Publication: Taxmann’s Corporate Professionals Today, March 2009
Article Summary: This article analysed the challenges arising from foreign exchange losses on Foreign Currency Convertible Bonds (FCCBs), particularly in the aftermath of the global financial crisis. FCCBs were widely used by Indian companies as a cost-effective financing instrument, offering low interest rates and the option of conversion into equity shares at a predetermined price. However, the sharp decline in stock prices made the conversion unattractive, while depreciation of the Indian Rupee significantly increased the repayment burden in rupee terms.
The article examined divergent accounting treatments adopted by companies to recognise such forex losses. While Accounting Standard (AS) 11 required such losses to be charged to the profit and loss account, Schedule VI of the Companies Act, 1956 permitted adjustment against the cost of fixed assets, thereby shielding reported profits. The introduction of AS 30 sought to provide a more balanced approach in specific cases, though inconsistencies in application remained a concern.
It also highlighted practical challenges faced by companies, including substantial increase in liabilities and the need to raise large funds for redemption. The article discussed mitigation strategies such as hedging foreign currency exposure and buyback of FCCBs at discounted prices, facilitated by regulatory relaxations from the Reserve Bank of India.
The article concluded that while FCCBs were initially perceived as a favourable financing tool but the inadequate risk management and inconsistent accounting practices adopted by companies exposed them to significant financial stress.
Key Insight: Foreign currency borrowings can become a source of financial risk if exchange rate volatility and accounting implications are not managed prudently.