New accounting norm expected to hit Q4 profits

ICAI asks companies to reveal forex derivative losses.

Corporate profits will come under severe pressure for the fourth quarter ended March 2008 as companies will have to provide for any losses on forex derivative products, owing to a new accounting norm announced on Saturday.

The Institute of Chartered Accountants of India (ICAI) has asked all companies to disclose and/or provide for all losses on derivative contracts, except for forward contracts, where a company needs to comply with accounting standard AS11.

"Q4 results will be disastrous and that will impact the stock markets. Investor concerns could also hamper foreign institutional investor flows," said the CFO of a leading company who spoke on condition of anonymity.

"It is good thing that the truth is coming out but the timing is bad for the market with so much bad news," he added.

Forex consultants estimate that corporate India may be sitting on a Rs 12,000 crore to Rs 20,000 crore loss on its exposure to foreign exchange derivatives.

"Things could get better as people will understand the impact better," said Sanjay Aggarwal, national industries director, financial services, for consultancy firm KPMG. "There was no transparency as the profit or loss a company was making on derivatives was not required to be reported."

So far companies were not required to declare their gains or losses on derivative products; ICAI's new accounting standard AS30 required them to reveal these gains or losses from April 1, 2011, a deadline it has advanced by three years.

The action may now shift to company boardrooms as they try to figure out ways to minimise the impact on their earnings. " The first thing companies would do on Monday is to unwind their profitable trades so that they can offset the losses they have made on other trades," said a foreign exchange consultant.

This is precisely what companies have been doing over the past few weeks, said sources in forex circles. "Companies who will be required to recognise large MTM losses for the March quarter could also consider new derivative contracts to improve effectiveness of their hedging strategy,'' said Aggarwal.

Companies, however, are unsure of certain issues under the new accounting standards. The accounting Standard AS11 does not cover accounting for forward contracts to hedge highly probable, forecast transactions, and these have to be marked to market.

For instance, take an exporter who enters into forward contract for the exports he will make in December 2008. "Now, the objective of this company was not to trade in derivatives but if it has to mark to market the derivative under the new rule, it will result in volatility in earnings," said an expert with a consultancy firm.

"AS30 also allows you an option that if you follow the rules related to 'hedge accounting,' you do not need to take the entire gain or loss to the profit and loss account. Some or a large part of the losses or gains can be parked in the reserves until the time the actual hedged transaction matures," said the consultant.

However, only companies that have adopted AS30 can qualify for hedge accounting. "The directive requires more clarity. What happens to transitional provisioning of AS30, which says that when you are moving to a new accounting standard, you could take your gains/losses to the reserves once," asked an accounting expert.

"It is unclear how they will treat the gains made on derivative trades, and if they can be set off against losses made on other trades," added a consultant.

Also read:

March 30: ICAI asks companies to disclose derivative losses

March 13: Forex derivative losses likely to touch $3-5 bn