Government notifications can typically be classified into three categories --- those that are crystal clear, those that are bewilderingly complex (so that by the time one completes reading it one forgets what the issue was all about), and those that are so short that it lets our imagination run amok as to the intent and applicability of the notification.
A notification belonging to the last category was recently issued by the Ministry of Corporate Affairs (MCA), Circular No 25/2012 dated August 9, 2012, on the treatment of foreign exchange losses. It states that there have been some complaints from entities who have opted to capitalise foreign exchange gains or losses as provided by Notification No 914E issued on November 29, 2011. The complaints pertain to the problems posed in implementing para 6 of Accounting Standard 11 on foreign exchange losses, and Para 4(e) of Accounting Standard 16 on borrowing costs.
Rather abruptly, the Circular states that in order to resolve the problems faced by industry, paragraphs 6 and 4E would not apply to an entity that has taken the option provided by Notification No 914E. The Revised Schedule VI to the Companies Act treats exchange differences representing differential interest rates as finance costs and not exchange gains or losses.
In less than 75 words, the Circular has gone up in arms against both AS 11 and AS 16 and the Revised Schedule VI to the Companies Act. The first problem that industry would have is from when the Circular is applicable.
In the absence of a specific mention, one can assume that it would be applicable from the date of the Circular. If so, can entities that have not frozen their accounts for March avail the generosity? The next issue is till when the generosity is applicable.
WINDOW DRESSING
Since the Circular is directly linked with Notification No 914E, it can be assumed that the sunset year of 2020 provided in that Notification would apply to this clarification. The argument that arose when the Notification No 914E was issued -- that eight years is too long a period to provide a departure from a particular portion of an accounting standards -- would be reignited again. One would not be shooting in the dark in surmising that the intention behind this Circular was to provide a fillip to corporate results.
The MCA has now allowed companies to capitalise exchange losses, if any, to the extent that such losses represent the difference in interest rates on local and overseas borrowing. This accounting flexibility will help bolster profits for Indian corporates that have borrowed in foreign currency.
Until now, exchange losses on foreign currency borrowings, to the extent they are regarded as adjustment to interest cost, had to be expensed in the profit and loss account. In the long run, such accounting jugglery – allowing corporates to carry forward interest expense to balance sheets — will be a disservice to companies.
MCA could do well to follow Stanza 461 of the Tamil classic Thirukkural, which states “Before undertaking a project, ponder what will be gained, lost and ultimately achieved”.
At first blush, the gain would be that the Government would win industry’s approval by scoring some brownie points. The loss is that proper accounting would be given go-by and what will be ultimately achieved is a jugaad solution.
OTHER APPROACHES
The brownie points could have been gained in other ways, too -- one of which could be permitting entities to distribute their gains/losses over financial statements of two years. A lower depreciation charge would also serve the purpose and increase profits, though the bugbear of tax would take away a third of the benefit.
By 2020, hopefully India would be well on their way into International Financial Reporting Standards (IFRS). If the Circular is still valid then there would be a difference between international standards and Indian accounting standards. The question that cries out for an answer is — in case the dollar drops and entities make windfall gains, would they request that opting for Notification No 914E is posing practical difficulties and request denotification?
There is a school of thought that mandating financial statements for a year to take the burden of all gains and losses of that year – as IFRS does- is more realistic than artificial props. The MCA could spend some time contemplating this.