Indian accounting practice for accounting for exchange differences arising from changes in foreign exchange rates differs from that stipulated in IFRS and adopted by Indian standard setters while formulating AS-11, The Effect of Changes in Foreign Exchange Rates. Exchange difference arises due to change in exchange rates. For example, a company borrowed US $ 1,000 to purchase equipment when the exchange rate was $1 = Rs 50. The loan and the asset were recorded at Rs 50,000. On the reporting date (March 31, 2012) the exchange rate is $1 = Rs 55. The loan is reported at Rs 55,000 resulting in an exchange difference of Rs 5,000 for the year 2011-12.If at the settlement date in 2012-13 the exchange rate is $1 = Rs 56, exchange difference of Rs 1,000 arises for the year 2012-13. As per AS-11 theexchange differences of Rs 5,000 should be recognised as an expensefor the year 2011-12 and Rs 1,000 should be recognised as an expensefor the year 2012-13. The government through various notifications has suspended the mandatory application of this rule up to March 31, 2020 so far it applies to the accounting for exchange differences related to a long term (more than 12 months at the date of origination) asset or liability.
Government notifications give an option to Indian companies to choose an alternative accounting policy, which, till recently, was acceptable globally. A company may choose to adjust the exchange difference to the cost of the depreciable asset if the liability relates to the asset. In effect, the exchange difference is amortised over the remaining useful life of the assets as a part of depreciation. In case of any other long-term assets or liability, the exchange difference is accumulated under ‘Foreign Currency Monetary Item Translation Difference Account’ and is amortised over the balance period of such long-term asset/liability. The choice is irrevocable.
According to this principle, the exchange differences of Rs 5,000 and Rs 1,000, in our example, should be added to the cost of asset and should be depreciated over the balance useful life of the asset.
The government issued a notification on August 9, 2012 clarifying that when a company chooses the amortisation/ depreciation principle, paragraph 4 (e) of AS-16, Borrowing Costs, will not apply. Paragraph 4 (e) of AS-16 stipulates that the borrowing cost includes exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs. The principle is same as that stipulated in IFRS. Application of this principle results in allocation of a part of the exchange difference to borrowing cost. Accordingly, a part (say Rs 2,000) of Rs 5000, in our example,is to be allocated to borrowing cost. AS-16 requires companies to add the borrowing costs that are directly attributable to the acquisition of a fixed asset to the cost of the asset and to recognise all other borrowing cost as an expense.
However, no borrowing cost should be capitalised after the construction of the asset is substantially complete. If we assume that the equipment, in our example, was acquired from outside, application of the principle of AS-16 results in charging Rs 2,000 of the totalRs 5,000 to the profit and loss account as expense. The government clarification implies that the principle of AS-16 will not be applicable and the total exchange difference of Rs 5,000 will be added to the cost of the asset.
Some may view that the amortisation/depreciation method is an income-smoothing trick. But there is a strong argument to support the accounting practice.
Exchange rates vary both ways. It might be favourable in one period while unfavourable in another period. Therefore, income and expense arising from exchange difference relating to long-term assets and liabilities might set off against each other over a long period. Therefore, it might not be inappropriate to adjust the profit/loss for a period for the exchange differences arising during that period.
Most Indian companies, particularly those that issued Foreign Currency Convertible Bonds (FCCB) when INR was strong against US $, choose to use the option given by government on the face of significant weakening rupee against dollar and other foreign currencies.This could protect them from taking a huge hit on the profit/loss due to exchange differences.
The government initiative demonstrates that under certain situations applicability of IFRS might not provide the desirable outcome. Most governments would like to reserve the right to frame accounting rules that is appropriate in a particular situation prevailing in the country.
The author is Chairman, Riverside Management Academy. Email: asish.bhattacharyya@gmail.com
