Facts of the Case
A foreign currency loan has been obtained by the company for financing Plant & Machinery, a depreciable fixed asset. The principal portion of the said loan is fully secured by entering into twelve forward contracts for the installments payable during the next twelve month cycle and a thirteenth contract for the balance principal amount of loan outstanding. Equal monthly installments towards principal portion are being paid using the respective forward contract rates. At the end of every twelve month cycle the loan is repaid in its entirety at the forward exchange rate. Further on the same day the same amount of foreign currency is received back as a fresh loan / renewal of loan at the spot exchange rate.
Treatment as per my opinion along with relevant provisions
Part I – Calculation of Exchange Gain / Loss (Para 11, 36 & 37 of AS 11)
As per AS – 11, the exchange gain / loss arising at the inception of the forward contract should be amortized over the period of the forward contract. Exchange gain / loss at inception is calculated as the difference between the spot rate as on the date of entering in to the forward contract and the forward rate.
By entering in to a forward contract the quantum of repayment in INR gets fixed and accordingly there is no need to restate the amount of loan payable as on 31st March at the closing spot rate. The amount of loan payable as on 31st March will appear in the balance sheet at an amount worked out using the forward rate.
Further a receivable and a payable in respect of the forward contract is to be created in the books of accounts. The same will be treated as a monetary item under AS – 11 and accordingly will be accounted for using the spot rates. At 31st March they will be restated using the closing rate. However since both, viz. Forward Contract Receivable (Asset) and Forward Contract Payable (Liability) are re stated using the same rates, the exchange rate difference arising on the same will get nullified and thus it will have no impact on the profit & loss account.
Part II – Treatment of Exchange Gain / Loss on principal amount of long term foreign currency borrowings. (Para 13, 46 & 46A of AS 11)
As per Para 13 of AS 11 all the exchange differences should be recognized as an income or expense in the period in which they arise. However there is an option provided as per Para 46 of AS 11 regarding the treatment of exchange gain / loss arising on Long Term Foreign Currency Monetary Items. If the same pertains to acquisition of a depreciable asset then the exchange difference (i.e. profit or loss as the case may be) can be adjusted (i.e. added to or deducted from as the case may be) to the cost of the depreciable asset and then amortized over the remaining life of the depreciable asset. In case the long term monetary item does not pertain to a depreciable asset then the same can be transferred to “Foreign Currency Monetary Item Translation Difference Account” and it is to be amortized over the balance life of the foreign currency monetary item. The said option is at present applicable for the period up to 31st March 2020. It must also be noted that this option once opted for cannot be revoked subsequently and the company is bound to account for all the exchange differences arising on Long Term foreign currency monetary items as per the above option only.
A long-term foreign currency monetary item means an asset or a liability which is expressed in foreign currency and has a term of 12 months or more at the date of origination of the asset or liability.
In the case of company, the above option is being exercised and thereby, in my opinion the treatment of exchange gain / loss shall be as follows.
The amortization of premium / discount pertaining to the year (calculated as per part 1 above) on the forward contract for monthly installment should be accounted for as profit / loss for the year. The monthly installments would be short term in nature as the same have a term of less than 12 months; hence the option to capitalize will not be available.
The amortization of premium / discount pertaining to the year (calculated as per part 1 above) on the forward contract for balance of principal amount (thirteenth contract) should be capitalized in the carrying value of the asset as per Para 46A of AS 11.
The relevant Para of AS – 11 are reproduced in annexure A for reference.
Part III – Treatment of Exchange Gain / Loss under the Income Tax Act (Section 43A of the Income Tax Act)
As per section 43A of the Income Tax Act, 1961 the foreign exchange gain / loss arising at the time of repayment of loan taken for an asset shall be adjusted to the cost / written down value of the asset.
In the case of company, the gain / loss arising at the time of payment of every installment should be adjusted to the carrying amount of the capital asset. The gain / loss shall be calculated as a difference between the forward rate (i.e. the rate at which payment is made) and the spot rate prevailing at the time of taking loan.
Relevant Extract of Section 43A is reproduced in Annexure B for reference.
Annexure A - Relevant Para’s of the Accounting Standard - 11
Para 11(a) – “foreign currency monetary items should be reported using the closing rate. However, in certain circumstances, the closing rate may not reflect with reasonable accuracy the amount in reporting currency that is likely to be realized from, or required to disburse, a foreign currency monetary item at the balance sheet date, e.g., where there are restrictions on remittances or where the closing rate is unrealistic and it is not possible to effect an exchange of currencies at that rate at the balance sheet date. In such circumstances, the relevant monetary item should be reported in the reporting currency at the amount which is likely to be realized from, or required to disburse, such item at the balance sheet date”
Para 13 – “Exchange differences arising on the settlement of monetary items or on reporting an enterprise’s monetary items at rates different from those at which they were initially recorded during the period, or reported in previous financial statements, should be recognised as income or as expenses in the period in which they arise”
Para 36 – “An enterprise may enter into a forward exchange contract or another financial instrument that is in substance a forward exchange contract, which is not intended for trading or speculation purposes, to establish the amount of the reporting currency required or available at the settlement date of a transaction. The premium or discount arising at the inception of such a forward exchange contract should be amortized as expense or income over the life of the contract. Exchange differences on such a contract should be recognized in the statement of profit and loss in the reporting period in which the exchange rates change. Any profit or loss arising on cancellation or renewal of such a forward exchange contract should be recognized as income or as expense for the period.”
