Few things in recent times have foxed companies and rattled investors like the mark-to-market (MTM) losses caused by a surging dollar.
Businesses of all kinds are grappling with the phenomenon and looking for ways to soften the blow. Some were caught on the wrong side of the currency movement, with their forex loans bloating in rupee terms while for others, profits dipped even after taking a forward cover - an instrument that is meant to shield them from exchange rate swings.
Indeed, MTM losses on foreign loans will multiply from next year if book-keeping rules are not changed and the rupee fails to recover. On one hand, discussions are underway to make accounting rules more realistic and allow companies to spread out MTM losses on foreign loans in the coming years; on the other hand, many companies are slowly discovering the maze of hedge accounting - a subject that few CFOs took the trouble to grasp, but a complex process that can lower MTM losses.
The flexibility that companies have in amortising losses on foreign loans will end in March. At present, a 10-crore MTM loss on a five-year loan can be absorbed at 2 crore every year over the life of the loan - a practice that cushions the bottom line. If rules are not changed, then from next financial year, the remaining loss (of 8 crore) has to be booked at one go, which can severely impact profitability.
The Accounting Standards Board, a body of senior professionals that initiate changes in accounting norms, is taking a close look at the matter, along with another accounting treatment that artificially inflates fixed assets.
"We should come out with a clear rule so that MTM losses on loans don't have to be provided in one quarter in the times to come. This will lower panic and volatility," said S Santhanakrishnan, a senior chartered account and member of the board.
In preparing balance sheets, companies match the higher loan liability by increasing the value of fixed assets, which many feel is misleading, particularly to lenders, and should be corrected. "If your loan goes up by 10 crore, is there any justification for raising the value of your asset which was financed with the loan? ", said Santhanakrishnan. Perhaps, a more prudent way would be to lower a company's reserves in balancing a higher loan liability.
According to G Ramaswamy, president, The Institute of Chartered Accountants of India (ICAI), the issues are being debated. "No decision has been reached. This has also assumed significance because several companies have booked MTM losses." So far, 12 Nifty companies have booked 3,120 crore MTM losses this quarter against a gain of 2,225 crore in the year-ago period.
HOW MTM LOSSES ARISE
With the dollar at 50, there will be 10-crore MTM loss on an unhedged $10-million foreign loan taken when dollar was 40. Here are other cases where MTM losses can crop up:
1) A company entering into a forward contract in early August with a bank to sell its export receivables (that's expected in December) will have to book an MTM loss when it announces the results for September 30. If the rupee has dipped 4 between August and September 30, the MTM loss is 4 for every dollar as on September 30.
But this is a notional loss that reflects a lost opportunity for the company to sell at a more lucrative exchange rate. Even though there is no real hit, stock prices fall as soon as results are announced. But a company is not required to show the MTM loss if it pursues hedge accounting which only some large companies have adopted.
"One reason for this is the level of complexity involved and the awareness. Although hedge accounting can be complex, for simple transactions (like sale of export receivables), it can be simplified and implemented on a larger scale," feels Kumar Dasgupta, partner, Price Waterhouse.
2) Companies that have swapped their expensive rupee loans into cheaper dollar loans through currency derivative deals also lose out badly when dollar gains. In a sharp depreciation, the loss on account of a stronger dollar can more than offset the savings in interest outgo. There is MTM loss on the derivative (like the forward contract) at the quarter end.
3) Since commodity prices are closely linked to global prices, commodity companies often pursue a different strategy. For them, a rise in dollar (say, from 40 to 50) is actually a gain: if the global price is $700 a tonne, then the local price rises from 2,800 to 3,500 a tonne.
But many of these companies swap their rupee loans into dollars to offset the loss from a weakening dollar. They book MTM loss on the loan swap derivative. Also, when dollar appreciates sharply, the local price of the commodity corrects only after a month or two.