to amortise this roll-over cost over the number of instalments for which the same has been incurred?

c) Whether this roll-over cost should be capitalised to Plant & Machinery?

                                                                       Opinion                                       August 16, 1989

1.The Committee notes that Part I of Schedule VI to the Companies Act, 1956, inter alia, prescribes 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 moneys 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 the cost of the fixed asset.” (Emphasis supplied by the Committee).

2.The Committee also notes from the terms of exchange contract between the company and the bank, that the contracted rate of Rs. 8.11 per DM shall be revised after every 6 months which shall depend upon the cost of roll-over. However, the Committee notes that in actual practice, instead of revising the rates, only the roll-over charges/credits are paid/received.

3.The Committee is of the view that since the originally contracted rate remains the same over the period of loan and only roll-over charges are to be paid or received, as the case may be, the roll-over charges are on account of the revision in the rates of foreign currency in the next six months. Had the company not paid or received the roll-over charges, and had obtained a contract note on the revised rates (i.e., the rates revised on the basis of the cost of roll-over) it would have debited or credited, as the case may be, the cost of the asset with the corresponding change in the amount of foreign currency loan on the date of balance sheet. The Committee is, therefore, of the view that the roll-over charges represent the difference arising on account of change in foreign exchange rates.

 4. The Committee is also of the view that these roll-over charges are not in the nature of any insurance premium or expense since they can also result into a revenue for the company. Thus, they are indicative of the increase or decrease in the liability of the company in the next six months.

5.The opinion of the Committee on the issues raised by the querist in para 10 of the query is as below:

                        (a)            No.

                        (b)            No.

(c) The Committee is of the opinion that the entire roll-over charges should be adjusted to the cost of plant and machinery.

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