UNIT 5

Accounting of Transactions of Foreign Currency

5.1           Accounting for Effects of Changes in Foreign Exchange Rates

The Accounting Standard 11: Accounting for effects of changes in Foreign Exchange Rates, comes into effect in respect of accounting periods commencing on or after 1-4-2004 and is mandatory in nature from that date. This revised standard supersedes the earlier (1993) Accounting Standard (AS 11).

1. Objective:

An enterprise may carry on activities involving foreign exchange i.e. it may have transactions in foreign currencies. In order to include foreign currency transactions in the financial statements of enterprise, transactions must be expressed into the enterprise’s reporting currency.

b.     Definitions:

The following terms are used in this statement with meanings specified:

1. Average rate is the mean of the exchange rates in force during a period.
2. Closing rate is the exchange rate at the balance sheet date.
3. Exchange difference is the difference resulting from reporting the same number of units of a foreign currency in the reporting currency at different exchange rates.
4. Exchange rate is the ratio for exchange of two currencies.
5. Fair Value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.
6. Foreign currency is a currency other than the reporting currency of an enterprise.
7. Monetary items are money held and assets and liabilities to be received or paid in fixed or determinable amounts of money.
8. Non-monetary items are assets and liabilities other than monetary items.
9. Reporting currency is the currency used in presenting the financial statements.

5.2           Translation of Transactions in Foreign Currency

1. Which Transactions Need to be Translated:

A concern may enter into the following transactions in foreign currency:

1. Import goods (where price is paid or payable in foreign currency);
2. Export goods (where price is received or receivable in foreign currency);
3. Purchase fixed assets (where price is paid or payable in foreign currency);
4. Take loan (and repay such loan; in foreign currency) to purchase fixed assets or for any other purpose;

b.     When transactions are translated:

1. Initial Recognition:

If the imports are on immediate cash payment basis, the Indian company will purchase US$ from say the State Bank of India (SBI) and remit such dollars to the party in U.S.A. The dollars will be purchased at the prevailing exchange rate. In this case, the translation into Rupees is done immediately. This is known as Initial Recognition.

Ii.            Recognition in Stages:

If the above import is on credit basis, the translation will be done at various stages i.e.

• On the date of purchase, the import bill will be recorded.
• If, on the date of the balance sheet, the bill is still outstanding, the creditors will be recorded.
• On the date of settlement, the payment, in US $ will be recorded.

Iii.            Accounting Problems:

At each stage the exchange rate may be different. This gives rise to two accounting problems-

• At what rate translation should be done on each date (purchase; balance sheet; payment); and
• If the exchange rates on these dates are different, how the gain or loss arising due to such difference should be recorded in the accounts.

c.     At What Rate Transactions Are Translated:

1. Spot Rate:

Transactions are translated at the exchange rate prevailing on the date of the transaction. This exchange rate is known as the spot rate. A transaction in foreign currency is recorded in rupees by applying to the foreign currency amount the exchange rate between rupee and the foreign currency at the date of the transaction.

5.3           Translation of Balances at Year-End

1. Which Balances need to be Translated:

After the initial recognition, the need for translation arises while preparing the balance sheet at the year-end. At this stage, the balances of following items denominated in foreign currency need to be translated into rupees:

1. Monetary Items:

Monetary Items are money held and assets and liabilities to be settled in fixed amounts of money, e.g. Foreign currency notes included in Cash on hand; balances in bank accounts denominated in a foreign currency; debtors, creditors or loans denominated in a foreign currency.

Ii.            Non- Monetary Items:

Non-monetary items are assets and liabilities other than monetary items e.g. Fixed assets, inventories, investment in equity shares.

b.     At What Rate Balances are translated:

1. Monetary Items:

Balances of monetary items e.g. Cash, receivables, payables etc. should be translated at the closing rate. However, where there are restrictions on remittances or where the closing rate is unrealistic, such item should be translated at the expected realizable value.

Ii.            Non-monetary items are carried at historical cost:

Balances of non-monetary items, valued at historical cost denominated in a foreign currency, should be translated at the exchange rate on the date of the original transaction.

Iii.            Non-monetary items carried at fair value:

Balances of non-monetary items which are carried in terms of fair value, denominated in a foreign currency, should be translated at the exchange rate that existed when such value was determined.

5.4 Journal Entries

Transactions which need to be translated:

Following four types of transactions are required to be translated.

1. Import of goods
2. Export of goods
3. Purchase of Fixed Assets
4. Foreign currency loans

X = Amount of transaction in Foreign Currency

R1= Foreign Exchange on the date of transaction

R2= Foreign Exchange on the date of settlement

R3= Foreign Exchange on the date of Year End

R4= Foreign Exchange on the date of settlement in the next year.

Note: Accounting treatment of profit/loss arising out of fluctuation of foreign currency exchange rate while making payment for purchase of Fixed Assets by a Ltd company

According AS 11 profit/loss arising out of fluctuation of foreign currency exchange rate should be treated as revenue item. This is applicable even in case of fixed assets.

However, as per Company Act, 2013 requirements, such exchange difference should be adjusted in the cost of respective fixed assets.

Since the syllabus of T Y B Com specifically states the application of AS 11 student should follow the AS11 and accordingly any such Profit/loss should be treated as revenue item.