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This article is based on some queries received from some of our readers who actually encountered some practical gaps while dealing with exchange loss derived in foreign currency borrowings and its related capitalization.
The content and facts of the case mentioned below has been modified to the extent so that it will not reveal any actual facts related specific to the reader’s case.
There are certain foreign currency borrowings which have been taken in order to construct/ create some of the assets of the entity. Company is currently availing option given under para 46/46A of AS-11 and amortizing exchange difference over the period of loan. Now, there are some queries which have been raised by the readers –
1) What is allowed for the entities transiting first time to Ind-As assuming that they want to continue with para 46/46A of AS-11?
2) What would be the change or implication in case an entity wants to discontinue the option of para 46/46A of AS-11?
3) How to deal with the amounts that have been capitalized in fixed assets already in the past (when an entity opted not to continue with para 46/46A) but since the entity opted for deemed cost exemption for Fixed Assets then what would be the approach?
4) If para 46/46 A of AS-11 does not follow by an entity then what exactly would be the requirement specific to the Ind-As going forward?
Let’s have relevant extracts from standards in order to have suggested approach towards the queries raised above-
Ind-As -101 – First Time Adoption
Para -D13AA – A first-time adopter may continue the policy adopted for accounting for exchange differences arising from translation of long-term foreign currency monetary items recognized in the financial statements for the period ending immediately before the beginning of the first Ind AS financial reporting period as per the previous GAAP.
Ind-As -21 – “The Effect of Changes in Foreign Exchange Rates”
Para -23– “At the end of each reporting period:
(a) foreign currency monetary items shall be translated using the closing rate;…………”
Ind-As -23 – “Borrowing Costs”
Para 6 (e) – exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.
Para 6A – With regard to exchange difference required to be treated as borrowing costs in accordance with paragraph 6(e), the manner of arriving at the adjustments stated therein shall be as follows:
(i) the adjustment should be of an amount which is equivalent to the extent to which the exchange loss does not exceed the difference between the cost of borrowing in functional currency when compared to the cost of borrowing in a foreign currency,
(ii) where there is an unrealised exchange loss which is treated as an adjustment to interest and subsequently there is a realised or unrealised gain in respect of the settlement or translation of the same borrowing, the gain to the extent of the loss previously recognised as an adjustment should also be recognised as an adjustment to interest.”
Let’s have a summarized way to understand what are the options/ references available based on the queries received-
1) Answering to the First bullet point, Existing accounting standards i.e. AS-11 (Indian GAAP) had given an option to the entities in its para 46/46A to amortised all exchange losses that are being derived from foreign currency borrowings over the period of the loan. This relief was given when exchange rates were heavily un-favourable to the entities who borrowed money in USD and hence in order to save guard Indian entities, the authorities had given this para in the past to spread the losses into longer period. Now, as per para D13 AA of Ind-As 101 those entities who want to retain this option can continue only upto the borrowing made on or before 31 March 2016 (borrowing taken upto that date , however can continue amortising the existing loans upto its actual completion) and hence w.e.f. all entities (whether they opt for this expemtion or not) will be required to follow Ind-As 21 & Ind-As 23 for the accounting treatments related to such exchange losses on forgien currency borrowed funds (new borrowed funds w.e.f.01.04.2016),
2) Answering to the Second bullet point, In order to discontinue the option given in para D13 AA of Ind-As 101, an entity needs to reverse all such exchange losses (Un-amortised portion of exchange loss) by adjusting retained earnings at the time of transition and going forward to follow the requirement of Ind-As 21 & Ind-As 23 for the treatment of such exchange loss on borrowed fund,
3) Answering to the Third point, Since the Deemed cost exemption that is available for fixed assets required no adjustment at the date of transition, hence even the entity opted not to continue with the para 46/ 46A treatment then also no adjustment required in fixed assets, however as mentioned in point no.3 above, all such unamortized part of exchange loss will be adjusted against retained earnings only,
4) Answering to the Fourth point, Since foreign currency borrowings will be monetary item as defined in Ind-As 21 and hence it will be re-measured at closing exchange rates (as per para 23-a of Ind-As 21) and difference will be debited/ credited to the PL of that period, However if the foreign currency borrowing has been taken for some eligible “Qualifying Assets” then exchange loss can be capitalized to the extent as defined in para 6 e of Ind-As 23 on “Borrowing costs”.
This can be understood by using an example below –
An foreign currency loan has been taken @ 3% where as the same type of loan is available in Indian market @ 8%. The repayment of loan will have some exchange loss which can be claimed to be part of capitalization but only upto the difference between 8% interest on loan available in entity’s functional currency and 4% interest on loan which is to be paid.
Loan of USD 100 taken in USD on 1 Jan 2000 @ 65/- INR rate = INR 6500
Loan of USD 100 as on 31 Dec 2000 @ 68/- INR rate = INR 6800
Exchange loss (A) INR 300
Interest obligation as per loan taken @3% @68/- INR rate (B) = INR 204
Total (A + B) INR 504 (x)
Equivalent Functional currency similar borrowing (refer note) = INR 450 (y)
Difference (x-y) which is not allowed for capitalization INR 54
1) Hence only INR 300 – INR 54 = INR 246 has been allowed to capitalized as an adjustment to the Interest cost and INR 54 is not allowed (transfer to PL),
2) Normally functional currency (domestic market) loan will be expensive than foreign currency loan and that is one of the reason to raise money in foreign currency,
3) Standards does not allow to capitalize exchange losses that is more than the difference between cost of funds in foreign borrowing & similar terms domestic borrowings,
4) Practical question arises how to calculate the difference at the inception, then one can use forward rates to arrive such difference (however nothing mentioned in the standards related o the approach for this),
5) In case at the time of settlement of loan, there is a exchange gain arises, then standards says to adjust the gain amount to the extent of loss previously recognized as an adjustment to the Interest Cost (as per para 6A ii of Ind-As- 23)
Management needs to carefully review the situations and accordingly changes in the existing processes will be required. At the same time it is essential to the Auditor to verify the requirement carefully as part of their audit processes.
A reader will appreciate about the main objective of the standard and an approach which one can follow while keeping in mind the basis of origin of such requirements. There could possibly be some specific situations or circumstances where the interpretation of any standard will be different as we should always keep in mind that IND-AS is principle based standards and lot more areas need management judgment in line with the standards relevant interpretation and best practices.
One has to look into all related facts and patterns before concluding this type of assessment based on this concept. Readers are requested not to take this article as any kind of advice (it is not exhaustive in nature) and should evaluate all relevant factors of each individual cases separately.
(Author of this article is an experienced chartered accountant who has specialization on various GAAP conversions assignments covering different industries around different part of the world including acting as an Independent IFRS Advisor & Corporate Trainer. He can be reached via email at email@example.com or Whatsapp +91-9634706933)