Accounting treatment of External Commercial Borrowings

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Pushpendra Kushwaha (Querist)

07 March 2024 If a Foreign Subsidiary Company takes External Commercial Borrowings (ECBs) from its Holding Company at a lower interest rate compared to the prevailing industry rate. In this scenario:
1. Is this considered a compound financial instrument, requiring accounting treatment as per Ind AS 109?
2. If so, what benchmark rate should be used for valuation, especially when a comparable rate is unavailable?
Further clarification:
a) The company has prepared its financial statements in accordance with Ind AS for the first time (First-time Adoption of IND AS).
b) The company has been in a loss-making position for the last 10-11 years. Therefore, the company is not in a position or eligible to take any borrowings from banks, financial institutions, or other non-related parties. So, what comparable rate should be used if Ind AS 109 is to be applied?

If any professionals or individuals have expertise or experience in handling this particular situation, please provide insights in the comments section below.

Aashok Kumar Sharma online

Aashok Kumar Sharma

(Expert)

06 July 2024 In the scenario described, where a foreign subsidiary company takes External Commercial Borrowings (ECBs) from its Holding Company at a lower interest rate compared to prevailing industry rates, here are the considerations regarding accounting treatment under Ind AS 109:

1. **Compound Financial Instrument Consideration**:
- **Ind AS 109**: According to Ind AS 109, a compound financial instrument consists of both a liability and an equity component. In your case, if the borrowing has characteristics of both debt and equity, it could potentially be considered a compound financial instrument.
- **Evaluation**: Whether the borrowing qualifies as a compound financial instrument would depend on its specific terms and conditions, including any options or conversion features that could affect its classification.

2. **Benchmark Rate for Valuation**:
- **Comparable Rate**: Ind AS 109 requires entities to use a market rate of interest for valuation purposes if one is available. This rate should reflect the interest rate at which similar instruments would be issued under current market conditions, taking into account the creditworthiness of the borrower.
- **Specific Situation**: Given that the subsidiary company is not eligible to borrow from external parties due to its loss-making status, finding a comparable rate from external borrowings might be challenging.

3. **Practical Approach**:
- **Internal Rate**: If a comparable external rate isn't available due to the company's unique circumstances, one approach could be to use an internal rate that reasonably reflects the company's borrowing cost if it had borrowed externally.
- **Documentation**: It's important to document the rationale behind the chosen rate and demonstrate that it reflects a reasonable estimate of what the borrowing cost would have been in the absence of the related party arrangement.

4. **First-time Adoption of Ind AS (Ind AS 101)**:
- When preparing financial statements for the first time under Ind AS, ensure compliance with Ind AS 101 requirements, including the necessary reconciliations and disclosures from previous GAAP (like Indian GAAP) to Ind AS.

5. **Audit and Professional Judgment**:
- Given the complexity and the need for judgment in applying Ind AS 109, it's advisable to consult with auditors or accounting professionals experienced in Ind AS implementation. They can provide specific guidance tailored to your company's circumstances and ensure compliance with applicable accounting standards.

In conclusion, while the subsidiary company's unique financial position may present challenges in finding a comparable market rate, applying Ind AS 109 principles requires careful consideration and documentation of the chosen valuation approach, especially in the absence of external benchmarks.

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