advance financial accounting

A

PROJECT

ON

“Study on Foreign Exchange Rate AS-11”

In the subject Advanced Financial Accounting

SUBMITTED TO

UNIVERSITY OF MUMBAI

FOR SEMESTER-I OF

MASTER OF COMMERCE

BY

SUNITA KUMARI YADAV

MCOM PART-I AND ROLL NO- 1890

UNDER THE GUIDANCE OF

Ms. FARAT SHAIKH

YEAR 2012-2013

DECLARATION BY THE STUDENT

I, SUNITA KUMARI YADAV student of M COM PART-I Roll Number 1890 hereby

declare that the project for the paper Advanced Financial Accounting Titled,

“Study on Foreign Exchange Rate AS-11”

Submitted by me for semester-I during the academic year 2012-2013, is based on actual

work carried out by me under the guidance and supervision of Ms. Farat shaikh.

I further state that this work is original and not submitted anywhere else for any

examination.

Signature of Student

EVALUATION CERTIFICATE

This is to certify that the undersigned have assessed and evaluated the project on

“Study on Foreign Exchange Rate AS-11”

Submitted by SUNITA KUMARI YADAV student of M COM Part-I.

This project is original to the best of our knowledge and has been accepted for internal

assessment.

Internal Examiner External Examiner Vice Principal

Ms. Farat shaikh Prof. A.N. Kutty

PILLAI’S COLLEGE OF ARTS, COMMERCE &

SCIENCE

Internal assessment : Project 40 Marks

Name of Student Class Division Roll

Number.

First Name: SUNITA

KUMARI

M COM

Father’s Name: B.B.S

PART I 1890

Surname: YADAV

Subject: Advanced Financial Accounting

Topic for the Project: “Study on Foreign Exchange Rate AS-11”

Mark Awarded

Signature

DOCUMENTATION

Internal Examiner

(Out of 10 Marks)

External Examiner

(Out of 10 Marks)

Presentation

(Out of 10 Marks)

Viva and Interaction

(Out of 10 Marks)

TOTAL MARKS (Out of 40)

CONTENTS

CHAPTER

NO.

TOPIC PAGE

NO.

1. Introduction 1

• MEANING 3

• Definition 4

• Objectives 5

• Scope 6

2. Foreign Currency Transaction 8

3. Financial Statement Of Foreign Operation 12

• Classification of Foreign Operation 12

• Integral 13

• Non-Integral 14

• Change in the classification of Foreign

Operation

16

4. Tax Effect Of Exchange Difference 16

5. Forward Exchange Contract 17

6. Conclusion 18

Foreign exchange rate AS-11

• Currency exchange rate refers

to the value of foreign nation’s

currency in terms of the home

nation’s currency.

• The exchange rate between

two currencies determines how

much one currency is worth in

terms of the other.

• There is always fluctuation in exchange rates. Different factors such as social,

political and economical factors tend to affect the currency exchange rates in the

currency market.

• The article below shares brief introduction to exchange rate and the types of

currency exchange rate. So, read on to get information about currency rate

exchange.

• There are two types of currency exchange rates.

1. The first one is the spot exchange rate that denotes the current exchange

rate.

2. While the other one is the forward exchange rate.

• Forward exchange rate basically refers to an exchange rate that is quoted and

traded today but for delivery and payment on a specific future date.

1

• Just going ahead with the introduction to online currency exchange rate, an

exchange system quotation is given by stating the number of units of quote

currency that can be exchanged for one unit of base currency.

• However, there is a market convention that determines which is the base

currency and which is the term currency.

• Direct quotation or price quotation in currency exchange rate basically refers to

the quotes that use a country's home currency as the price currency while

indirect quotation specifically refers to the quotes that use a country's home

currency as the unit.

• If a currency is free-floating, its exchange rate is allowed to vary against that of

other currencies and is specified by the market forces of supply and demand.

• Exchange rates for such currencies are likely to change almost constantly as

quoted on financial markets mainly by banks.

2

• In finance, an exchange rate (also known as the foreign-exchange

rate, FOREX rate or FX rate) between two currencies is the rate at which one

currency will be exchanged for another.

• It is also regarded as the value of one country’s currency in terms of another

currency.[1] For example, an interbank exchange rate of 91 Japanese yen (JPY,

¥) to the United States dollar (US$) means that ¥91 will be exchanged for each

US$1 or that US$1 will be exchanged for each ¥91.

• Exchange rates are determined in the foreign exchange market,[2] which is open

to a wide range of different types of buyers and sellers where currency trading is

continuous: 24 hours a day except weekends, i.e. trading from 20:15 GMT on

Sunday until 22:00 GMT Friday.

