There has been quite a flip-flop on the accounting of foreign exchange differences. Exchange losses/gains arising out of rate changes is dealt with in AS-11. Initially, all exchange gains and losses had to be recognised in the profit-and-loss account. As this left a significant dent following losses on a weakening rupee, industry wanted an option to defer/capitalise exchange differences. Accordingly, AS-11 was amended by introducing paragraph 46, and companies did not need to recognise exchange differences immediately for accounting periods commencing on or after December 7, 2006.

With this option, if the long-term foreign currency monetary item was related to the acquisition of a depreciable capital asset, the exchange differences should be added to or deducted from the cost of the asset and depreciated over its lifetime. If related to an acquisition other than a depreciable capital asset, the exchange differences should be accumulated in the “Foreign Currency Monetary Item Translation Difference Account” and amortised over the life of the monetary item. Though at first this benefit was allowed up to March 31, 2011, paragraph 46 was amended twice to extend it up to 2020, and a new paragraph — 46A — was added without any sunset date.

During these amendments the standard setter seems to have overlooked paragraph 4(e) of AS-16 Borrowing Costs, which substantially reduces the intended relief under paragraph 46/ 46A by stipulating that “exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs”.

Indian companies borrow in dollars at a much lower interest rate compared to rupee loans. However, due to exchange rate movement, the dollar loan liability increases and erodes the savings on interest rates. In a stable world in which the Interest Rate Parity theory worked perfectly, there would be 100 per cent offset. In other words, it is logical to see exchange difference as an interest cost.

The CA Institute clarified that the 4(e) component within the exchange difference should not be amortised/ capitalised (except when incurred for constructing a qualifying asset). As the 4(e) component comprised a substantial part of the exchange loss, industry again made a representation for amortising/ capitalising all exchange differences including the 4(e) component. The Ministry of Corporate Affairs issued a circular this August, clarifying that all exchange differences including the 4(e) component can be amortised/ capitalised.

The drafting of the circular raises numerous questions. First, the withdrawal of 4(e) seems restricted to paragraph 46A, and not 46. When notifying paragraph 46A, the Ministry apparently intended it to cover all companies opting for deferral/ capitalisation of exchange differences, so that paragraph 46 will become redundant. This seems to explain why its circular deals only with paragraph 46A. In keeping with this, companies should switch to 46A in order to benefit from amortising/ capitalising the 4(e) component.

Secondly, it is not clear whether the circular has a retrospective or prospective effect. However, its wording suggests the Ministry sees it as a clarification (though this is highly contentious as, in reality, it is a substantive amendment). Hence, one could argue that this circular becomes applicable from the date on which paragraph 46A became applicable — that is , accounting periods beginning on or after April 1, 2011. However, if companies have already finalised financial statements for the year ended March 31, 2012, they may either apply the circular retrospectively from April 1, 2011 or prospectively from April 1, 2012. As the benefit to amortise/ capitalise is available only for companies following 46A, it may be inappropriate to retrospectively seek 4(e) relief from the date paragraph 46 became applicable — that is, accounting periods commencing on or after December 7, 2006.

Due to the conflicting standards and interpretations, coupled with ambiguous drafting, there should be appropriate disclosures in financial statements to provide greater clarity on how these issues have been dealt with.

Dolphy D’Souza is Partner and National Leader, IFRS services in a member firm of Ernst & Young Global

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