Brief facts of the enquiry:

The Accounting Standards Board (the Board) received enquiries regarding:

A.Scope of exemption from IFRS 16 Leases, under S.R.O 986(I)/2019; and

B.Accounting of capitalized exchange losses under exemption from IAS 21 The Effects of Changes in Foreign Currency

Opinion:

The Board based on the enquired fact pattern discussed the following matters:

•Whether, pursuant to the S.R.O 986(I)/2019, lease arrangements for the land of the project (where power plant is constructed), office premises and branch are exempt (or not) from the application of IFRS 16.

In this regard the enquirer submitted three alternate views:

•View A: All lease arrangements of the power project, including land, office premises and branch office are exempt.

•View B: The project asset’s which are specifically mentioned in the PPA, such as land are exempt. However, lease arrangements for other assets such as office premises and branch office, are not exempt.

•View C: Lease arrangements of land, office premises and branch office are not exempt.

•Whether the exchange losses capitalized under the exemption from IAS 21 granted vide S.R.O 986(I)/2019 can be depreciated/amortised over the tenure of the loan (rather than over the life of the asset).

A.Scope of exemption from IFRS 16 Leases, under S.R.O 986(I)/2019

The Board recognised that the exemption from IFRS 16 (granted through S.R.O. 986(1)/2019) is in perspective of the power generation arrangement i.e. the Power Purchase Agreement (PPA), between a power producer and a power purchaser. Relevant part of the S.R.O. 986(1)/2019 is reproduced hereunder:

“IFRS 16 (Leases) to the extent of the power purchase agreements executed before the effective date of IFRS 16 i.e. January 1, 2019.”

(Emphasis is ours)

The Board noted that the exemption from IFRS 16 ‘to the extent of the power purchase agreement’ for a power producer would cover the circumstances where:

a)Lease arrangement is the PPA;

b)Power producer is a lessor under such PPA;

c)Power purchaser is a lessee under such PPA; and

d)Power producer has conveyed the right of use of assets (generally complex/power generation facility) to the power purchaser against the capacity invoices.

On the other hand, all other arrangements where power producer is either a lessee or a lessor are not exempt under the above-mentioned S.R.O.

The Board based on the above discussion concluded that the scope of exemption from IFRS 16 under S.R.O. 986(1)/2019 only includes those assets which have been leased by a power producer to a power purchaser (i.e. customer) under the PPA (executed before January 1, 2019) against the capacity invoices.

B.Accounting of capitalised exchange losses under exemption from IAS 21 The Effects of Changes in Foreign Exchange Rates

The Board noted that the exemption from the requirements of IAS 21 (granted through S.R.O. 986(1)/2019) is to the extent of capitalization of the exchange differences related to foreign currency long-term loans and related interest.

Relevant part of the S.R.O. 986(1)/2019 is reproduced hereunder:

“International Accounting Standard 21 (The Effects of Changes in Foreign Exchange Rates) to the capitalisation of exchange differences.”

The Board noted that exchange losses pursuant to above relaxation are capitalised in the items of property, plant and equipment.

The Board also noted that IFRS (i.e. IAS 16 Property, Plant and Equipment) outlines the principles for recognition and depreciation of property, plant and equipment.

Cost of an item of property, plant and equipment besides purchase price, may include various other components such as duties, borrowing costs, site restoration costs etc.

Paragraph 50 of IAS 16 requires an item of property, plant and equipment (asset) to be depreciated over its useful life.

IAS 16 defines the useful life of an asset as (emphasis added) ‘the period over which an asset is expected to be available for use by an entity; or the number of production or similar units expected to be obtained from the asset by an entity’.

Importantly, depreciation is not based on or aligned with the liability incurred in acquiring the asset, rather it is based on the pattern in which the asset is used.

The Board based on the limited review of financial statements of power sector companies (done by the Technical Services Team) noted that companies capitalize the exchange losses (under the exemption from IAS 21) in the carrying amount of property, plant and equipment, and are depreciating such amounts over the life of the related asset or term of the PPA.

The Board also considered it pertinent to discuss and explain the relevant background information about the exemption from IAS 21. This exemption was initially granted by SECP in the backdrop of certain revisions in the repealed Companies Ordinance 1984. SECP made those revisions in 2004.

Prior to those revisions, under the repealed Companies Ordinance 1984, companies were allowed to include exchange differences (gain/losses relative to the foreign currency borrowings out of the proceeds of which assets were acquired) in cost of respective fixed assets. The fixed assets were depreciated as per depreciation policy. However, SECP removed the provision of capitalisation of exchange differences from the corporate law. All companies, consequently, were required to charge exchange differences in the profit and loss account in accordance with IAS 21. However, subsequently, SECP on the request of power producer companies granted the exemption by allowing capitalisation of foreign exchange losses which otherwise are not allowed under the IFRS.

Relevant part of the fourth schedule related to ‘Fixed Assets’ of the repealed Companies Ordinance 1984 (which was applicable prior to 2004) is as under:

“Any exchange, gain or loss in any year, as a consequence of fluctuations in rate of exchange, relative to the foreign currency borrowings out of the proceeds of which assets were acquired may be added to or deducted from the value of the respective assets and where such addition or deduction is made, the amount thereof under each sub-head shall be disclosed together with the depreciation policy therefor.”

The Board also observed that under IAS 23 Borrowing Costs, the exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs are one of the examples of borrowing costs. These exchange differences can be capitalised as borrowing costs incurred on a qualifying asset. Importantly, such capitalised exchange differences are depreciated of over the life of the qualifying asset, rather than over the tenure of related foreign currency borrowing.

The Board based on the above discussion concluded that the exchange differences on foreign currency borrowings capitalised in the carrying value of asset (under the exemption from IAS 21 granted through S.R.O. 986(I)/2019) should be depreciated over the period the related asset is expected to be available for use to company. Therefore, the depreciation/amortization should not be based on the tenure of the borrowing.

(Issued in September, 2020)