Accounting for exchange rate volatility and Investor Perception

An unstable rupee has created a lot of panic in the forex market. Rupee has been depreciating steadily. In fact, rupee depreciated by 20% to 25%. Many Indian corporates looked for foreign currency borrowings in dollar to reduce cost and in many cases they were able to do by 150 to 200 base points. They were able to it by hedging their positions so that exchange rate volatitly do not eat up their accrued benefits.

Unhedged positions result in huge foreign exchange losses on foreign currency borrowings due to depreciation of rupee. AS-11 the Effects of Changes in Foreign Exchange Rates initially required such losses to be recognized immediately and fully in the P&L.

Capitalization/Amortization or Recognize in P&L

However as per notification no 695 and 696 dated December 29, 2011 the MCA has extended the option to capitalization /amortization to 2020.Such capitalization/amortization is not permitted under IFRS, which requires all exchange gains/losses to be recognized immediately in the P&L. This notification will also allow companies to use the capitalization/amortization policy, even if they had not used such an option earlier

Effect of the treatment

In the event of depreciating rupee the option to defer exchange differences on long term monetary items may give relief to companies who want to smoothen the impact of exchange differences on its statement of profit and loss. But in case of appreciating rupee then exchange difference impact of earlier years will cause a major dent in subsequent years close to repayment of those long term monetary items.

Investor Perception

While the Indian Inc may be prefer to opt the capitalization /amortization way, but the investors may be benefited if the full recognition policy is opted, as it depicts the position of the company as at a particular date, which an amortization policy distorts.

An investor may always opt for a company which did not have a carry forward exchange loss. It is welcome, that the companies that use the capitalization/amortization policy are required to make full disclosures in the financial statements. This will be useful to investors, to take appropriate calls on their investments.

Conclusion

Let us conclude in a positive note that the MCA, ICAI and NACAS shall provide a stringent frame work of discourses so that the investors interest will be safeguarded.

( Courtesy : Business line and The Economic Times)