Accounting Standards

Need For Standards

BACKGROUND

Business activities are varied. Strenuous task to present the facts intelligibly, in a summarized form. Methods & Principles adopted by various reporting enterprise are cohernt, not misleading. Information to the extent possible Uniform & Comparable Standards are evolved. Discipline Guidelines [i.e Uniform practices & Common techniques]. Yardsticks for evaluation [i.e Comparative analysis]. It greatly enhances the users of FS like Investor {AS 13},Employees, Lenders, Creditors, Suppliers, Governments. To eliminate confusing variations in the treatment of several accounting aspects. To bring Feasibility & Uniformity in presentation. AS is an authoritative pronouncement of code of practice. It intend to apply only to material items.

It Provides

Objective

Other Factors

 Compilation with Companies Act 1956

As per section 211 of Cos Act 1956 Sub sec (3A) Every P&L a/c, and Balance Sheet should comply with AS. Sub sec (3B) if not complied then following should be disclosed: Deviation from AS Reason for such deviation {AS1} Financial effect, if any arising. Sub sec (3C) AS means as recommended by ICAI As per section 217 of Cos Act 1956 sub sec (2AA) Boards report shall also include a Directors Responsibility Statement, indicating : The preparation of Annual Accounts are in compilation of applicable ASs As per section 227(3) Powers & Duties Of Auditors Auditors report shall also state that in his opinion, P&L and Balance Sheet are complied.

EFFECTIVE DATE 01ST APRIL,2004

Why Foreign Currency transaction (FCT) arises?

OR
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Lack of Technology

Cheap Manpower

OR

Globalization Holding/Subsidiary/Branches/JVs/Associate

Because of following reasons FCT arises;

Dealings of an entity with clients who is in other currency country. Activity undertaken through Branch Business with Associates (AS -23) Holding/Subsidiary relationship Business with Joint Ventures (AS -27)

This AS address two principal issues;

Selection of an appropriate rate to be used for a transaction

Manner in which financial effect of change in exchange rates should be recognized in the separate financial statement of an enterprise, and also in the Consolidated Financial Statements (AS -21)

Effects in Changes in Forex Rates

FOREIGN CURRENCY TRANSACTIONS
1.INITIAL RECOGNITION.

TRANSLATING FINANCIAL STATEMENTS OF FOREIGN OPERATIONS

1.CLASSIFICATION INTO INTEGRAL & NON INTEGRAL.
2.DISPOSAL OF NON INTEGRAL OPERATIONS. 3. CHANGE IN CLASSIFICAION. 4.TRANSLATION PROVISIONS.

2.REPORTING AT SUBSEQUENT BALANCE SHEET DATES.

3.RECOGNITION OF EXCHANGE DIFFERENCES.

FORWARD EXCHANGE CONTRACTS TAX EFFECTS OF EXCHANGE DIFFERENCES DISCLOSURE

Note: AS 11 does not deal with the re-statement of the Financial Statements in different currency

Required because of following Transactions;-

Buying & Selling of Goods & Services

Borrowing & Lending Money. Acquiring or Disposing of Fixed Assets.

The above Transactions should be recorded by applying Exchange Rates. In some cases Average Rates are also applied. Reporting Entity should normally establish an appropriate accounting policy and disclose the same in Financial Statements.

For Reporting at the end of the each accounting period, items in Balance Sheet required to be classified into following:-

Monetary Items
Money held and assets and liabilities to be received or paid in fixed or determinable amounts of money.

Non Monetary Items

Assets and Liabilities other than monetary items.

Examples ; Cash, Debtors, Creditors.

Examples ; Fixed Assets, Inventories and Investments in Equity Shares.

FOR TRANSLATION OF BALANCE SHEET ITEMS THAT ARE DENOMINATED IN FOREIGN CURRENCY, THE FOLLOWING PRINCIPLES APPLY:

CLOSING RATE FOR THE FOLLOWING:-

1.Monetary Items, excepting that restrictions on remittances etc.

