Top companies ignore ICAI rule on forex loss treatment
August, 06th 2008
First-quarter results of several big companies such as Reliance Industries [Get Quote], Reliance Communications [Get Quote], Bharti Airtel [Get Quote] and Jet Airways [Get Quote] would have been a lot worse had they followed the Accounting Standards 11 rules prescribed by the Institute of Chartered Accountants of India.
Most of these companies, however, chose to comply with Schedule 6 of the Companies Act, which is at variance with the treatment prescribed in AS11 for the exchange loss incurred on foreign currency-denominated liabilities for acquiring fixed assets.
For example, if the forex loss on this account were taken to the profit and loss account as required under AS11, the net profits of Reliance Industries for the quarter-ended June would have been 23 per cent lower than reported. Similarly, Reliance Communications' net profits would have shrunk 70 per cent if it had taken the forex loss on the P&L account.
"The effect of changes in foreign exchange rates has to be charged to the profit and loss account. The standard has been notified by the government and is part of the rules. Any violation has to be dealt with by the government," said ICAI President Ved Jain.
Schedule VI of the Companies Act permitted companies to adjust the exchange gain/loss to the cost of fixed asset. For instance, if a company bought a fixed asset for $10 (Rs 400) with a forex loan and suffered an exchange loss of say Rs 30, it could add this loss to the cost of the fixed cost (Rs 400 + 30).
This practice was not in line with international standards and the ICAI amended the guideline in 2003 and it was notified by the government in December 2006.
"Companies are taking legal opinion to take shelter under the Companies Act because they don't want to take a hit. A simple accounting treatment has manifested itself into a legal debate. The companies regulator should modify the Companies Act,'' said Viren Mehta, director, Ernst & Young.
A Reliance Industries spokesperson said the company has continued to adjust the foreign currency exchange differences on amounts borrowed to buy fixed assets to the carrying cost of fixed assets in compliance with Schedule VI to the Companies Act based on legal advice it received. Had the accounting treatment under AS11 been followed, the net profit for the first quarter would have been lower by Rs 940 crore.
A Bharti spokesperson said the company follows US GAAP voluntarily for financial reporting to its investors and for the quarterly financial results. It said the Indian GAAP accounts are prepared for statutory purposes.
Under US GAAP reporting, the company has been taking the profit or loss on restatement of forex loans/liability for fixed assets to the P&L account. However, under the Indian GAAP accounts, the company had to abide by the requirement of Schedule 6 of the Companies Act, 1956, which mandates that such gains or losses should be adjusted in the value of the fixed assets.
"Though AS11 talks of taking such gains and losses to the P&L account, we have been legally advised that in the case of difference or conflict between the provisions of an Act and the Rules, the Act shall prevail and the company should comply with the provisions of the Companies Act, which requires these gains or losses to be adjusted against the value of fixed assets," the company's statement said.
A Jet spokesperson said any income or expense on account of exchange difference either on settlement or on translation is recognised in the P&L account except when they relate to the acquisition of fixed assets, in which case, they are adjusted to the carrying cost of such assets.
Reliance Communications did not respond to queries.
The practice has been on for some time, but experts said it's rampant this quarter. Companies have been taking shelter under the Companies Act as they were advised that the law overrides the accounting standard. But "the dichotomy is further complicated'', as Mehta puts it, with AS II being notified under the Companies (Accounting Standards) Rules, 2006
"I don't think there's any room for adding forex losses to the cost of fixed assets. Once a standard is notified, it's a rule. It's a legal issue; it would be interesting to see if rules prevail over the law," said Seshagiri Rao, CFO for JSW, which has taken such forex losses to the P&L account.
But who will challenge these companies? "Companies are governed by the listing agreement that require them to follow the accounting standards. Why are stock exchanges not asking any questions?'' asked a corporate observer.
Experts feel that ICAI should clarify that pending the amendment of the Act, companies will have to follow the accounting standard. The problem is that the institute can't pull up companies or accountants, who will say 'I have disclosed'.
"The three agencies (Sebi, ICAI and the ministry of company affairs) need to work in tandem so that there's no ambiguity," said Sanjay Aggarwal, head, financial services, KPMG.
The problem is that the Companies Act has not gone through a consequential amendment.