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M. R. Rajaram

After a much debate, the method of accounting of forex exposure and derivative contracts has taken a final shape. The apparent inconsistency between Schedule VI of the Companies Act and the accounting standard requirements has also been set right, with the Department of Company Affairs issuing a clarification. The Government has reiterated the need for companies to comply with the requirements of the accounting standard. It is a different matter that Government could bring in finality on this matter by amending the Schedule VI instead of issuing press releases and statements.

Until the last quarter, there were three different types of accounting of profit/loss on account of outstanding foreign loans raised for funding expansion. A few companies were capitalising the profit/loss on the back of Schedule VI requirement. A few other companies based in the South were not reflecting the profit/loss in the quarterly results by giving a note to the effect that the same will be reflected in the year-end.

Most of the companies followed the accounting standard, by reflecting the profit/loss in the quarterly results. Hopefully, in this quarter’s results one should see uniform treatment by all companies, reflecting the profit/loss in the quarter’s result.

Most corporate loans are denominated in dollars, and the rupee has depreciated against the dollar by about 9 per cent in the September quarter alone. As a result, a large number of companies may report losses as was seen in the case Jubilant Organosys Ltd and Biocon Ltd.

The immediate and natural reaction to such reported losses is one of disappointment. But investors should do a proper analysis before jumping to any conclusion. First, examine the cause for the losses reported in the accounts. If they emanate from some exotic or speculative derivative contracts, there is a strong reason to get worried. However, if the loss is on account of future obligations relating to loan raised for funding the expansion, it warrants further examination before reaching a conclusion.

In this context, it is important to understand the spirit of the accounting standard requirements. In line with prudence, which is the rock bed for accounting, it is fair that the accounting standard demands provision for a possible loss. But from a business point of view, it is important to understand the rationale, if any, for the risk taken by the company and the overall situation in which such a risk is taken.

Today, many companies plan expansion for servicing not only the domestic market but also the global market. When reasonable share of volume comes from export, one of the attractive sources of finance for such projects is foreign currency loans. In such a situation, forex loan becomes attractive not only because of lower cost overall but also because it provides a natural hedge against forex exposure from export.

In this backdrop, one gets a natural hedge against forex exposure from export only if one doesn’t take cover against the obligations for interest as well as for repayment of the forex loan. Such a position is logical and economically correct.

However under the current accounting standard requirements, such companies will be forced to report losses in this quarter on this account. But on an overall basis, the weakening of rupee in most cases will be financially beneficial to the company as the loss on account of the forex loan will be more than off set by higher realisation from exports.

But the higher realisation from export will be reflected in the accounts over a period of time, more than offsetting the forex loss required to be reported earlier. In fact, the profitability of such companies should improve though they are required to report loss for the quarter on this account.

The accounting requirement for reporting the loss is based on the conservative principle of reflecting the potential loss from loan but not necessarily reflecting the business scenario. Hence it is important for the investors to properly understand the underlying reasons for the forex losses likely to be seen in the corporate results for the September quarter.

More Stories on : Accounting Standards | Forex

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