Capitalisation of exchange losses of foreign currency borrowings arising from the devaluation of the Renminbi

Since mid-August 2015, real estate industry players in Mainland China have been experiencing unprecedentedly significant exchange losses arising from their foreign currency borrowings.

This publication provides insights into the accounting treatment of such exchange losses.

Key highlights:

  • Certain portion of the exchange losses arising from the devaluation of Renminbi (RMB) in August 2015 is considered as an adjustment to interest costs and is eligible for capitalisation in the qualifying assets of the entities.

  • There are two possible methods to estimate the amount of exchange losses that can be included in borrowing costs and to be capitalised:

    (a) based on interest rates on similar borrowings in the entity's functional currency
    (b) based on forward currency rates at the inception of the loan

  • With method (a), it might be practically difficult or even impractical to identify RMB borrowings which are similar to foreign currency borrowings in major terms at the date of inception of the foreign currency borrowings. Method (b) is considered to be more objective, entityspecific and practical as it makes use of the market spot and forward exchange rates at the date of inception of the foreign currency borrowings of an entity and the entity's specific interest rate.

  • According to our analysis of spot rates, three-year and five-year forward exchange rates of RMB/USD from January 2011 to September 2015, the extent of exchange losses which can be capitalised ranges from 0.5% to 3.0% per annum of the borrowings, depending on the date of inception, tenor and USD interest rate of the borrowings.

  • Entities need to choose an accounting policy between "discrete annual period approach" and "cumulative approach" for capitalising the exchange losses in the qualifying assets when construction of the qualifying assets takes more than one accounting period.