AS 11 will prevent forex-led distortions

Posted on    22 May 2009

A clarification regarding tax treatment of the accounting option is warranted

Author : Suresh Surana/DNA

India has been growing by 8-9% for the past few years and this outstanding growth has resulted in heavy inflow of foreign funds to the country. Many companies have used foreign currency borrowings through external commercial borrowings (ECBs) and foreign currency convertible bonds (FCCBs) etc for their massive expansion plans. These borrowings were considered to be highly cost-effective due to low interest rates abroad, strengthening value of rupee and, in case of instruments like FCCBs, increasing share prices.

However, following the global financial meltdown, the scenario has completely changed. In the last 15 months, the rupee has been extremely volatile, having fluctuated from Rs 40 to Rs 51 and is currently at Rs 47.50 against the US dollar. The resulting impact is vitiation of operating performance with heavy forex losses on account of external borrowing for many companies. In some cases, such forex losses far outweigh the profits from the operations of the companies. This has been seen in the financial results of several companies, including Tata Steel, Ranbaxy and Suzlon. On the other hand, if the current trend of strengthening of rupee continues, we may find several companies reporting substantial gains in the first quarter of the current financial year.

Considering this, the government has come out with a notification amending certain aspects of Accounting Standard 11 (AS 11). As per this notification, the companies are given an option to amortise certain forex losses and gains arising on long-term foreign currency monetary items (defined as assets and liabilities expressed in foreign currency and having a term of 12 months or more at the date of origination of the asset or liability). The remaining aspects of AS 11 would continue to apply as earlier.

It is important to note certain aspects pertaining to the notification:


* Applicable only to companies: The notification is applicable only to companies. As such, non-corporate entities such as partnership firms cannot avail of the relaxation permitted by the notification.

* Applicable to gains as well as losses: The notification is applicable to forex gains as well as losses. However, in most of the companies, there will be losses due to borrowings like ECBs and FCCBs. The remaining aspects of

AS 11 would continue to apply as earlier.

Accounting implications

The companies are given an option to amortise the forex gains and losses arising on such forex assets and liabilities instead of booking the gains/ losses at one time. Such amortisation should be over the balance period of such long-term asset/ liability but not beyond March 31, 2011. In case of depreciable assets, the amortisation would be over the remaining life of the asset. The amendment is applicable with retrospective effect and is applicable from accounting periods beginning on or after December 7, 2006.

A simplified illustration of amortisation is given below.

Suppose Company A has a loss of Rs 120 resulting from forex movements on its FCCB liabilities as of March 31, 2009 and the FCCB matures on December 30, 2012. As per AS 11, the company was required to book the complete loss in its profit and loss account, i.e. Rs 120. However, as per the amendment, the company has an option to amortise the loss over a period up to March 31, 2011 (i.e. 3 years) and as such, the loss booked on March 31, 2009 would be only Rs 40.

Impact on investors

Although the losses booked would be lesser due to this amendment, the user of financial statement would know the impact of such exercise due to the disclosure requirements. If these accounting options are exercised by the company, then a disclosure shall be made of the fact and of the amount remaining to be amortised in the financial statements of the period.

A prudent investor would be able to ascertain the likely impact of the forex losses/ gains based on such disclosures. As the amendment only gives an option to the company, the investors would need to understand the option the company has adopted and its impact on its profitability and net worth by referring to the relevant disclosure.

Likely tax implications

As per the amendment, the accounting option needs to be exercised retrospectively for all such foreign currency monetary items retrospectively from accounting periods commencing on or after December 7, 2006 and as such, the forex gains and losses booked earlier would have to be reversed in case the company opts for the revised accounting treatment. As the returns for years ending up to March 31, 2008 have already been filed, it could lead tax authorities to reassess the earlier year's tax in such cases.

With respect to the amortisation of forex losses/ gains (other than related to long-term borrowings for fixed assets), the income-tax treatment is litigative.

Generally speaking, AS 11 has not been notified under section 145 of the Income Tax Act (which deals with accounting standards to be notified by the central government for tax purposes). However, in the absence of any specific provisions to the contrary in the income-tax laws and the fact that the accounting standards represent the generally accepted accounting principles, it should be possible for the assessees to adopt the same treatment as AS 11 for tax purposes also.


In the prevailing uncertain economic scenario, this move can be said to be a very pragmatic one and would prevent distortions of financial results happening due to extreme volatility in the foreign exchange rate, which is an exceptional economic condition. However, investors would be required to carefully analyse the disclosures relating to this amendment in order to ascertain the likely impact on the profits of the company in the long term.

Considering the potential tax litigations that are likely to prevail due to this notification, a clarification from the Central Board of Direct Taxes regarding tax treatment of the accounting option would also be welcome.

The writer is a chartered accountant. Views are personal.


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