AS 11 : The burning Issue.

The economies of the globe are feeling the pinch of Recession and given the magnitude of meltdown, there is no surprise that India Inc. is trying its best to save its financials ( Profit and Loss Account and Balance Sheets) from bleeding. The Export service has already dived enough and the future appears to be no better. Many Indian Companies have exposure in foreign markets and Financial instruments denominated in Foreign currencies.

The accounting regulator requires that the foreign currency liabilities to be marked to market (to be simply put the amount of resource outflow that would be required to settle the liability as on the balance sheet date).(AS 11 requires foreign currency monetary assets and liabilities to be measured at the exchange rate on each balance sheet date. Any change in a monetary asset or liability that arises because of exchange rate variation is to be taken to the P&L account).

The rupee has depreciated sharply in the recent past. The companies having foreign currency liabilities need to mark the liabilities to market which means that the loss on MTM has to be charged to the profit and loss account. A simple example: ABC ltd borrowed $ 1,00,000/-( $1= INR 40). On the balance sheet date USD 1 is at Rs 52.This would mean that the equivalent INR liability would increase by Rs 12,00,000/- and the entire amount has to be charged to Profit and Loss account as a foreign currency loss. This would obviously change the face of Profit and Loss account.

However the Schedule VI of Companies Act 1956 allows companies to add the increase in Liability to the coressponding asset which was financed by the loan. In the above case if the loan was taken to purchase a Machinery, the company can add Rs. 12,00,000/- to the cost of the asset. This would mean that the company can show profits higher by Rs.12,00,000/-(less depreciation).

Though the Accounting Standards issued by the ICAI are mandatory in nature, in case of any difference between an AS and any provisions of Act, the Act would supercede the Accounting Standard. This means that companies are free to follow Schedule VI of the companies Act. Earlier when Rupee had appreciated, companies had no problems whatsoever in following the Accounting Standard 11.

The revised AS 11 is one of those standards that is almost fully in conformity with IAS 21, the corresponding international standard. Abandoning AS 11 would raise serious questions about the commitment of Indian companies to follow IFRS.

So India Inc. should not look at the volatility resulting from AS 11 from a narrow perspective. If financial performance is volatile, the function of accounting is to report that volatility. As Indian standards converge with IFRS, there will be a lot more volatility in the reported profit. A good accounting system should bring out the underlying volatility of a business, and not seek to hide it from investors and other users of financial statements. Volatility in the foreign exchange markets can be managed by hedging. Let us not fiddle with accounting to fix that problem.