Indian Accounting Standard & Exchange Rates Effect

By: Dr. A. Oliver Bright

Indian Accounting Standard and Effect of Changes in Foreign Exchange Rates

As a part of liberalization policy, the Govt. of India incorporated many changes in the Exchange Systems. The LERMS (Liberalized Exchange Rate Management Systems) facilitated many Indian Companies to conserve them in Forex contracts. The Liberalized Exchange Risk Management Inter alias, permitted companies to cancel "Forward exchange contracts" if the exchange rates moved in their favor. This made certain question to the accounting aspects, which cannot be answered by the "Accounting Standard" (AS-11) of "Institute of Chartered Accountants" of India (ICAI). The LERMS thrusts the following question.

Companies are permitted to cancel forward contracts on exchange if it moves favorably to them. Then

1.How should such profit be treated?
2.Should they be taken to income statement?
3. Should they be credited to Asset A/C?
4. What is the treatment for rollover charges?

There were no transparent principles or standards or guidelines in Indian Accounting Standards to answer these questions. So the companies exercised its discretion in accounting such items in the books of accounts.

The audit report of TISCO Ltd for 1992-93 showed the net excess on cancellation of some contracts. The contract was related to loan utilized for the purchase of Fixed Assets. It showed 14 crores rupees after adjusting the roll over charges under "Extra Ordinary Items" in Profit and Loss Account. It was given under the note.22 of the Auditor's Report.

The ICAI realized the emergence of Accounting Treatment for such item and introduced the AS-11 (Revised). ICAI made it mandatory to follow the AS-11 (Revised) from 01/04/04 for any effect on Exchange Rate.

Provisions of AS-11 (Revised)

1.The enterprise must apply the following statement
a. Accounting for transactions in Foreign Currencies
b.Translating the financial statement of foreign operations for inclusion in the financial statement of the enterprise.

2. Recording the transaction on initial recognition.
A foreign currency should be recorded in the reporting currency. The reporting currency is the currency used for presenting it in the Financial Statement.
The amount must be based on the conversion of the spot rate. The spot rate is the rate on the date of transaction.
3. Effect of changes in Exchange rates subsequent to initial recognition.
For balance sheet recognition the foreign exchange assets and liabilities are divided under
a. Monetary items.
b. Non- monetary items.

Monetary Items
Monetary items are defined as money held, assets and liabilities to be received or paid in fixed determinable amount of money.
Exchange rates are foreign currency notes, balance in bank account denominated in foreign currency, receivables, payable, loans denominated in foreign currency etc.
The rate for converting the monetary items or non-monetary items for balance sheet purpose is as follows.
Monetary items- Closing rate i.e. the rate on the balance sheet date. If closing rate is not accurate, approximation may be allowed.

Non-Monetary items
1.At historical cost. The rate is the rate prevailing on the date of transaction.
2.When terms like realizable value, face value etc used, the rules in existence related to that terms must be used to determine the value.

Purchase of Fixed Assets:
The value must be at the closing rate (Rate of the date of Balance Sheet). The rate difference due to translation of a liability on such purchase must be treated as income or expense for that particular period in which they arise.

Forward Contract
In the case of forward contract the currency rate of both the countries will be reflected, it should be recognized as interest income or expense over the life of the contract.
If the forward contract is made for the purchase of fixed asset, the premium or discount should be adjusted with the cost of the fixed asset.

Cancellation of Forward Contract
The profit or loss due to the cancellation of forward contract must be treated as income or expense. But, if it arises out of liability on purchase of fixed assets, profit or loss must be adjusted with cost of fixed assets.

Translation of various Items
1. Opening Stock - Exchange rate at the commencement of the accounting
2. Closing Stock - Rate at the end of Accounting Period.
3. Revenue Items - Average rate (a) means of the rates during that period
(b) Weighted average is applied where there is wide
Fluctuation and when the income and expenses are not
Earned or incurred evenly.
4. Depreciation - Value of the asset used for depreciation.
5. Monetary items - Closing rate.
6. Non- monetary items - Rate on the transaction date.
7. Balance of Branch at
Head Office Account - Translate it in reporting currency after adjusting the
Unreported transactions.

Disclosure of Financial Statements:
1.The amount of exchange difference in profit and loss account.
2.The amount of exchange difference adjusted in fixed assets.
3.The difference out of forward exchange contrast not included in profit & loss account.

The AS -11 (Revised) accommodated most of the accounting concepts but there is a confusion created in
1.Realization concept and
2.Period concept

There are certain problems in realizing the amount out of foreign exchange transaction. If the amount realized is in a specific period itself this problem does not arise. When uncertainty exists the period concept is also get confused in the application of AS-11 (Revised). The Institute Of Chartered Accountants Of India (ICAI) may give standard guidelines by considering the contingencies and controversy exists in realization and period. This would facilitate more clarity and transparency in books of accounts and financial statements.


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