Para 37 – “The risks associated with changes in exchange rates may be mitigated by entering into forward exchange contracts. Any premium or discount arising at the inception of a forward exchange contract is accounted for separately from the exchange differences on the forward exchange contract. The premium or discount that arises on entering into the contract is measured by the difference between the exchange rate at the date of the inception of the forward exchange contract and the forward rate specified in the contract. Exchange difference on a forward exchange contract is the difference between (a) the foreign currency amount of the contract translated at the exchange rate at the reporting date, or the settlement date where the transaction is settled during the reporting period, and (b) the same foreign currency amount translated at the latter of the date of inception of the forward exchange contract and the last reporting date”
Para 46 – “In respect of accounting periods commencing on or after 7th December, 2006 and ending on or before 31st March 2011, at the option of the enterprise (such option to be irrevocable and to be exercised retrospectively for such accounting period, from the date this transitional provision comes into force or the first date on which the concerned foreign currency monetary item is acquired, whichever is later, and applied to all such foreign currency monetary items), exchange differences arising on reporting of long-term foreign currency monetary items at rates different from those at which they were initially recorded during the period, or reported in previous financial statements, in so far as they relate to the acquisition of a depreciable capital asset, can be added to or deducted from the cost of the asset and shall be depreciated over the balance life of the asset, and in other cases, can be accumulated in a “Foreign Currency Monetary Item Translation Difference Account” in the enterprise’s financial statements and amortized over the balance period of such long-term asset/ liability but not beyond 31st March, 2020, by recognition as income or expense in each of such periods, with the exception of exchange differences dealt with in accordance with paragraph 15 (Deals with Non – Integral Foreign Operations). For the purposes of exercise of this option, an asset or liability shall be designated as a long-term foreign currency monetary item, if the asset or liability is expressed in a foreign currency and has a term of 12 months or more at the date of origination of the asset or liability. Any difference pertaining to accounting periods which commenced on or after 7th December, 2006, previously recognized in the profit and loss account before the exercise of the option shall be reversed in so far as it relates to the acquisition of a depreciable capital asset by addition or deduction from the cost of the asset and in other cases by transfer to “Foreign Currency Monetary Item Translation Difference Account” in both cases, by debit or credit, as the case may be, to the general reserve. If the option stated in this paragraph is exercised, disclosure shall be made of the fact of such exercise of such option and of the amount remaining to be amortized in the financial statements of the period in which such option is exercised and in every subsequent period so long as any exchange difference remains unamortized.”
Para 46A – “(1) In respect of accounting periods commencing on or after the 1st April, 2011, for an enterprise which had earlier exercised the option under paragraph 46 and at the option of any other enterprise (such option to be irrevocable and to be applied to all such foreign currency monetary items), the exchange differences arising on reporting of long term foreign currency monetary items at rates different from those at which they were initially recorded during the period, or reported in previous financial statements, in so far as they relate to the acquisition of a depreciable capital asset, can be added to or deducted from the cost of the asset and shall be depreciated over the balance life of the asset, and in other cases, can be accumulated in a ‘‘Foreign Currency Monetary Item Translation Difference Account” in the enterprise’s financial statements and amortized over the balance period of such long term asset or liability, by recognition as income or expense in each of such periods, with the exception of exchange differences dealt with in accordance with the provisions of paragraph 15 of the said rules.
(2) To exercise the option referred to in sub-paragraph (1), an asset or liability shall be designated as a long-term foreign currency monetary item, if the asset or liability is expressed in a foreign currency and has a term of twelve months or more at the date of origination of the asset or the liability: Provided that the option exercised by the enterprise shall disclose the fact of such option and of the amount remaining to be amortized in the financial statements of the period in which such option is exercised and in every subsequent period so long as any exchange difference remains unamortized.”
Annexure B - Relevant Extract of the Section 43A of Income Tax Act, 1961
“Notwithstanding anything contained in any other provision of this Act, where an assessee has acquired any asset in any previous year from a country outside India for the purposes of his business or profession and, in consequence of a change in the rate of exchange during any previous year after the acquisition of such asset, there is an increase or reduction in the liability of the assessee as expressed in Indian currency (as compared to the liability existing at the time of acquisition of the asset) at the time of making payment—
(a) Towards the whole or a part of the cost of the asset; or
(b) Towards repayment of the whole or a part of the moneys borrowed by him from any person, directly or indirectly, in any foreign currency specifically for the purpose of acquiring the asset along with interest, if any,
The amount by which the liability as aforesaid is so increased or reduced during such previous year and which is taken into account at the time of making the payment, irrespective of the method of accounting adopted by the assessee, shall be added to, or, as the case may be, deducted from—
(i) The actual cost of the asset as defined in clause (1) of section 43; or
(ii) The amount of expenditure of a capital nature referred to in clause (iv) of sub-section (1) of section 35; or
(iii) The amount of expenditure of a capital nature referred to in section 35A; or
(iv) The amount of expenditure of a capital nature referred to in clause (ix) of sub-section (1) of section 36; or
(v) The cost of acquisition of a capital asset (not being a capital asset referred to in section 50) for the purposes of section 48,
And the amount arrived at after such addition or deduction shall be taken to be the actual cost of the asset or the amount of expenditure of a capital nature or, as the case may be, the cost of acquisition of the capital asset as aforesaid.”
Please Note that the above is based completely on my personal opinion. Alternative views are welcome and appreciated.
Thanks & Regards
CA Yash Goyal
CAclubindia
