AS - 11 notification

Has India Inc been finally blessed with an amendment that could clear the smoke screen that is being created by the unprecedented volatility in the currency market?

There used to be a time when the Indian rupee gained considerably against the U.S dollar, and Indian corporations pleased with the currency movements, booked huge gains in their books without even a whimper of a doubt regarding whether it was notional or real profits that they were booking. This happiness proved to be very short lived, when consequently the dollar started appreciating in value against the rupee. All hell broke loose and companies were forced to book mammoth losses in their books due to the adverse movement in currency. The impact of the translation difference was so huge that in some cases more than 50% of the entire operating profits were wiped out. Management started questioning the nature of the loss saying it was notional rather that real, debates broke out and accounting standards were challenged.

Enter The National Advisory Committee on Accounting Standards, with the AS 11 notification. What it sets out to do is provide theses hard hit corporations with an option to suspend the application of as 11 for another 2 years till the market has become stable. The companies will be given 2 options primarily, those companies with foreign currency borrowings relating to a depreciable asset, an option to capitalize the forex fluctuation on the loan and companies that have other general long term borrowings, an option to accumulate the same in a “foreign currency monetary item translation difference account” and ammortise the same over the balance period of such long term borrowing, but not beyond 31^st march 2011.

What this means in essence is that companies will be able to report better results in the coming years free from notional losses arising out of forex fluctuations. Additionally, since the suspension can be applied only retrospectively the suspension will facilitate reversal of huge mark to market losses earlier booked. Pursuant to the adoption of the suspension, companies can start with a clean slate and be back in profits in 2 years, coinciding with the adoption of IFRS in India.

This notification like any other is not alien to criticism. Against the backdrop of the recent supreme court ruling which says that foreign currency losses are real and not notional, The notification provides a chance for Indian corporations to dress up their accounts until such time that IFRS becomes mandatory when mark to market provisions will come into play once again. This might lead to a lack of investor confidence in the Indian accounting standards itself. Critics are of the opinion that the NACAS has abandoned due process under political pressure. Regarding the applicability of the notification, not all but few companies that have long term foreign currency borrowings or derivative transactions which are not used for hedging purposes can reap huge benefits from the issuance.

The average investor does not stand to gain much from the amendment as the reversal of earlier losses will be transferred directly to reserves eluding the P&l. How effective this notification is in healing the wounds of bleeding Indian corporations in the long run is something that only time can tell.