The Ministry of Corporate Affairs has vide notification1 dated 31 March 2009 relaxed the provisions of Accounting Standard (AS) 11, The Effects of Changes in Foreign Exchange Rates2 in so far as they relate to the recognition of losses or gains arising on restatement of long-term foreign currency monetary items. By another notification3 consequential amendments to Schedule VI to the Companies Act, 1956 have also been made.
The notification gives companies an option in accounting for exchange differences arising on reporting of long-term foreign currency monetary items (assets as well as liabilities) other than those which form a part of the company’s net investment in a non-integral foreign operation.
As per the option, such exchange differences can now be
(a) Adjusted to the cost of the asset, where the long-term foreign currency monetary items relate to the acquisition of a depreciable capital asset (whether purchased within or outside India), and consequently depreciated over such asset’s balance life and
(b) Accumulated in ‘Foreign Currency Monetary Item Translation Difference Account’ (FCMITDA) and amortised over the balance period of long-term monetary asset/liability but not beyond 31 March, 2011, in cases other than those falling under (a) above.
A long-term foreign currency monetary item has been defined as an asset or liability expressed in foreign currency which has a term of 12 months or more at the date of origination of the asset or liability. Thus, foreign exchange differences on monetary items such as sundry creditors, debtors etc. with a term of less than 12 months would not qualify for accounting as per the option given in the notification. For determining the term of a monetary item, the period from the date of origination should be considered even if such a date was prior to the applicability date of the notification.
For determining the term of a monetary item, the period from the date of origination should be considered even if such a date was prior to the applicability date of the notification.
Safeguards built into the notification
The MCA has built in some specific safeguards into the notification to emphasise the ‘one time’ relief nature of these amendments:
1. The relaxation of the AS 11 provisions is only valid for the accounting periods commencing on or after 7 December, 2006 and ending on or immediately before 31 March, 2011.
2. If a company opts to follow the notification, such option has to be
• applied to all long-term foreign currency monetary items
3. Financial statements should include the disclosure of the fact of exercise of option and of the unamortised amount till such an exchange difference remains unamortised.
The notification comes into effect on 31 March, 2009 but applies retrospectively i.e. from accounting periods commencing on or after 7 December, 2006 and ending on or immediately before 31 March, 2011.
If the option (as mentioned earlier) provided by the notification is exercised, the relevant exchange differences, for accounting periods commencing on or after 7 December, 2006, recognised in profit and loss account prior to exercise of option, have to be reversed:
• by adjustment to the cost of the asset to the extent they relate to the acquisition of depreciable capital assets, and
• in other cases, by transfer to ‘Foreign Currency Monetary Item Translation Difference Account’.
In both cases, the corresponding adjustment (debit or credit) has to be made to the general reserve.
In case the company does not have any general reserve or the balance is inadequate, the corresponding adjustment should be recognised as debit/credit balance of profit and loss account.
Based on our initial analysis of the notification, the following are some of the implications that can be considered by preparers of financial statements as they approach the reporting season for March 2009 financial statements.
• A company now has the option to capitalise the foreign exchange fluctuation on a long-term monetary liability to acquire a depreciable capital asset
• The option is available whether or not the monetary item is denominated in the same currency in which the asset is purchased. For example, if a company has taken a US Dollar (USD) loan to purchase machinery in India or outside it, the foreign exchange fluctuation on the USD loan can be capitalised. Similarly, if a company has taken a Japanese Yen (JPY) loan to buy a ship in USD, the company can capitalise the JPY-INR exchange rate movements
• Derivatives that are within the scope of AS 11 and which are intended to establish the amount of reporting currency required or available at the settlement date of a long-term foreign currency monetary item are covered by the notification. However, other derivatives (including hedges of highly probable forecast transactions and firm commitments) are not impacted by this notification
• The option has to be applied retrospectively, i.e. from the first financial year commencing or after 7 December, 2006
• In case the company opts to follow the accounting treatment as per the notification, it should follow the same approach for tax financials in case the tax year is different from the statutory financial year
• FCMITDA should be shown as part of reserves and surplus on the balance sheet. It is similar in nature to the ‘Foreign currency translation reserve’ (see paragraph 24 of AS 11)
• If there has been a refinancing of a foreign exchange liability such that the total term gets extended beyond 12 months due to refinancing, the fresh liability should not be treated as long-term, unless its term is 12 months or more
• Any extension of repayment period does not make the liability long-term if the original term was less than 12 months
• The notification is applicable only to companies registered under the Companies Act. Unless ICAI states to the contrary, other entities are required to follow AS 11 as issued by the ICAI (i.e. without the amendments made by the notification.)