• The spot exchange rate refers to the current exchange rate. The forward

exchange rate refers to an exchange rate that is quoted and traded today but for

delivery and payment on a specific future date.

3

• A foreign exchange rate is the relative value between two currencies. In

particular, the exchange rate is the quantity of one currency required to buy or

sell one unit of the other currency

• Example:-

In travel, the exchange rate is

defined by how much money, or

the amount of a foreign currency,

that you can buy with one US

dollar. The exchange rate defines

how many pesos, euros, or baht

you can get for one US dollar (or

what the equivalent of one dollar

will buy in another country).

4

• An enterprise may carry on activities involving foreign exchange in two

ways. It may have transactions in foreign currencies or it may have foreign

operations.

• In order to include foreign currency transactions and foreign operations in the

financial statements of an enterprise, transactions must be expressed in the

enterprise’s reporting currency and the financial statements of foreign

operations must be translated into the enterprise’s reporting currency.

• The principal issues in accounting for foreign currency transactions and foreign

operations are to decide which exchange rate to use and how to recognize in

the financial statements the financial effect of changes in exchange rates.

5

a) This Standard should be applied:

(a) In accounting for transactions in foreign currencies;

and

(b) In translating the financial statements of foreign

operations.

In respect of accounting for transactions in foreign currencies entered into by the

reporting enterprise itself or through its branches before the effective date of the

notification prescribing this Standard under Section 211 of the Companies Act, 1956,

the applicability of this Standard would be determined on the basis of the Accounting

Standard (AS) 11 revised by the ICAI in 2003.

The Effects of Changes in Foreign Exchange Rates

• This Standard also deals with accounting f o r foreign currency

transactions in the nature of forward exchange contracts

• This Standard does not specify the currency in which an enterprise resents

its financial statements. However, an enterprise normally uses the currency of

the country in which it is domiciled.

• If it uses a different currency, this Standard requires disclosure of the

reason for using that currency. This Standard also requires disclosure of the

reason for any change in the reporting currency.

6

• This Standard does not deal with the restatement of an enterprise’s financial

statements from its reporting currency into another currency for the

convenience of users accustomed to that currency or for similar

purposes statements from its that currency or for similar purposes.

• This Standard does not deal with the presentation in a cash flow statement of

cash flows arising from transactions in a foreign currency and the translation

of cash flows of a foreign operation (see AS 3, Cash Flow Statements).

• This Standard does not deal with exchange differences arising from foreign

currency borrowings to the extent that they are regarded as an adjustment to

interest costs (see paragraph 4(e) of AS 16, Borrowing Costs).

7

A foreign currency transaction is a transaction which is denominated in or requires

settlement in a foreign currency, including transactions arising when an enterprise

either:

• Buys or sells goods or services whose price is denominated in a foreign currency;

• Borrows or lends funds when the amounts payable or receivable are denominated in a foreign currency

• Becomes a party to an unperformed forward exchange contract

• Otherwise acquires or disposes of assets, or incurs or settles liabilities, denominated in a foreign currency.

A foreign currency t r a nsac t i on should be recorded, on initial recognition in the

reporting currency, by applying to the foreign currency amount the exchange rate

between the reporting currency and the foreign currency at the date of the transaction.

8

Question:

On 31st December 2005 the following balances appered in the books of the Calcutta

branch of an English firm having its head office in London:

Particular Dr. Cr.

Stock on 1.1.2005 12600 -

Purchases and sales 75000 112500

Debtor and creditor 39000 26000

Bill of exchange 10400 9100

Wages and salaries 4800

Rent, rates and taxes 3600

Sundry charges 1500

Furniture and fixtures 4910

Bank balance 28990

London office 33200

Total 180800 180800

Stock on 31.12.2005 was Rs. 32500. Calcutta branch account in the books of London

office showed a debit balance of £ 2280 on 31.12.2005. Fixtures and furniture were

acquired from a remittance received from London of £ 350 which exactly covered the

cost of such fixtures etc.

The rate of exchange may be taken at

DATE RATE

31.12.2004 Rs. 14 per £

31.12.2005 Rs. 13 per £

The average rate for the year 2005 may be taken at Rs.12 per £

Prepare the trading and profit and loss account and balance sheet relating to Calcutta

branch in the London books.

