Reference is made to the change in KenGen's accounting policy with regard to treatment of foreign currency gains and losses which are now being charged to a reserve account instead of in the income statement.

Had Kenya's biggest power generating company adhered to provisions of the International Accounting Standards (IAS 21) while preparing its financial statements last year, the firm could have reported a pre-tax loss of Sh894.6 million.

But a change in accounting policy saw the management transfer foreign exchange losses of Sh5.3 billion incurred in the year from the income statement to a special "foreign currency revaluation reserve account."

The effect was that KenGen reported a Sh4.6 billion pre-tax profit in the financial year ended June 2009.

The matter, highlighted by the Business Daily on Thursday, was brought to the attention of the Institute of Certified Public Accountants of Kenya (ICPAK) by KenGen some time back in which they requested a clarification of the same.

KenGen requested the Institute's guidance on whether the current provision under IAS 39, which provides for exemption from IAS 21 would fit within the type of hedging provided by the Government.

In summary, the deviation was not in line with IAS and neither is it in line with Kenya's reporting standards given that we did adopt the use of IAS/IFRS in 1999 as a country.

We advised KenGen not to deviate from the IASs and the need to disclose any deviation and the reason thereof.

However, the request raised issues that provide food for thought for accounting professionals as detailed below.

To enhance the credibility of financial statements, the Institute has adopted and requires that all companies prepare financial statements on the basis of the International Financial Reporting Standards (IFRSs).

Further, the use of IFRSs ensures the neutrality of the information in financial statements is safeguarded.

Effects of Changes in Foreign Exchange rates IAS 21, which deals with the Effects of Changes in Foreign Exchange rates, provides that 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.

There is no provision for the recording of the Forex differences in equity.

The only provisions for any deferral of gains/losses in equity is the application of hedge accounting under IAS 39, Financial Instruments: Recognition and Measurement.

For a hedging relationship to qualify for hedge accounting all of the following conditions must be met; Firstly, at the inception of the hedge there is formal designation and documentation of the hedging relationship and the entity's risk management objective and strategy for undertaking the hedge.

That documentation shall include identification of the hedging instrument, the hedged item or transaction, the nature of the risk being hedged and how the entity will assess the hedging instrument's effectiveness in offsetting the exposure to changes in the hedged item's fair value or cash flows attributable to the hedged risk.

Secondly, the hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk, consistently with the originally documented risk management strategy for that particular hedging relationship.

Thirdly for cash flow hedges, a forecast transaction that is the subject of the hedge must be highly probable and must present an exposure to variations in cash flows that could ultimately affect profit or loss

The fourth condition is that the effectiveness of the hedge can be reliably measured, i.e the fair value or cash flows of the hedged item that are attributable to the hedged risk and the fair value of the hedging instrument can be reliably measured.

Finally, the hedge is assessed on an ongoing basis and determined actually to have been highly effective throughout the financial reporting periods for which the hedge was designated

Given the information availed to us by KenGen, in our opinion, the above conditions do not apply and therefore the arrangement does not qualify for hedge accounting.

Further, although there is a statutory instrument in place that allows for the recovery of the Forex movements in the future rates charged to the end consumers, as these amounts are recovered in the future, an asset cannot be recognised at present for these amounts, and therefore there is no offsetting journal that could minimise the impact of the Forex movements.

The International Accounting Standards Board (IASB) which is the global body responsible for developing financial reporting standards is currently looking into this issue and recently issued a new exposure draft for Rate-regulated Activities.

This is, however, still an exposure draft and we request accountants to assist the institute in reviewing the exposure draft so as to enrich our comments to the IASB and ensure that it adequately addresses the foreign currency challenges facing independent power producers in Kenya.

Kigen is the Chief Executive of ICPAK.