The change is part of the International Financial Reporting Standards (IFRS), proposed to be made mandatory for all companies. The recently notified Accounting Standard 39 (AS 39) norm recognises and measures financial assets, financial liabilities and some contracts to buy or sell non-financial items. Called ‘embedded derivatives’, companies are required to state upfront the perceived changes in the foreign exchange component of the contracts given out by them every year, by making a provision in the profit and loss account.
A foreign exchange component is present even in contracts given to domestic suppliers such as Bharat Heavy Electricals, to arrive at a fair system of comparison with competing foreign companies. On an average, the forex component comprises nearly a third of NTPC’s total contract values. AS 39 defines derivatives as a financial instrument or other contract whose value changes in response to currency exchange rate fluctuations. What has irked NTPC is the need to account for the variation in fair value of the advance contracts entered with suppliers in foreign currencies (embedded derivatives) as separate entries in the profit and loss account. It has sent a letter of protest it has sent to the Institute of Chartered Accountants of India (ICAI), the accounting standards body, against the new norms. AS 39 was prepared by the Accounting Standards Board of ICAI, vetted by the National Advisory Committee on Accounting Standards and notified by the ministry of corporate affairs.
NTPC feels AS 39 is fraught with serious consequences for Indian companies, particularly rate-regulated entities (where a government regulator determines the rate for the product or service) such as those in the power sector.
Currently, all expenditure towards equipment procurement is included in the asset cost. According to NTPC’s director (finance) A K Singhal, the Central Electricity Regulatory Commission (CERC) allows generation companies to capitalise foreign exchange risks. “Any rate variation is a pass through in tariffs (rates),” he said.
Companies like NTPC follow the Construction Work In Progress (CWIP) method for accounting, where a general ledger records the costs directly associated with constructing an asset. Once the asset is placed in service, all costs associated with it that are stored in the CWIP account are shifted into the most appropriate fixed account asset.
If AS 39 is followed, it would impact the asset costs and increase the volatility of earnings reported by Indian corporate entitties, says NTPC’s letter to ICAI.