9

Solution :-

Calcutta branch

Trading and profit and loss account

(For the year ended on 31.12.2005)

Particular £ Particular £

To opening stock 900 By sales 9375

To purchases 6250 By closing stock 2500

To gross profit c/d 4725 -

11875 11875

To wages and salaries 400 By gross profit b/d 4725

To rent, rates and taxes 300

To sundry expenses 125

To net profit 3900

4725 4725

Balance sheet of Calcutta branch as at 31st December 2005

10

Liabilities £ Assets £

London office

account:

Bank 2230

Balance existing

2280

Bill receivable 800

Add: profit

3900

6180 Debtors 3000

Stock 2500

Creditors 2000 Furniture and

fixtures

350

Bills payable 700

8880 8880

Working notes:

WN-1

Particular Rate per £

1

Dr. Rs. Cr. Rs. Dr. £ Cr. £

Stock 1.1.2005 14 12600 900

Purchase and sales 12 75000 112500 6250 9375

Debtors and

creditors

13 39000 26000 3000 2000

Bill of exchange 13 10400 9100 800 700

Wages and salaries 12 4800 400

Rent, rates and taxes 12 3600 300

Sundry charges 12 1500 125

Furniture & fixtures - 4910 350

Bank balance 13 28990 2230

London office - - 33200 - 2280

- 180800 180800 14355 14355

WN-2

Stock on 31st December 2005 Rs.32500; @ Rs.13 to £ 1 it is 2500

11

Classification of foreign operation

The method used to translate the financial statements of a foreign operation

depends on the way in which it is financed and operates in relation to the

reporting enterprise. For this purpose, foreign operations are classified as either

“integral foreign operations” or “non-integral foreign

• A foreign operation that is integral to the operations of the reporting enterprise

carries on its business as if it were an extension of the reporting enterprise’s

operations.

• For example, such a foreign operation might only sell goods imported from

the reporting enterprise and remits the proceeds to the reporting enterprise.

In such cases, a change in the exchange rate between the reporting currency

and the currency in the country of foreign operation has an almost

immediate effect on the reporting enterprise’s cash flow from operations.

• Therefore, the change in the exchange rate affects the individual monetary

items held by the foreign operation rather than the reporting enterprise’s

net investment in that operation.

• In contrast, a non-integral foreign operation accumulates cash and other

monetary items, incurs expenses, generates income and perhaps arranges

borrowings, all substantially in its local currency.

• It may also enter into transactions in foreign currencies, including transactions

in the reporting currency. When there is a change in the exchange rate

between the reporting currency and the local currency, there is little or no

direct effect on the present and future cash flows from operations of either

the non-integral foreign operation or the reporting enterprise.

• The change in the exchange rate affects the reporting enterprise’s net

investment in the non-integral foreign operation rather than the individual

monetary and non-monetary items held by the non-integral foreign

operation.

12

• Integral Foreign Operations

• The financial statements of an integral foreign operation should be translated

using the principles and procedures in paragraphs 8 to 16 as if the

transactions of the foreign operation had been those of the reporting

enterprise itself.

• The individual items in the financial statements of the foreign operation

are translated as if all its transactions had been entered into by the reporting

enterprise itself.

• The cost and depreciation of tangible fixed assets is translated using the

exchange rate at the date of purchase of the asset or, if the asset is carried

at fair value or other similar valuation, using the rate that existed on the

date of the valuation.

• The cost of inventories is translated at the exchange rates that existed

when those costs were incurred. The recoverable amount or realisable

value of an asset is translated using the exchange rate that existed when the

recoverable amount or net realisable value was determined. For example,

when the net realisable value of an item of inventory is determined in a

foreign currency, that value is translated using the exchange rate at the date

as at which the net realisable value is determined.

• The rate used is therefore usually the closing rate. An adjustment may be

required to reduce the carrying amount of an asset in the financial statements

of the reporting enterprise to its recoverable amount or net realisable value

even when no such adjustment is necessary in the financial statements of

the foreign operation.

• Alternatively, an adjustment in the financial statements of the foreign operation

may need to be reversed in the financial statements of the reporting

enterprise.

• For practical reasons, a rate that approximates the actual rate at the date of

the transaction is often used, for example, an average rate for a week or a

month might be used for all transactions in each foreign currency occurring

during that period. However, if exchange rates fluctuate significantly, the

use of the average rate for a period is unreliable.

13

• Non-integral Foreign Operations

• In translating the financial statements of a non-integral foreign operation for

incorporation in its financial statements, the reporting enterprise should use the

following procedures:

(a) the assets and liabilities, both monetary and non-monetary, of the non-integral

foreign operation should be translated at the closing rate;

(b) income and expense items of the non-integral foreign operation should be

translated at exchange rates at the dates of the transactions; and

(c) all resulting exchange differences should be accumulated in a foreign

currency translation reserve until the disposal of the net investment.

• For practical reasons, a rate that approximates the actual exchange rates, for

example an average rate for the period is often used to translate income and

expense items of a foreign operation.

• The translation of the financial statements of a non-integral foreign operation

results in the recognition of exchange differences arising from:

(a) Translating income and expense items at the exchange rates at the dates of

transactions and assets and liabilities at the closing rate;

(b) T ranslating the opening net investment in the non-integral foreign operation at an

exchange rate different from that at which it was previously reported.