TRANSCTION DATE RATE OR RATE EXISTED ON FAIR VALUE ESTIMATION:1.For Non- Monetary Items

SELECTION OF RATES FOR TRANSLATION IS BASED ON THE FOLLOWING PRINCIPLE

Grouping of Non Monetary Items

Those that are carried at Historical Cost Those that are carried in terms of Fair Value or similar valuation

Stipulation Regarding Exchange Rate

Rates applicable on the date on which transaction was originally concluded Rates applicable on the date on which Fair value or similar valuation was determined.
MANOJ P DESAI

The rule of CAPITALISING THE EXCHANGE DIFFERENCE HAS BEEN WITHDRAWN after companies act adopted AS 11 as its Accounting Standard from Effective Date 07th December,2006. The Exchange difference should be charged to Profit & Loss account.
Three reasons for the change:1.RBIs ability to bring about a turn around in the forex reserves position .
OBSERVE THIS PICTURE

Important Note.

2. Availability of a variety of derivative instruments to enterprises which enable them to hedge their open positions effectively with little strain on managing transaction risk. 3.Need to realign accounting practices in India with International practices.

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SPACE BAR

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.

A Transaction relating to a monetary item being settled at the rate different from the rate at which it was initially recorded (initial recognition)

A Transaction being reported at a rate different from the rate at which it was either initially recorded (balance sheet reporting)

A Transaction being settled at a rate different from the one taken for reporting in the last financial statement (settlement)

AS-R LAYS DOWN THE FOLLOWING PRINCIPLE FOR RECOGNITION OF EXCHANGE DIFFERENCES:-

Example

INCOME or EXPENSE in the PERIOD in which they arise

Exchange Difference should be transferred to FCTR - NONINTEGRAL OPERATIONS

Note
Transaction Date Intervening Reporting Date Settlement Date Period in which Exchange Difference arise

12th January

31st March

24th April

a) 12th Jan to 31st Mar. b) 1st Apr to 24th Apr. 15th Sept to 10th Jan since it is in same year. a) 2nd Oct to 30th Nov. b) 1st Dec to 20th Dec.

15th September

NIL

10th January

02nd October

30th November

20th December

Where an entity has nonintegral foreign operations, the exchange differential attributable to some monetary items having specific characteristics should be accumulated in FOREIGN CURRENCY TRANSLATION RESERVE ACCOUNT

NOW WE ARE ENTERING INTO A NEW CONCEPTS WHICH IS INCLUDED IN REVISED AS-11

IMPORTANT TO NOTE;

FOREIGN OPERATIONS Indian company

having foreign branch has been brought FOREIGN OPERATIONS into ambit of FOREIGN OPERATIONS.

NON-INTEGRAL

Foreign operations is a subsidiary, It is essential to an enterprise to classify all its operations Associate, Joint term is defined be it a branch, an associate, a joint venture This or a Venture, or Branch of negatively. It is an the reporting subsidiary. Into either INTEGRAL OR NON INTEGRAL operation that is not enterprise, the FOREIGN OPERATIONS. an integral foreign INTEGRAL FOREIGN activities of which operation. OPERATIONS based or conducted in The objective of this classification into IFO or a country other than NIFO is to get the financial statements to the country of the An Integral Foreign reporting enterprise. produce results, that are Operations is a compatible results with foreign operation, the companys cash effect of the rate changes on activities of which are flows and on its an equity. integral part of those of the reporting enterprise.

Classification in the manner will lead to selection of an appropriate method for translation of foreign operations of an entity for the purpose of reporting.
MANOJ P DESAI

Points to be noted in this regard; 1. 2. 3. 4. Nature of overseas operations. Foreign branch carries on its operations as if it were an extended arm of the reporting entity. Forex impact is directly related to on cash flows of reporting entity. Such an impact will arise from and will be relatable to all monetary items.

EXAMPLES FOR IFOS ARE GIVEN BELOW; 1. 2. 3.

