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Auditors may stick to rule book on MTM loss
March, 09th 2009

IT is similar to buying a stock at Rs 500 in May and accounting for it on March 31, when the scrip has crashed to Rs 100. While in securities investments the rule is clear that this Rs 400 MTM loss has to be provided for (or deducted from earnings), in foreign currency derivative contracts, its not an open and shut case.

The issue corporates are grappling with is whether to provide for this loss on contracts struck to hedge (or cover the risks of a choppy market). Many of them are engaged in a vigorous discussion with their auditors, trying to explain why this bit of the accounting rules should be skipped. More so, in an unusual year like this.

Interestingly, these losses are not due to some complex exotic derivatives that banks sold to corporates. There are losses even on plain vanilla contracts. Many companies had entered into options contracts in the past, and there are MTM losses on simple forwards, said RVS Sridhar, head of markets at Axis Bank.

The Accounting Standards Board, which is looking into the finer points of derivatives accounting , has proposed that MTM losses should be provided only for speculative contracts. The Institute of Chartered Accountants of India (ICAI) is expected to look into the matter.

According to the chairman of the Board S Santhanakrishnan, widespread MTM losses could lead to an unnecessary panic and an artificial MTM crisis should be averted.

Under current rules, which have a few grey areas, no provision is needed for MTM losses if the forex contracts are treated for what is known in accounting parlance as hedge accounting . This does not mean that a corporate can avoid MTM provision only if it has a genuine underlying like actual dollar receivables from exports.

There are other conditions which have to be fulfilled for a contract to qualify as a hedge or come under the purview of hedge accounting. Given the intense scrutiny that auditors find themselves in post Satyam, it is likely that many of them would stick to the rule book and, therefore, insist on these conditions.

In all likelihood, most companies will have to provide MTM losses. This is because very few companies, I believe, have maintained hedging documents, which is a condition for hedge accounting. And, secondly, companies are likely to fail the effectiveness test, since the market has been highly volatile, said Sanjay Aggarwal, executive director at KPMG. What he means is that a company will not pass the effectiveness test a key condition for hedge accounting if the net loss from changes in MTM arising from the underlying and the hedge instruments breach the range specified in the accounting standards.

Accounting for derivative losses is a fairly new subject for India Inc. A year ago, ICAI had underscored the need for providing MTM losses when several corporates were hit by exotic derivatives, which boiled over into disputes with banks which in many cases ended in outof-court settlements. Once again, several corporates are faced with a similar situation, albeit on a smaller scale.

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