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ICAI directive on derivative deals to hit cos
March, 31st 2008

Companies sitting on losses from derivative transactions in the forex market are in for a rude awakening. The Institute of Chartered Accountants of India (ICAI) wants Indian firms to provide for such losses in the current financial year itself, in their profit and loss accounts.

The institute would like Indian companies to adopt AS 30 guidelines, accounting norms pertaining to derivatives, for the year ending March 31, 2008. ICAI had earlier recommended that these guidelines be followed from April 1, 2009 and be made mandatory from April 1, 2011.

Even if companies do not follow the AS 30 guidelines right away, they will still have to provide for the derivatives, which they had bought and sold during the year. For the year ending March 31, 2008, companies, which have suffered losses in the derivatives market, will now have to declare mark-to-market positions and provide for the same in their profit and loss accounts.

The announcement has led to some confusion in terms of enforceability of these guidelines. The earlier guidelines were based on an Act of Parliament and Indian corporates are bound to follow them.

But with the new guidelines, only chartered accountant firms are covered and not Indian corporates. Thus, there is a chance that there will be companies that may not follow these guidelines, and not declare the losses, as they are not bound by it. Again, AS30 guidelines are a different set that leads to dichotomy.

Ernst & Young-India director Viren Mehta admits to the confusion. Certain provisions are treated in the AS 30 guidelines differently compared with how they are treated now. In the coming days, there could be greater clarity on these issues, he says.

Indian companies are sitting on huge losses on account of the forex derivative transactions they undertook during the year. Hexaware was the first to declared that it has suffered losses on account of derivative transactions to the tune of $20-$25 million.

There are many companies, which are not disclosing these losses, as it is not mandatory to show these numbers in the balance sheets. But with the new accounting norms they now have some compulsions.

Even if the company does not follow the new guidelines, the auditor will have to qualify his audit report appropriately, says Greenback Forex director Manis Thanawala, who is also a member of ICAI. Thus, auditors will have to mention the losses from forex derivatives in the balance sheet, even if the Indian companies do not want to.

Some companies have come forward to declare their losses. Such losses were caused by the exotic financial positions that they had taken in the forex market to take advantage of the low volatility of certain currencies against the dollar. But with the depreciation of the dollar, these positions are showing huge losses on a mark-to-market basis.

Indian corporates could have easily forwarded these positions till 2011, and not show them in their balance sheets at all on a mark-to-market basis, with the view that the market will improve and once again these positions will become in the money, or profitable.

But with the new guidelines, these losses will now have to be declared for the year ended March 31, 2008 itself. This is something most Indian companies are unprepared for. Companies, which thought that they could escape declaring the losses, will now have to come forward and show their numbers, which could hit their balance sheet, which, in turn, may impact their market capitalisation.

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