WHo ll be benefitted from AS 11 Change

Hi friends refer this extract from THE HINDU- BUSINESS LINE todays issue..Hope it ll be informative for you all...

Who will gain from AS-11 change?

Whether the amendment will prop up earnings from this quarter or not would depend on the accounting practice it has followed so far and the nature of foreign exchange transactions.

What is AS-11 and how did it impact profits?

AS-11 required all foreign currency monetary transactions of companies to be reported based on the closing exchange rate at the end of an accounting period. The gain/loss arising on this restatement (due to exchange rate changes between the date of transaction and the end of that quarter) had to be charged to the profit and loss account, as an income/expense. The impact of AS-11 was most keenly felt on borrowings made in foreign currencies and on mark-to-market differences from treasury positions held by companies. These had to be restated at the end of every quarter, thereby booking notional profits/losses. In 2007, for instance, when the rupee was strengthening against the dollar, companies made handsome gains from the profits made on forex translation.

However in 2008, when the tide turned against the rupee, companies had to charge hefty amounts as notional losses on their foreign currency loans/FCCBs, as the size of the obligation expanded in rupee terms. The impact was quite sharp for some companies.

For instance, net forex losses took away 73 per cent of the operational profits of JSW Steel for the December 2008 quarter. The company ended the quarter with a net loss. Similarly, Mahindra & Mahindra and Tata Motors too incurred huge notional exchange losses.

The currency fluctuation, therefore, added to the woes of corporates whose profits had already taken a hit from slower sales and higher interest costs. The amendment to AS-11 must be viewed against this backdrop.

What does this amendment to AS-11 seek to do?

Under the amended version, if a foreign currency borrowing relates to a depreciable capital asset, then translation differences from the loan may be capitalised to the asset, instead of charging to the profit and loss account. This means that forex gains or losses on these borrowings will bypass the P&L account to be directly added to or deducted from the cost of an asset as carried in the balance sheet.

In the case of JSW Steel, if the company’s foreign borrowings were against specific assets, the forex loss of Rs 177 crore incurred in the December quarter would not be charged to profits under the amended AS-11. It would, instead, be added to the value of its fixed assets and depreciated over its life. In other words, the profits would be higher by this amount as a result of not charging the loss to revenues. Note that it would be the exact reverse if the company had recorded forex-related gains, instead of losses.

When a company has ‘other’ foreign currency borrowings, that cannot be directly attributed to an asset (say, for general expenses or working capital requirements) or has other foreign currency outstanding, which is over 12 months old (from its date of origination), then the translation difference shall be charged to a special translation difference reserve that will be created. This amount shall be spread out and amortised before March 31, 2011 or the period of the borrowing, whichever is earlier. For JSW Steel, had the borrowing been for other than ‘capital asset’ related purposes, then if the company follows this amendment, it need not fully charge the losses to its profit and loss account. It can, instead, create a separate translation reserve and spread out (amortise) the same over the loan period or before March 31, 2011, whichever is earlier.

Impact: In a nutshell, the assets/liabilities and the net worth of the company would absorb the effect of the currency volatility. The per share earnings would be free of any immediate impact from the same. Large forex differences on borrowings would not make an appearance in the quarterly numbers.

When will this amendment take effect?

This amendment is applicable retrospectively for accounting periods starting December 7, 2006 and should be enforced from the March 2009 quarter onwards. This means that companies which opt for this changed standard have to adjust (in this quarter) the forex fluctuations they recorded in earlier periods.

As an investor, you will not, however, be able to view the effect of retrospective changes in the March quarter earnings as they would be effected directly in the general reserve/respective fixed assets, bypassing the P&L statement.

Impact: The back-dated effect would call for companies to adjust both the forex profits and losses recorded in earlier quarters in their general reserve now.

For instance, Subex or Jain irrigation Systems, if they opt for this change, would have to adjust their general reserve for forex gains on FCCBs recorded in their P&L in 2007, as well as the losses accounted in 2008.

Are companies under obligation to adopt this change introduced?

Companies (to which this standard is applicable) have a choice to either adopt this changed standard or stick to the old one. However, if they intend to adopt it, companies will have to do so from the March quarter and continue to follow it up to the deadline of 2011. They cannot opt for it at a later stage.

Will this change provide relief for all companies that have forex losses in their quarterly numbers?

No, it will benefit only some. Whether the amendment will prop up a company’s earnings from this quarter or not would depend on the following: One, the accounting practice so far followed by it and, two, the nature of foreign exchange transactions.

Accounting practice followed : Take the examples of Reliance Industries, Hindustan Construction and Reliance Communications. These companies have not so far followed AS-11 to report their forex fluctuations. They instead chose to follow Schedule VI of the Companies Act, when the foreign borrowings were utilised for acquiring fixed assets.

Here’s what they did: Schedule VI requires fluctuations in foreign currency loans to be capitalised against the respective fixed assets while AS-11 so far required the same to be charged to the P&L. These companies followed Schedule VI and directly adjusted the currency differences in the balance sheet instead of depressing/inflating the earnings. (The same was highlighted in the company’s ‘notes to accounts’ and it was left to auditors to take cognisance of the difference in practice).

This practice has now become acceptable with the amendments to AS-11. As these companies have already been capitalising the forex changes, they may not reap any benefits if they choose to take ‘the old wine in a new bottle’.

However, for general purpose foreign loans, if any, taken by these companies, there may yet be some relief by way of creating a translation reserve instead of a charge against profits.

Nature of forex losses: Not all forex transactions would attract this relief. The AS-11 amendment will not provide any respite for companies incurring MTM losses on their hedging or other derivative transactions.

Mindtree and Ranbaxy Labs, for instance, incurred heavy mark-to-market losses in the December quarter as a result of hedging their revenues arising in foreign currencies as well as treasury operations. However, they chose to adopt AS-30 — a recent Standard that talks about accounting for financial instruments used for hedging cash flows.

Mindtree, for example, created a hedging reserve to deal with forex differences arising from its hedging activity. However, the company also incurred forex translation differences in transactions that were not strictly hedging in nature and more of treasury operations.

The company expensed the same in its P&L. In other words, as the exchange losses of Mindtree or Ranbaxy are not from foreign loans so far, the amended AS-11 will not apply to these companies.