Capitalisation of Exchange Loss on Foreign Currency Loan under Ind AS 23

1. Question

Alpha Private Limited, hereinafter referred to as “the company” is engaged in the business of producing precision automotive components. In April 2024, the company initiated a project to install a new automated machinery to enhance its production capacity. The machinery was imported from “Den Limited” of Japan. These machinery however requires substantial installation, configuration, and testing before they can be brought to use. The overall period in which machine becomes ready for use is expected to be 15 months from the date of import.

To finance the purchase of machinery, the company obtained a foreign currency loan of USD 1 million from a Japanese financial institution. The loan carries a fixed interest rate of 3% per annum, payable annually, and is repayable over a tenure of three years. However, if the company had opted for a similar borrowing in Indian Rupees, the applicable interest rate in the domestic market would have been approximately 9% per annum for a loan of equivalent tenure and risk profile.

At the time of obtaining the loan, the prevailing exchange rate was Rs. 82 per USD, which subsequently depreciated to Rs. 87 per USD by the end of the financial year. The company incurred an exchange loss of Rs. 50,00,000 on the outstanding loan balance during the construction period as a result of this exchange rate fluctuation. Furthermore, the borrowing is secured and is designated exclusively for the purpose of financing the acquisition and installation of new machinery.

Considering Ind AS 21, The Effects of Changes in Foreign Exchange Rates and Ind AS 23, Borrowing Cost, whether the company should transfer the exchange difference in profit or loss or whether it should capitalise the entire exchange loss as part of the cost of the machinery? Explain the rationale and accounting treatment.

2. Relevant Provision

2.1 Ind AS 23 – “Borrowing Cost”

Para 6 of Ind AS 23

Borrowing cost may include exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

Para 6A of Ind AS 23

With regard to exchange difference required to be treated as borrowing costs in accordance with paragraph 6, the manner of arriving at the adjustments stated therein shall be as the adjustment should be of an amount which is equivalent to the extent to which the exchange loss does not exceed the difference between the cost of borrowing in functional currency when compared to the cost of borrowing in a foreign currency.

Para 8 of Ind AS 23

An entity shall capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of thecost of that asset. An entity shall recognise other borrowing costs as an expense in the period in which it incurs them.

Para 10 of Ind AS 23

The borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been made. When an entity borrows funds specifically for the purpose of obtaining a particular qualifying asset, the borrowing costs that directly relate to that qualifying asset can be readily identified.

2.2 Ind AS 21 – “The Effects of Changes in Foreign Exchange Rates”

Para 15 of Ind AS 21

An entity may have a monetary item that is receivable from or payable to a foreign operation. An item for which settlement is neither planned nor likely to occur in the foreseeable future is, in substance, a part of the entity’s net investment in that foreign operation, and is accounted for in accordance with paragraphs 32 and 33. Such monetary items may include long-term receivables or loans.

Para 28 of Ind AS 21

Exchange differences arising on the settlement of monetary items or on translating monetary items at rates different from those at which they were translated on initial recognition during the period or in previous financial statements shall be recognised in profit or loss in the period in which they arise, except as described in paragraph 32.

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