Recently, Firstsource Solutions Ltd announced that it voluntarily adopted accounting standard 30 on the recognition and measurement of financial instruments. Issued by the Institute of Chartered Accountants of India, the standard is mandatory for Indian companies only from April 2011 and is recommendatory from April 2009.
The BPO firm’s initiative to adopt the standard early is easy to understand. The accounting standard allows it to route the impact of exchange rate fluctuations on its foreign currency convertible bonds (FCCBs) through the balance sheet rather than through the profit and loss (P&L) account.
Firstsource had issued FCCBs worth $275 million (Rs1,369 crore) to fund its $330 million acquisition of MedAssist Holding Inc. Before it adopted AS-30, the company had to restate its liability on the bonds based on quarter-end exchange rates and provide for the difference in its profit and loss account. The rupee’s depreciation was so sharp in the June quarter that the difference on account of the restatement was higher than the profit the company generated during the period. Profit from operations before tax stood at Rs37.6 crore, but the loss on account of the FCCB restatement was Rs80.2 crore. The net result was that profit after taxation stood at a negative Rs50 crore. If the same policy had been followed in the September quarter, the net loss would have been Rs96 crore, nearly double that in the June quarter.
But by adopting AS-30, this translation loss has found its way into the balance sheet under the head, “translation reserve account”. From now on, all of the volatility on account of the restatement of its FCCB liability will be captured in this account and won’t mar its quarterly or even annual results.
How did Firstsource’s FCCB qualify for this relief under AS-30? Without getting into the nitty-gritty, the new accounting standard allows the treatment of foreign currency denominated loans as a hedging instrument if it’s backed by an asset in the same currency. In Firstsource’s case, the loan is backed by the $330 million US-asset, MedAssist. For the multitude of Indian companies who have taken foreign currency loans to fund overseas acquisitions, AS-30 would come as a relief. They too can now keep the volatility caused by fluctuating exchange rates out of their P&L.
However, it would be unfortunate if Indian companies leave their foreign currency liabilities unhedged simply because the pain of a depreciating rupee is not visible in its P&L. In Firstsource’s case, the rupee was at 39.6/dollar when it completed its FCCB issue last December. Based on that day’s exchange rate, it would have a rupee liability of about Rs1,500 crore (including interest) in December 2012, when the bonds matured. Today, the liability stands at Rs1,900 crore. The difference of Rs400 crore is the loss Firstsource faces if exchange rates remain at current levels. Based on last year’s performance, that’s as much as three years’ profits. That’s the impact of not hedging one’s foreign currency liabilities.
In the past, Indian companies haven’t hedged this liability because of their view that rupee was headed only in one direction, which is to appreciate against the dollar. That view has now been shaken, but it’ll be unfortunate if companies still shy away from hedging their foreign currency liabilities just because AS-30 allows them to bury the negative impact of a rupee depreciation in the balance sheet.
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