A Spanish proverb goes: “Debts are like children- the smaller they are, the more noise they will make”. Companies with Foreign currency convertible borrowings (FCCBs) are slowly realising that these debts are creating enough noise, irrespective of size. By definition, FCCBs are denominated in foreign currency and the meteoric rise in the greenback vis-a-vis the rupee has added to the commotion.

FCCBs were like magic to many entities since the instruments permitted them to borrow without having to worry about servicing the debt as the repayment was after more than half a decade. The downward trend in the bourses has ensured that stock prices are not tempting enough for the lenders to consider converting into equity.

FALLING POPULARITY

In essence, FCCBs are loans with options for either bullet repayments at a premium or conversion into equity. Though FCCBs as instruments have faded in popularity falling by 46 per cent in 2011 as compared to the previous year, the twin blows of a stubborn dollar and a sentimental market have increased the amount due for repayment. Back-of-the-envelope calculations estimate that the amount due for repayment in 2012 alone can be in excess of Rs 52,000 crore.

Accounting standards for FCCBs have helped mute the noise a bit. While the FCCB appears as a borrowing on the balance sheet, the premium payable on redemption stays off it.

This is because India has implemented neither the International Financial Reporting Standards (IFRS) nor the Indian accounting standards on financial instruments. IFRS standards permit remeasurement of the conversion option only if the option represents an obligation to issue a fixed number of shares for cash which is also fixed.

Exchange rate fluctuations ensure that the remeasurement option is not possible under IFRS. Consequently, the conversion option is considered to be a liability and any fluctuations therein visit the profit and loss account. In addition, IAS 21 on foreign exchange differences ensures that the liability does not remain static on the balance sheet but is remeasured every year through the profit and loss account. Any redemption premium or otherwise on the liability component is deemed to be a part of the liability and is amortised over the period of the bond. When the D-day for conversion or redemption arrives, the entity has two options.

It will either transfer the carrying amount of the liability and the fair value of the option to equity or extinguish the liability on redemption. If the entity finds itself cash-rich prior to the D-day and wishes to extinguish the liability, the consideration paid is compared to the carrying value of the liability and the fair value of the conversion option. Any resultant differences hit the profit and loss account.

IFRS standards have this housewife philosophy of providing for a stormy day every year even if the event is much later, the only requirements are that the event has to be certain and can be measured reliably. Decommissioning costs payable after decades is a typical example.

REDEMPTION OF FCCB'S

Punj Lloyd's zero-coupon $125-million FCCBs, issued in FY-07, were due for repayment in 2011. While 60 per cent of the bonds were converted into equity by shareholders earlier, the balance was repaid by the company as the low market price may have made conversion unattractive. Following good accounting practices, Punj Lloyd's redemption did not appear too difficult as the company has been providing for premium on redemption in its balance sheet. Besides, its cash balance was sufficient to redeem the remaining 40 per cent of FCCBs. However, not all companies can be in the position that Punj Llyod was.

MANDATING STANDARDS

The Institute of Chartered Accountants of India (ICAI) drafted the accounting standards on financial instruments in 2007. These standards have not deviated substantially from IFRS Standards. However, the date of implementation of these standards remains in limbo with the 2011 deadline having been given the go-by. The recent decision to permit capitalising forex losses till a distant 2020 reflects a softening of the stand to enforce accounting standards that could be initially harsh on the financial statements. However, as the FCCB imbroglio shows, they at least mirror facts as they are. It is necessary that the ICAI mandates its trilogy of accounting standards on financial instruments at the earliest and the MCA does the same for the IFRS equivalents.

(The author is a Bangalore-based chartered accountant.)

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