“It just doesn’t make sense, Mr. Mehta,” said Anjali, the CFO of a fast-growing manufacturing firm.
She pointed to a line on her draft P&L statement. “We have a major quality dispute with our German supplier. We both know we’re only going to settle for about a third of the invoice. Yet, I’m booking a massive forex loss on the full amount. It’s killing our quarterly numbers!”
Mr. Mehta, her Chartered Accountant, nodded knowingly. “Anjali, you’re dealing with a ‘forex phantom.’ The loss you’re seeing isn’t entirely real. You’re following one accounting standard, but you’re missing the crucial first step. Let’s exorcise this phantom.”
This scenario is a headache for finance professionals everywhere. When a foreign currency payable is disputed, what’s the correct way to account for the exchange gain or loss? The answer lies in a powerful two-step approach using Indian Accounting Standards (Ind AS), an approach that ensures your financial statements reflect reality, not just the paper invoice.
Step 1: Tame the Liability with Ind AS 37
The common mistake is to treat the disputed invoice as a standard trade payable. But the moment a genuine dispute arises, its character changes. It is no longer a liability of a certain amount; it becomes a provision under Ind AS 37, Provisions, Contingent Liabilities, and Contingent Assets.
Ind AS 37 requires you to recognize a liability at the “best estimate” of the expenditure required to settle it. You don’t just get to use the full invoice value. You must assess the most likely outcome.
In Anjali’s case, her company has strong evidence (emails, reports) that the final settlement will be around 30-40% of the original bill. Therefore, the correct action is to write down the liability to this best estimate. The difference is recognized as a gain in the P&L immediately.
What about the rest of the amount? The remaining 60-70% doesn’t just disappear. It becomes a contingent liability, which is disclosed in the notes to the financial statements, not recognized on the balance sheet.
Step 2: Calculate the Real Forex Impact with Ind AS 21
Only after you have determined the correct carrying amount of the liability using Ind AS 37, do you turn to Ind AS 21, The Effects of Changes in Foreign Exchange Rates.
The provision you’ve just recognized (the “best estimate”) is a monetary item in a foreign currency. Ind AS 21 mandates that this item must be re-translated using the exchange rate at the reporting date. The resulting exchange difference is your true forex gain or loss.
Example: The Right Way vs. The Wrong Way of Handling Forex Disputes
| Particulars | Incorrect Approach (Forex on Full Amount) | Correct Approach (Forex on Best Estimate) |
|---|---|---|
| Initial Liability | €100,000 (₹80,00,000 @ ₹80/€) | €100,000 (₹80,00,000 @ ₹80/€) |
| Re-measurement (Ind AS 37) | Not performed. Liability stays at €100,000. | Liability written down to €35,000. A ₹52,00,000 gain is booked in P&L. |
| Year-End Liability (@ ₹83/€) | €100,000 = ₹83,00,000 | €35,000 = ₹29,05,000 |
| Forex Loss for the Period | ₹3,00,000 | ₹1,05,000 |
| Net P&L Impact | ₹3,00,000 Loss | +₹50,95,000 Gain |
As you can see, the incorrect approach not only overstates the year-end liability massively but also creates an artificial forex loss, hiding the significant gain from the likely settlement. The correct approach provides a true and fair view of the company’s financial position and performance.
Navigating the Complexity with Confidence
Applying this two-step process requires careful judgment, robust documentation to support your “best estimate,” and a deep understanding of the interplay between two complex accounting standards. Auditors will rightly scrutinize these estimates with professional scepticism. You need to have your analysis, evidence, and accounting rationale ready.
This is where modern tools become indispensable for professionals like Mr. Mehta and CFOs like Anjali. Manually tracking the nuances of Ind AS 37 and Ind AS 21, cross-referencing paragraphs, and ensuring every condition is met can be daunting. An AI-powered assistant like Vidur AI can be a powerful ally in this process.
Imagine asking a simple question: “What is the accounting treatment for a disputed foreign payable under Ind AS?” Vidur can instantly provide the relevant sections from both Ind AS 37 and Ind AS 21, explain the concepts of “provision” and “best estimate,” and outline the exact steps required. By providing instant, accurate, and reliable information on complex regulatory and accounting topics, Vidur empowers professionals to make confident, compliant decisions, and banish the ‘forex phantoms’ from their financial statements for good.
