The Hindu Business Line : An arrangement of convenience?

The recent relaxation on partial applicability of ‘Accounting Standard 11, The Effects of Changes in Foreign Exchange Rates - Revised 2003’ (AS-11 Revised) by the Ministry of Corporate Affairs (MCA) on March 31, 2009, has evoked a mixed response from the accounting and corporate world.

Owing to the palpable demand destruction across sectors in a near-recessionary economic scenario, further aided by the re-statement losses on dollar-denominated borrowings against the weakening rupee, earnings of many Indian companies have largely remained muted in the last two quarters. Whether the recent amendment would assuage the sentiments of companies and investors alike, in an otherwise cold world of numbers, remains to be seen.

Looking back

The genesis of AS-11 Revised can be traced to the erstwhile ‘Accounting Standard 11, Accounting for the Effects of Changes in Foreign Exchange Rates’ (erstwhile AS-11) issued by the Institute of Chartered Accountants of India (ICAI) in 1994. The erstwhile AS-11 initiated the treatment of transactions in foreign currencies, including translations of financial statements of foreign branches of an entity. Nevertheless, Schedule VI to the Indian Companies Act, 1956 (Companies Act) could be adopted for the capitalisation of exchange differences on overseas liabilities against purchase of fixed assets.

AS-11 Revised was a nip to the earlier provisions and was issued in line with ‘IAS 21, The Effects of Changes in Foreign Exchange Rates’, to harmonise Indian Generally Accepted Accounting Principles (IGAAP) with International Financial Reporting Standards (IFRS). It stipulated the charge-off of all exchange differences; however, the treatment under Schedule VI would be within IGAAP framework. With the release of the ‘Companies (Accounting Standards) Rules, 2006’ (2006 Rules), Section 211 of the Companies Act mandated the compliance of the accounting standards issued by the ICAI; thereby supervening Schedule VI treatment of exchange differences for accounting periods commencing on or after December 7, 2006.

However, many large corporate entities continued Schedule VI provisions and, in the process, defeated 2006 Rules by obtaining a legal opinion. To further vindicate the accounting convenience, Companies (Accounting Standards) Rules, 2009 (2009 amendment) was issued on March 31, 2009.

The 2009 amendment

This amendment is optional and non-reversible; hence, enterprises may continue to adopt earlier accounting policies.

Provisions are to be exercised on a retrospective basis from December 7, 2006, or the first date on which the asset/liability is acquired, whichever is later;

Applicable only to long-term foreign currency monetary items and not applicable for short-term, non-monetary or both short-term and non-monetary items.

Exchange differences should be accumulated and amortised over the period of the long-term foreign currency monetary items or the life of the depreciable assets but not permissible beyond March 31, 2011.

Disclosures shall be made in financial statements of such exercise and amounts remaining un-amortised for every subsequent period.

The amendment poses many accounting conundrums. To begin with, there appears a dilution of the proposed roadmap of IFRS adoption by the ICAI from April 2011. Further, the 2009 amendment is not applicable to non-corporate entities which have been the real losers due to restatement losses of dollar-denominated borrowings.

Restatement of cash and cash equivalents such as EEFC accounts will not be covered by this amendment, as they are foreign currency monetary items but not long-term assets. Moreover, selective application of the treatment is not possible and requires adoption across all long-term foreign currency monetary items.

(The authors are Chennai-based chartered accountants.)

The old rule of non-addition or deduction of exchange differences on acquisition of land holds good being non-depreciable assets. The amendment also seeks to adjust the general reserve which is a clear distinction from the normal transitional provisions of other accounting standards where adjustments to revenue reserves are stipulated; therefore, entities may end up having debit balances if there is no general reserve. How tax implications would unfold also remains to be seen.

Derivate instruments

Regarding derivative instruments, the 2009 amendment seeks to postpone the recognition of income/expenses and hence, in respect of a hedge, there will be a one-side impact on the financial statements. Though a hedge may be a short-term derivative product, mark-to-market restatement will not offset the exchange differences on the underlying to the full extent. Derivative instruments being non-monetary items are not covered in this amendment.

On the disclosures' front, if the amounts remaining to be amortised are net income, then there is leeway for non-disclosure since `income' is never `amortised'. Further, disclosing `Foreign Currency Monetary Item Translation Difference Account' as a separate item and grouping under reserves, as a liability or an asset in the financial statements needs clarity. The restatement performed at each balance-sheet date is required to be captured separately. The restatement should be captured year-wise at the end of each accounting period separately and push the same into the income statement based on the balance life of the asset/liability.

Albeit there may be possibilities of amortising exchange differences accumulated on depreciable capital asset beyond March 31, 2011, where the life of the depreciable asset extends that date, this treatment would not be applicable for a long term monetary item other than depreciable capital assets.

The changing of an accounting policy is warranted by adoption of another accounting policy, and currently, it is difficult to categorise the 2009 amendment as either required by statute or for compliance with accounting standards or appropriate financial presentations.

The 2009 amendment to the AS-11 Revised provisions, though provide salutary effects to earnings of entities in the short-term, contain numerous challenges than seeking alleviation of IFRS and IGAAP differences. As a prerequisite of adoption of IFRS require explicit and unreserved compliance to standards by SEC-listed companies, it would be a welcome sign to bring such rigid adoption of standards by preparers of accounts and not convert norms into mere arrangement of convenience.

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Who will gain from AS-11 change?
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Accounting norms can do the trick for corporate profitability
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