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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
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
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.
At every balance sheet date:
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.
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
|Particulars||Ind AS 21||AS 11|
|Forward exchange contracts||Ind AS 21 disregards the forward exchange contracts and similar other financial instruments from its scope which are treated as per Ind AS 39||AS 11 doesn’t exclude accounting for such contracts|
|Functional currency approach||Ind AS 21 is based on the functional currency approach||AS 11 isn’t based on such approach|
|Foreign operation accounting||Ind AS 21 is based on the functional currency approach||AS 11 is based on the integral and non-integral foreign operations method for accounting for the foreign operation|
|Presentation Currency||Under Ind AS 21, the presentation currency could be different from the local currency and it prescribes a detailed guidance on the same||AS 11 doesn’t explicitly prescribes this|
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”.
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.