Issue raised in GAPS in GAAP — July 2007 Under revised AS-11 The Effects of Changes in Foreign Exchange Rates, the accounting treatment for monetary items and non-monetary items is different. Monetary items are revalued at each reporting date and the gain or loss is recognised in the income statement. Non-monetary items are reported at the exchange rate at the date of the transaction. They are not revalued at each reporting date and hence there is no exchange gain/loss. Thus the classification of an item as monetary or non-monetary is critical.
Monetary items have been defined as ‘are money held and assets and liabilities to be received or paid in fixed or determinable amounts of money’. Nonmonetary items are defined as ‘assets and liabilities other than monetary items.’ Paragraph 12 of the standard briefly elaborates what monetary and nonmonetary items are, as follows: “Cash, receivables and payables are examples of monetary items. Fixed assets, inventories, and investments in equity shares are examples of non-monetary items.”
The Expert Advisory Committee (EAC) of the ICAI has opined on the issue of monetary and non-monetary items (EAO-VOL-19-1.13). This opinion was given in the context of the pre-revised AS-11, but is relevant under revised AS-11 as well. The issue was whether foreign exchange advances received (and converted into Indian rupees) for export of a fixed quantity of goods, which are adjusted against future supplies, are monetary or non-monetary items.
The EAC noted the definition of ‘monetary items’ as ‘money held and assets and liabilities to be received or paid in fixed or determinable amounts of money’. The EAC was of the view that the words ‘received or paid’ do not necessarily envisage receipt or payment in cash. What is of essence in the definition of monetary items is that the value of the asset or liability should be fixed or determinable in monetary terms. In the present case, the EAC felt that the liability of the company in respect of the advance taken from the foreign customer is fixed in monetary terms, though it will be discharged through exports rather than through payment in cash. As such, the EAC was of the view that the advance received from the foreign customer is a monetary liability. Consequently monetary items denominated in a foreign currency should be revalued at each reporting date and exchange gain/ loss is recognised in the income statement.
Under IAS-21 The Effects of Changes in Foreign Exchange Rates, monetary items are defined as ‘Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency.’ Paragraph 16, of IAS-21 provides further elaboration as follows.
Monetary items Paragraph 16 “The essential feature of a monetary item is a right to receive (or an obligation to deliver) a fixed or determinable number of units of currency. Examples include: pensions and other employee benefits to be paid in cash; provisions that are to be settled in cash; and cash dividends that are recognised as a liability. Similarly, a contract to receive (or deliver) a variable number of the entity’s own equity instruments or a variable amount of assets in which the fair value to be received (or delivered) equals a fixed or determinable number of units of currency is a monetary item. Conversely, the essential feature of a non-monetary item is the absence of a right to receive (or an obligation to deliver) a fixed or determinable number of units of currency. Examples include: amounts prepaid for goods and services (e.g. prepaid rent); goodwill; intangible assets; inventories; property, plant and equipment; and provisions that are to be settled by the delivery of a non-monetary asset.”
Therefore as can be seen from the above, though the definition of monetary items and non-monetary items is the same under IAS-21 and AS-11, they have been interpreted differently. The interpretation in paragraph 16 of IAS 21 and that contained in the EAC opinion take the exact opposite position. If one were to apply paragraph 16 above, one would conclude that advance received for future export of goods, is a non-monetary item. However, based on EAC opinion, this would be a monetary item.
Given that Indian GAAP is attempting to converge with IFRS, such interpretation differences would create unnecessary GAAP differences. In the given instance, intuitively, it appears that the right answer is not to revalue the advances received, which has been fully converted into Indian rupees. The advance has been received for future supply of fixed quantities of goods; has been fully converted into Indian rupees, and hence revaluing them at each reporting date and recognising exchange gain/loss is inappropriate. Such exchange gain/loss is merely a book entry that is reversed in the future (as sales in this example). If the recommendation of EAC were to be followed in this instance, it would give rise to a theoretical gain or loss in one period and an opposite effect when the transaction is concluded. This would substantially distort the profit and loss account between two periods.
A similar issue was raised (Query 37, Vol. XXVIII) much later with regards to treatment of advance paid in foreign currency for acquisition of fixed assets. This time the opinion of the EAC is in line with the interpretation in IAS-21. The Committee opined “the words received or paid in the definition of the term monetary items do not necessarily envisage receipt or payment in cash. What is of essence is that the value of the asset or liability should be fixed or determinable in monetary items. Accordingly, where the advance is related to a fixed price contract for the receipt of a specified quantity of goods, it will be a non-monetary asset, since it represents a claim to receive a specified quantity of goods and not a right to receive money.”
The change in the point of view by the EAC in this case, is a step in the right direction and will align the interpretation on this issue with global practice.