• Retrospective application of the option under the notification will mean that even for the relevant foreign currency loans that have already been repaid in periods beginning on or after 7 December, 2006, the related foreign currency differences should be added to the depreciable capital asset
• As regards consolidated financial statements, it appears that the accounting policy as followed by the parent company would have to be followed for the subsidiaries/joint ventures/associates even though their separate/stand alone financial statements may be based on a different accounting policy
• Even if the option is exercised by the company, the foreign exchange losses and gains would continue to be treated as per the present practice for determining the current tax liability. However, the accounting treatment as per the option in the notification may give rise to timing differences under AS 22, Accounting for Taxes on Income4
• Adjustment to the general reserves under the transitional provisions should be made on a net of tax basis. This is supported by the approach taken by the ICAI in the transitional provisions while issuing new or revised standards. Thus, the deferred tax asset/liability arising in the event of the option being taken, is to be recognised against the corresponding net adjustment to the general reserves
• Companies may have paid Minimum Alternate Tax (MAT) based on book profits of the previous year. The transitional provisions may also have the impact of changing the book profits of not only the current and future years but also of the previous year. If the expert advice is that the MAT liability can not be revised, since as per the tax laws it is based on the financial statements for that year as per Schedule VI (and if the financial statements for the previous year are not restated) the MAT liability for the previous year should not be revised • AS 16, Borrowing Costs4, requires exchange differences arising from foreign currency borrowings to be capitalized as borrowing costs for qualifying assets to the extent that they are regarded as an adjustment to interest costs. The notification would apply to exchange differences over and above those covered by AS 16
• If a company opts to follow the accounting treatment as per the notification, it should consider this as a change in accounting policy and make appropriate disclosure. As regards quarterly reporting, the requirements of the Listing Agreement for change in accounting policy should be followed
• In the case of some listed companies, their respective Board of Directors have approved the financial statements for the year ended 31 December, 2008 and published the audited results in the media, but the financial statements are yet to be adopted by the shareholders at the Annual General Meeting (AGM). The issue arises whether such companies can also avail the option under the notification. If the company so decides, it seems that the Board of Directors can amend the accounts and resubmit them to the statutory auditors for their report before the accounts are placed before the AGM. The report issued by the statutory auditor on such amended accounts will be in substitution of the report issued on the accounts before amendment. Considering that the financial results have already been put in the public domain, adequate disclosure of the fact and the reason for revision should be made in the financial statements as well as in the audit report. The requirements of the listing agreement should also be followed.
AS 11 vs AS 30
ICAI has issued AS 30, Financial Instruments: Recognition and Measurement5, which is a comprehensive standard that addresses derivatives and most other financial instruments. It deals with a large number of issues, the suggested resolution of some of which would require changes in law and regulations. The standard is recommendatory with effect from financial years commencing on or after 1 April, 2009. However, pursuant to an earlier ICAI announcement of March 20086 some of the companies earlier adopted AS 30 even for the financial year ended 31 March, 2008 (only in relation to areas which are not covered by legal or regulatory requirements, notified accounting standards and other authoritative pronouncements).
Thus, to the extent transactions are covered by AS 11, a company would not be able to adopt the principles of AS 30 till AS 30 is notified accompanied by consequential revision to AS 11.
Implications in an individual case
The implications of the notification are varied. While it has been issued with the intention of providing relief to companies in these challenging economic times, adopting it is not an easy decision. Companies should carefully consider the various aspects of the notification including the fact that this choice once made is irrevocable, before deciding on their course of action. Moreover, each individual case may have certain unique features. Hence, the above analysis is meant primarily to facilitate the understanding of the implications of the notification.