In view of the significant depreciation of the Rupee against the US dollar, the Ministry of Corporate Affairs (MCA) issued various notifications to amend Accounting Standard (AS) 11, ‘The Effects Of Changes In Foreign Exchange Rates’, and provide relief to companies that had raised long-term foreign currency borrowings. These amendments provided companies with an irrevocable option to capitalise foreign exchange differences arising on all long-term borrowings either as an adjustment to the cost of a related depreciable asset, or by accumulating these differences in a Foreign Currency Monetary Item Translation Difference Account (FCMITDA), if the borrowing did not relate to a depreciable asset. The balance in FCMITDA would be subsequently amortised in the profit and loss account over the life of the borrowing. Several companies elected to apply this alternative treatment and, did not immediately recognise foreign exchange losses on their long-term foreign currency borrowings in their earnings.

While these notifications provided companies relief, the capitalisation benefit was not available in respect of some foreign exchange differences covered by paragraph 4(e) of AS 16, Borrowing Costs. Paragraph 4(e) covers exchange differences on the principal amount of foreign currency borrowings, to the extent of the difference between interest rates on local currency borrowings, and foreign currency borrowings. This component of foreign exchange differences is considered to be in the nature of borrowing costs under AS 16.

For example: If the total exchange difference during a year is 8 per cent, the local currency borrowing rate is 12 per cent, and the foreign currency borrowing rate is 7 per cent — 5 per cent of the exchange difference (12 per cent minus 7per cent) is treated as borrowing costs and generally expensed through the profit and loss account. Only 3 per cent (8 per cent minus 5) is eligible for the capitalisation benefit under the MCA circulars.

MCA clarification

On August 9, 2012, the MCA issued a clarification that paragraph 4(e) of AS 16 shall not apply to companies that have chosen an accounting policy to capitalise or defer exchange differences per the previous circulars. As a result, such companies will now be permitted to fully capitalise such foreign exchange differences without separation of the borrowing cost element under paragraph 4(e) of AS 16. The clarification is expected to result in an improvement in reported profits of impacted companies.

Effective date

The August 9 clarification does not specify any transitional provisions. Accordingly, it is possible that varied practices may emerge in this area. Some companies may take a view that the change represents an amendment to the accounting requirements, and should be applied prospectively. Others may think that since the MCA circular is in the nature of a ‘clarification’, the revised requirement should be applied retrospectively for all past periods.

Applicability

The clarification explicitly refers only to companies that have capitalised foreign exchange differences under paragraph 46A of AS11. While paragraph 46A was introduced in December 2011, and was applicable from the financial year commencing April 1, there are several companies that capitalise on exchange differences under an earlier notification (paragraph 46), which was effective from December 7, 2006. It is unclear whether the benefit relating to the exemption from separating the borrowing cost element will also be available to such companies that are following paragraph 46. It is possible that certain companies may elect to transition from paragraph 46 to paragraph 46A to seek the benefit of the new exemption. Further, it is possible that companies that had previously not elected to seek the benefits under paragraph 46 or 46A, because a substantial portion of the exchange differences were being treated as borrowing costs not eligible for the benefits, may now elect to follow paragraph 46A and get the benefits of capitalisation or deferral.

Conclusion

Foreign exchange accounting has been an area of significant debate in recent times due to the volatility in the Rupee – US dollar exchange rate. The current clarification represents the latest in a series of measures that the MCA has taken to provide relief to companies that have experienced substantial volatility in earnings due to the fluctuating exchange rates. While interpretation issues remain and accounting practices will evolve over time, it is expected that most companies will benefit in terms of reduced volatility in their reported profits. To ensure consistency, the MCA should consider providing implementation guidance, which may be considered by companies as they apply the new provisions in their financial statements for the quarter ending September 30.

Koosai Lehery and Kavita Gunderia contributed to the article.

Jamil Khatri is Global Head of Accounting Advisory Services, KPMG in India

Related Topics
comment COMMENT NOW