Confusion over exchange fluctuations

Exchange fluctuation is probably the single biggest worry on the minds of most corporates in current times. And why would it not be! The rupee has depreciated more than 20 per cent against the dollar during the period from April 2011 to December 31, 2011. It's not only the depreciation of rupee, but also the volatility of exchange fluctuations that have got most treasury experts worried. Companies are slowly realising that inspite of doing everything right, the exchange rate on the last day of the quarter could play spoilt sport. Many corporates were expecting Santa to bring some Christmas goodies to an otherwise dull year. Santa, played by MCA, always comes at quarter ends or year-ends and this time too brought some completely unexpected goodies.

Corporates were expecting a deferment of one year till March 2013, in the provisions relating to exchange fluctuations but Santa was generous and seemingly deferred these provisions till March 2020! But as is the case with life, only time will tell, whether the goodies brought by Santa are useful or not. There may be euphoria amongst corporates at this announcement, since it apparently appears to postpone the losses and show them as assets! However, corporate should realise that this announcement can actually work against them. Before, we get into that let us understand what these changes are.

The MCA had on March 31, 2009 made an announcement stating that exchange fluctuations in case of long-term foreign currency monetary items, which could otherwise hit the profit and loss account, could be deferred and amortised till March 31, 2011. It also stated that in case of fixed assets, these exchange fluctuations could be added/deducted from the cost of fixed assets. This date of March 31, 2011 was further changed to March 31, 2012 through an announcement made on May 11, 2011.

The current change on December 29, 2011 has been made vide 2 notifications;

- One notification has made changes to paragraph 46 of the Companies (Accounting Standards) Rules 2006 [the “Rules”] whereby the date of March 31, 2012 has been replaced with March 31, 2020.

- The second notification has inserted a new paragraph 46A which covers accounting periods commencing on or after April 1, 2011 and also additionally covers enterprises which had not exercised the option in the earlier notification under paragraph 46 as well as the enterprises covered earlier.

beneficial or not?

Even though these notifications apparently appear to be beneficial to the industry, considering the current situation, but they could do exactly the reverse in the long-term future. What would happen in a situation of the rupee strengthening?

The rupee has significantly depreciated by more than 20 per cent against dollar. In a scenario where the rupee starts strengthening against other currencies, corporates who opt for applying this notification could end up deferring the gains to future periods. Hence, instead of the notification working in their favour, it could work against them. Also, they need to remember that this option is irrevocable.

Doesn't this unnecessarily inflate the net worth of these companies? The regulator's view probably is that in case of long-term foreign currency assets/liabilities, short-term exchange fluctuations distort the P&L account of these companies, since the ultimate settlement exchange rate would be the one prevailing on the settlement date.

Even though this view has merit considering the extent of fluctuation, a better option be to require the unamortised portion to be parked as a deduction/addition to retained earning/accumulated profits. This would ensure that the overall net worth of the corporate is fairly stated. The current provisions tend to artificially increase the net worth, which may not be the intention of the regulator.

Is amortisation a right option or does it further distort the picture? Amortisation as an accounting method is used when the expense/income pertains to multiple periods and generally the amount is constant. In the method proposed by MCA, the amortisation does not have any basis and seems arbitrary just to achieve the objective of deferring losses. As is the case with most announcements, they create more confusion than clarity and this one does not disappoint in that respect.

clarity and misuse

One notification has made changes to paragraph 46 of the Rules and has changed the applicability period to accounting periods “commencing on or after December 7, 2006 to March 31, 2020”. However, the amortisation period remains unchanged at March 31, 2011. This error was there is earlier notification dated May 11, 2011 as well.

Many companies in India have expanded overseas and hence have inter-company transactions in the form of loans or receivables/payables which do not have a defined period and can mutually be agreed to be for any period which the company wishes. Since the losses/gains can be amortised over the period of the assets and liabilities, corporates may be tempted to misuse these provisions to increase/decrease the period of the underlying assets/liabilities so as to achieve a particular result.

Hence, MCA needs to relook at some of the implementation complexities and misuse that could happen and clarify some of these before the December quarter results. On the other hand, corporates need to be very careful in evaluating whether these provisions are really beneficial to them keeping the future in mind. Having said this one question tickling the minds of most CFO's would be (and that too because these provisions are inconsistent with IFRS ) if this means that IFRS would not happen in India for times to come? Would anyone dare to answer!

(The author is Partner in member firm of Ernst & Young Global.)

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