ICAI asks companies to reveal forex derivative losses

[Sukumar]

New accounting norm expected to hit Q4 profits

Corporate profits will come under severe pressure for the fourth
quarter ended March 2008 as companies will have to provide for any
losses on forex derivative products, owing to a new accounting norm
announced on Saturday.

The Institute of Chartered Accountants of India (ICAI) has asked all
companies to disclose and/or provide for all losses on derivative
contracts, except for forward contracts, where a company needs to
comply with accounting standard AS11.

"Q4 results will be disastrous and that will impact the stock markets.
Investor concerns could also hamper foreign institutional investor
flows," said the CFO of a leading company who spoke on condition of
anonymity.

"It is good thing that the truth is coming out but the timing is bad
for the market with so much bad news," he added.

Forex consultants estimate that corporate India may be sitting on a Rs
12,000 crore to Rs 20,000 crore loss on its exposure to foreign
exchange derivatives.

"Things could get better as people will understand the impact better,"
said Sanjay Aggarwal, national industries director, financial
services, for consultancy firm KPMG. "There was no transparency as the
profit or loss a company was making on derivatives was not required to
be reported."

So far companies were not required to declare their gains or losses on
derivative products; ICAI's new accounting standard AS30 required them
to reveal these gains or losses from April 1, 2011, a deadline it has
advanced by three years.

The action may now shift to company boardrooms as they try to figure
out ways to minimise the impact on their earnings. " The first thing
companies would do on Monday is to unwind their profitable trades so
that they can offset the losses they have made on other trades," said
a foreign exchange consultant.

This is precisely what companies have been doing over the past few
weeks, said sources in forex circles. "Companies who will be required
to recognise large MTM losses for the March quarter could also
consider new derivative contracts to improve effectiveness of their
hedging strategy,'' said Aggarwal.

Companies, however, are unsure of certain issues under the new
accounting standards. The accounting Standard AS11 does not cover
accounting for forward contracts to hedge highly probable, forecast
transactions, and these have to be marked to market.

For instance, take an exporter who enters into forward contract for
the exports he will make in December 2008. "Now, the objective of this
company was not to trade in derivatives but if it has to mark to
market the derivative under the new rule, it will result in volatility
in earnings," said an expert with a consultancy firm.

"AS30 also allows you an option that if you follow the rules related
to 'hedge accounting,' you do not need to take the entire gain or loss
to the profit and loss account. Some or a large part of the losses or
gains can be parked in the reserves until the time the actual hedged
transaction matures," said the consultant.

However, only companies that have adopted AS30 can qualify for hedge
accounting. "The directive requires more clarity. What happens to
transitional provisioning of AS30, which says that when you are moving
to a new accounting standard, you could take your gains/losses to the
reserves once," asked an accounting expert.

"It is unclear how they will treat the gains made on derivative
trades, and if they can be set off against losses made on other
trades," added a consultant.

N.Sukumar
Research Analyst
www.kences1.blogspot.com