Changes in exchange rates can have a direct effect on the cash flows of Entity acts as a Selling Agents reporting entity. theyentity do,or then will Entity setup to Raise a Finance to help If investing for Taxthey reasons be IFO
Translation of FINANCIAL STATEMENTS OF IFOS;ITEMS

Entity Produces raw material or component, and transfers the goods for inclusion in the ultimate product being manufactured by investing company.

SELECTION OF RATE Rate applicable on the date of transaction Date of Purchase. Date on which fair value determined Date on which such value or amunt was determined (closing rate) Closing Rate

Initial Recognition Cost and Depreciation of Tangible Fixed Assets Assets carried at fair value Assets that are shown at realizable value or recoverable amount Contingent liability

Resulting exchange difference to be RECOGNISED IN THE PROFIT AND LOSS ACCOUNT.

Point to be noted in this regard; The reporting entity to exercise CONTROL over foreign operations, is not necessarily a determinant factor. Indications to test whether the entity is an NFO: 1. 2. 3. 4. 5. Nature, Size, Frequency and materiality of transactions of foreign entity with reporting entity. Extent of Autonomy (Dependent/Independent)

An NFO accumulates cash and other monetary items, incurs Cost of Production or services being incurred and settled in its local currency. expenses, generates income and arranges borrowings, all Sales being in currencies other than reporting currency. substantially in local currency. The above are indications but still we need to exercise our judgment to decide it as NFO or IFO. Change in forex will not have direct impact on cash flows of reporting entity.
Translation of FINANCIAL STATEMENTS OF NFOS;-

Mode of Financing (Local currency borrowings rather from reporting entity)

The effectITEMS if any would be traceable to a change inOF the Net SELECTION RATE Investment in Foreign of reporting entity. Assets and Liabilities (Balance Sheet items) Operations both Apply Closing Rate
monetary and non-monetary Income and Expenses Apply the Rate relevant on the date of Transactions Resulting Forex should be accumulated in FOREIGN CURRENCY TRANSLATION RESERVE (FCTR), UNTIL DISPOSAL OF NET INVESTMENT OF THAT NFO.

Goodwill or Capital Reserve arising on acquisition of NFO (Subsidiary) should be translated at Closing Rate

Points to be noted in this regard

1. Normal consolidation procedures such as elimination of intragroup transactions of subsidiary, associate, JV, Etc should be applied. Exchange differences attributable to monetary items should be recognized as INCOME OR EXPENSE in case of IFO and to be accumulated in FCTR in case of NFO.

2.

3.
4.

Financial Statements of different reporting dates can be used subject to conditions laid down in AS 21.
Principles laid down in AS 23 and AS 27 should also be applied.

TAX EFFECTS OF FOREIGN EXCHANGE RATES:Here comes relation to AS 22 (Timing Difference) when a foreign branch is changed its identity from IFO (Forex recognized in P&L account) to NFO (where Forex is accumulated in FCTR account)

There are two types of transactions as given below;-

ENTERED FOR HEDGING PURPOSES

ENTERED FOR SPECULATIVE PURPOSES

This is done in the intention of managing or minimizing risks a risk associated with changes in Forex Premium (Loss)/Discount (Gain) arising out of contract should be recognized over the tenor of the contract period. But any Profit or Loss arising on Cancellation or Renewal of contract to be recognized as Income or Expense for the Period

The Gain/Loss arising out of Speculative Contract to be computed and should be recognized on the Reporting Date" (Balance Sheet Date)

1. 2.

Amount of Forex differences included in the Net Profit or Loss for the Period. RELATED IAS IS GIVEN BELOW Net Forex differences accumulated in FCTR (as owners equity)

3.

If the reporting currency is different from the currency of the country in which the reporting entity is domiciled (registered office), this should be disclosed with explanatory notes.
Reconciliation between opening and closing balance in the said reserve account to be highlighted.

4.

5.

A change in classification of significant foreign operation, additional disclosures are called for in the following areas;a. Nature of change in classification b. Reasons c. Impact of such change on shareholders funds d. Impact on P&L account for the period.

Change in Forex occurring after balance sheet date is disclosed in accordance with AS 4.