(c) Other changes to equity in the non-integral foreign operation.

14

These exchange differences are not recognized as income or expenses for the period

because the changes in the exchange rates have little or no direct effect on the

present and future cash lows from operations of either the non-integral foreign

operation or the reporting enterprise. hen a non- integral foreign operation is

consolidated but is not wholly owned, accumulated exchange differences arising from

translation and attributable to minority interests are allocated to, and reported as part

of, the minority interest in the consolidated balance sheet.

• When the financial statements of a non-integral foreign operation are

drawn up to a different reporting date from that of the reporting

enterprise, the non-integral foreign operation often prepares, for purposes of

incorporation in the financial statements of the reporting enterprise,

statements as at the same date as the reporting enterprise.

• When it is impracticable to do this, AS 21, Consolidated Financial Statements,

allows the use of financial statements drawn up to a different reporting

date provided that the difference is no greater than six months and

adjustments are made for the effects of any significant transactions or

other events that occur between the different reporting dates.

• In such a case, the assets and liabilities of the non-integral foreign

operation are translated at the exchange rate at the balance sheet date of

the non- integral foreign operation and adjustments are made when

appropriate for significant movements in exchange rates up to the

balance sheet date of the reporting enterprises in accordance with AS 21.

15

• Change in the Classification of a Foreign Operation

When there is a change in the classification of a foreign operation, the translation

procedures applicable to the revised classification should be applied from the date of the

change in the classification.

The consistency principle requires that foreign operation once classified as integral or

non-integral is continued to be so classified. However, a change in the way in which a

foreign operation is financed and operates in relation to the reporting enterprise may lead to a

change in the classification of that foreign operation. When a foreign operation that is integral

to the operations of the reporting enterprise is reclassified as a non-integral foreign operation,

exchange differences arising on the translation of non-monetary assets at the date of the

reclassification are accumulated in a foreign currency translation reserve. When a non-integral

foreign operation is reclassified as an integral foreign operation, the translated amounts for non-

monetary items at the date of the change are treated as the historical cost for those items in the

period of change and subsequent periods. Exchange differences which have been deferred are

not recognized as income or expenses until the disposal of the operation.

• Gains and losses on foreign currency transactions and exchange differences arising on

the translation of the financial statements of foreign operations may have associated tax

effects which are accounted for in accordance with AS 22, Accounting for Taxes on

Income.

16

An enterprise may enter into a forward exchange contract or another financial

instrument that is in substance a forward exchange contract, which is not intended for

trading or speculation purposes, to establish the amount of the reporting currency required

or available at the settlement date of a transaction. The premium or discount arising at the

inception of such a forward exchange contract should be a mortised as expense or income

over the life of the contract. Exchange differences on such a contract should be recognized

in the statement of profit and loss in the reporting period in which the exchange rates

change. Any profit or loss arising on cancellation or renewal of such a forward exchange

contract should be recognized as income or as expense for the period.

• The risks associated with changes in exchange rates may be mitigated by entering into

forward exchange contracts. Any premium or discount arising at the inception of a

forward exchange contract is accounted for separately from the exchange differences on

the forward exchange contract.

• The premium or discount that arises on entering into the contract is measured by

the difference between the exchange rate at the date of the inception of the forward

exchange contract and the forward rate specified in the contract.

• Exchange difference on a forward exchange contract is the difference between

I. The foreign currency amount of the contract translated at the exchange rate at the

reporting date, or the settlement date where the transaction is settled during the

reporting period,

II. The same foreign currency amount translated at the latter of the date of inception of

the forward exchange contract and the last reporting date.

• In recording a forward exchange contract intended for trading or speculation

purposes, the premium or discount on the contract is ignored and at each balance sheet

date, the value of the contract is marked to its current market value and the gain or loss

on the contract is recognized.

17

The Statement is applied in accounting for transactions in foreign currency and

translating financial statements of foreign operations. It also deals with accounting

of forward exchange contract.

• Initial recognition of a foreign currency transaction shall be by applying the

foreign currency exchange rate as on the date of transaction. In case of voluminous

transactions a weekly or a monthly average rate is permitted, if fluctuation during

the period is not significant.

• At each Balance Sheet date foreign currency monetary items such as cash,

receivables, and payables shall be reported at the closing exchange rates unless there

are restrictions on remittances or it is not possible to affect an exchange of currency

at that rate. In the latter case it should be accounted at realizable rate in reporting

currency. Non monetary items such as fixed assets, investment in equity shares

which are carried at historical cost shall be reported at the exchange rate on the date

of transaction. Non monetary items which are carried at fair value shall be reported

at the exchange rate that existed when the value was determined.

18