The Hindu Business Line : M to M is more than mood swings

That the Indian corporates are lobbying hard to get Accounting Standard 11, that among other things, mandates marking financial transactions in a foreign currency to market, off their backs given the huge translation losses staring at their face now that the Indian rupee (INR) has fallen steeply vis-À-vis the US dollar, is widely known and criticised. There are mainly two grounds on which the Indian corporates’ contention is lampooned. First, they did not protest when they had in the past enjoyed the upside of the M to M (mark to market) when the rupee did well against the greenback giving a huge treasury profits. And this is just plain duplicity according to the critics. There is considerable merit in this criticism.

Second, M to M is rooted in the age-old concept of conservatism that an accountant wears as a badge of honour. Here the critics have got it wrong. Had M to M been rooted in conservatism, it would not have called for recognition of profits on the notional reduction in liability on foreign currency loans merely on the basis of the strong rupee for the nonce as on March 31 or any other valuation date.

Conservatism does not encourage the notion of premature optimism which underpins M to M, when it calls upon an enterprise to value foreign exchange assets and liabilities on the basis of the closing exchange rate irrespective of it results in translation losses or gains. Conservatism on the contrary is all about premature pessimism alone.

The right and not-so-right

It is one thing for a currency exchange to mark to market a futures contract in a foreign currency on a day-to-day basis and accordingly adjust the margin account of those who have entered into such futures contracts. For example, if a person has bought one unit of INR-$ three month currency future representing $1,000 at Rs 55, he would have been paid Rs 1,000 vide his margin account had the INR depreciated to Rs 56 the next day and would have been charged Rs 2,000 the second day should on this day the INR appreciate to Rs 54.

This is fine because in the futures market, transactions are settled on a day-to-day basis in sync with the underlying principles of M to M. The gains or losses in such a scheme of things are real because should one quit midway through before the expiry of the futures contract, he would have to bear such loss or savour such gain as the case may be.

What is not fine however is to call upon a company to restate its balance sheet on the basis of the notional gain or loss arising due to exchange rate fluctuations on the balance-sheet date. Pray, how would outstanding liability on account of $100 million ECB for 20 years raised when the dollar was Rs 40 get burgeoned from Rs 400 crore to Rs 500 crore merely because on the balance sheet date the rupee had depreciated to Rs 50 a dollar. To be sure, the portion of the ECB that has become due for repayment should be so restated but not the entire loan. It is here that M to M defies logic.

In the same example, if the ECB matures after 20 years for bullet repayment, it would be idle to inflict an additional (albeit notional) liability of Rs 100 crore on the company on the first balance-sheet date after borrowing, with a concomitant matching hole in its income statement, merely because on that date the rupee had slipped by Rs 10 vis-À-vis the dollar with reference to the exchange rate prevailing on the date of raising of ECB.

Marking to market of financial assets and liabilities on the balance-sheet date is thus a manic-depressive tendency.

A manic depressive experiences alternate bouts of high and low spirits. While one can be pardoned for being given to mood swings, financial statements should not be overly sensitive to temporary gyrations in the market.

Instead, they should eschew knee-jerk reactions. A notional heightened liability on account of adverse exchange rate on the balance-sheet date is not even a contingent liability. In the event, it is baffling to find AS-11 and its international counterpart elevating a notional liability to the level of crystallised liability.

Section 43A of the Income-Tax Act, 1961 suffered from the same malaise before it was set right by the Finance Act, 2002 — depreciable assets got embellished by the notional increase in the foreign currency loan liability and got truncated by the notional decrease in such liability on the balance-sheet date.

The Finance Act, 2002 has rightly ordained that such embellishment or truncation should take place only on actual payment of an increased amount or as the case may be on actual reaping of benefits of lesser repayment.

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

Related Stories:
India Inc for easing accounting norms on exchange differences
Accounting norms can do the trick for corporate profitability
CII for change in accounting rules on forex fluctuations

More Stories on : Accounting Standards | Accountancy | Forex

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
India faces growing Chinese hostility after 26/11

M to M is more than mood swings

AS 11: India Inc. vs ICAI

Fluctuating standards

Agriculture hostage to knee-jerk actions

Freedom of speech

Should accounting be driven by economic conditions?

When profits pinch water

Konkan’s development

Judges’ salaries