AS 11 The Effects of Changes in Foreign Exchange Rates

Businesses might be involved in foreign exchange related transactions in a couple of ways. To include foreign operations and foreign currency transactions in their financial statements, the transactions should be expressed and reported in financial statements in the reporting currency of the enterprise.

AS 11 The Effects of Changes in Foreign Exchange Rates deals with the reporting of foreign exchange transactions in the financial statements

Applicability of AS 11 The Effects of Changes in Foreign Exchange Rates

The standard deals with the principal issue with respect to accounting for foreign operations and foreign currency transactions in deciding which exchange rate to be used and a guidance on recognizing the financial effect of changes in exchange rates in the financial statements.

The standard also deals with transactions in foreign currency which are in the nature of forwarding exchange contracts

• This standard doesn’t specify the currency in which companies represent their books of accounts. Though, a company usually uses the domiciled country’s currency. In case it employs a different currency, the Standard necessitates disclosing the reasons for the same. The Standard also requires disclosing the reasons for any change in reporting currency
• AS 11 does not deal with restating financial statements of any business from a reporting currency into another currency for the easing the users accustomed to such currency or for such similar purposes
• The Standard doesn’t deal with presentation of the cash flow statement of cash flows which arises due to transactions in the foreign currency and translation of cash flows of foreign operations
• The Standard also doesn’t deal with the exchange differences which arises from the borrowings in foreign currency to the point that they’re considered as an adjustment to the interest costs

Foreign Currency Transactions

Initial Recognition

A foreign currency transaction is any transaction that is denominated in or needs to settle in any foreign currency. Such foreign currency transactions must be recorded, on initial recognition in reporting currency, by applying the exchange rate between the foreign currency and the reporting currency to the foreign currency amount at the date of the transaction.

Reporting at Subsequent Balance Sheet Dates

At every balance sheet date:

• all the foreign currency monetary items must be reported at the closing rate. Though, in specific circumstances, the closing rate might not exhibit with reasonable accuracy amount in the reporting currency which is expected to be realized from. 
  In such scenarios, the monetary items must be reported in reporting currency at the value which is expected to be realized from, or needed to disburse, such monetary item at the balance sheet date;
• non-monetary items that are carried in terms of historical cost denominated in a foreign currency should be reported using the exchange rate at the date of the transaction; and
• non-monetary items that are carried at the fair value or similar valuation denominated in the foreign currency must be reported at the exchange rates prevailing when such values were determined

Recognition of Exchange Differences

Exchange differences which arise on reporting the enterprise’s monetary items at the rates different from the ones at which they’re recorded initially must be recognized the income or as an expense.

Case Study

X Ltd. bought fixed assets worth 3,000 lakh on 1.1.2006 and was financed by a foreign currency (US Dollar) loan which is payable in 3 equal annual installments. The exchange rates were 1 Dollar = INR 40.00 and INR 42.50 as on 1.1.2006 and 31.12.2006 respectively. The initial installment was rendered on 31.12.2006. The total difference in the foreign exchange is capitalized. Here, these transactions would be accounted as follows:

According to para 13, any exchange differences which arises on reporting the enterprise’s monetary items or settlement of monetary items at the rates different from the ones at which they’re recorded initially during the period, or reported in the previous financial statements, must be recognized as an income or an expense in the period in which it arises.

Computation of the Exchange Difference: 
Foreign currency (US Dollar) loan = `3,000 lakh ÷ 40 (Exchange rate on 1/1/2006) = USD 75 lakhs

Exchange difference = USD 75 lakhs × (42.50 – 40.00) = INR 187.50 lakhs. Hence, the entire loss arising due to the exchange differences of INR 187.50 lakhs must be charged to the profit and loss account for the respective year.AS 11 vs Ind AS 21

Para 46 and 46A

The broad principle is that the exchange differences should be taken to the profit or loss statement, notwithstanding the exchange difference which arises on the revenue account or the capital account. However, the Union Government of India, vide its notification issued on March 31st, 2009, inserted the above-mentioned paragraphs in the AS 11 The Effects of Changes in Foreign Exchange Rates

The exchange differences which arises on the account of a depreciable asset isn’t required to be charged to the profit or loss statement and might be added or reduced from the cost of such asset. This addition should be depreciated together with the asset over the useful life of such depreciable asset.

The underlining conditions are that such asset should be a depreciable capital asset and they’ve to be represented in the Balance sheet in the Foreign currency terms and it should be designated as “Long-term Foreign currency monetary item”. 

Tax Effects of Exchange Differences

Profit and losses on the foreign currency transactions and on the exchange differences which arises on the translation of financial statements of a foreign operation might have accompanying tax effects that are accounted as per AS 22, Accounting for Taxes on Income.