1.25 Query: Translation of financial statements of foreign branches.
1. A corporation is engaged, principally, in the business of exports of handicrafts, handlooms, carpets, garments and gold jewellery etc. The export turnover during the year 1991-92 amounted to Rs. 169.18 crores (provisional). The corporation has selling outlets in Paris and New York, selling-cum-order booking outlet at Neuss (Germany) and a liaison office at Japan.
2. The financial statements of foreign branches of the corporation are required to be incorporated in the final accounts of the corporation and these require translation from the foreign currency to Indian rupees. The translated financial statements are subject to the main principle of “true and fair view” as are the ones expressed in rupees for domestic transactions.
3. The procedure followed by the corporation for translation of financial statements of foreign branches is as stated below:
(i) Revenue Items (Expenditure/Income):
At the average rate as prevailing on the first and the last day of the accounting year.
(ii) Current Assets/Current Liabilities:
At the closing rate prevailing as on the date of the balance sheet.
(iii) Opening Stock:
As valued at the end of the previous accounting year.
(iv) Closing Stock:
As valued at the closing rate prevailing as on the date of the balance sheet. However, items out of the opening stock, which are included in the closing stock are also valued at the current closing rate, i.e., appreciation on this accounts is taken in the valuation of the closing stock as on the date of the balance sheet.
(v) Fixed Assets:
At the rates in force at the close of the month in which the assets were acquired.
(vi) Depreciation:
At the rate used for translation of values of the assets on which depreciation is calculated.
(vii) Branch Balance in Head Office Books:
After all inter-office transactions are duly recorded/responded, the head office account as per branch books is translated to be equal to branch account stated rupees in head office books. The exchange difference is credited or charged to difference in exchange account in the branch books.
(viii) Translation of items in the financial statements of the foreign branches:
The exchange difference arising out of translation of the items in the financial statements of the foreign branches for the purpose of preparing consolidated accounts is credited or charged to profit and loss account in the head office’s books of account.
The following disclosures are made in the notes forming part of the accounts under significant accounting policies:
Conversion into Indian currency:
“The balances in the books of account of foreign offices, maintained in India in foreign currencies, are converted into Indian currency at the TT buying rates as certified by our bankers as under:
(i) Current assets and current liabilities at the current rates.
(ii) Revenue income and expenses at the average rates.
(iii) Opening inventories, at rates adopted in the previous year.
(iv) Fixed assets bought at the foreign offices at rates in force at the close of month of their acquisition.”
4. The government audit team, during the course of audit of accounts for the financial year 1990-91, raised the issue that while valuing closing stocks, if any item out of the opening stock is included, such item has to be valued at the rates prevalent at the year end, in which such stocks were acquired. In other words, the closing stocks which are over one year old, should be valued at the closing rates prevalent in the previous years in which such stocks were acquired. However, the management is of the opinion that valuation of the closing stocks, including stocks over one year, at the current closing rates is in conformity with the relevant provision of Accounting Standard 11, issued by the Institute of Chartered Accountants of India.
5. In July 1991, the government had announced steep devaluation of the Indian rupee vis-à-vis major foreign currencies. Till recently, the corporation had been translating revenue items at the simple average rate. However, in view of the steep devaluation in July 1991 of the Indian rupee, the corporation proposes to translate the revenue items at the weighted average rate as provided in paragraph 13 of Accounting Standard 11.
6. Further, w.e.f. 3.3.1992, the government has introduced the scheme of “Liberalised Exchange Rate Management System” (LERMS) under which the banks announce two rates – (1) the official rate of exchange and (2) the market rate of exchange. Under LERMS, all remittances received in India including invisible receipts are converted 40% at the official rate of exchange and 60% at the market rate of exchange. Prior to 3.3.1992, the foreign exchange required for remitting to the foreign branches for meeting the maintenance expenditure of the foreign branches was being acquired at the official rate of exchange. However, under the new system, foreign exchange requirement for the maintenance of the offices abroad is now to be acquired at the market rate of exchange. The corporation remits funds to the foreign offices for maintenance after obtaining permits from the Reserve Bank of India.
7. The foreign branches are independent profit centres. Despatches of trading stocks to the foreign branches are made at cost. After the introduction of LERMS, the corporation proposes to record the foreign currency transaction, i.e., despatches of trading stocks to foreign shops, at the official rate of exchange and the difference between the official rate of exchange and the market rate of exchange on 60% of the value of despatches are to be recorded as “Premium on convertible rupee element of exports”.
8. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(a) Whether the procedure followed by the corporation in translating the financial statements of the foreign branches and the disclosure made in the notes forming part of the accounts under “Significant accounting policies” (as stated in para 2 above) is in conformity with the relevant provisions of Accounting Standard 11, issued by the Institute of Chartered Accountants of India.
(b) Whether the closing stocks, which include items out of the opening stock, are to be valued at the current closing rate or whether the items out of the opening stock are to be valued at the closing rate prevalent at the time of the acquisition of the stocks, as contended by the government auditors.
(c) Whether, in view of the steep devaluation of the Indian Rupee, it would be appropriate to apply weighted average rate for the translation of the revenue items (Expenditure/Income) for the financial year 1991-92.
(d) After the introduction of “LERMS” under which banks quote two rates, viz., official rate of exchange and market rate of exchange:
(i) Whether the official rate or the market rate has to be applied for arriving at the average rate for the purpose of translating revenue items.
(ii) Whether the official rate or the market rate has to be taken as the closing rate for translating current assets, current liabilities and closing stock.
(iii) Whether, in view of the fact that foreign exchange for meeting maintenance expenses for foreign branches is to be acquired at the market rates of exchange, the overhead expenses are to be translated at the market rate of expenditure.
(iv) Whether, in view of the fact that 40% of the remittances to India would be converted at the official rate of exchange and 60% at the market rate of exchange, despatch of trading stocks to foreign branches can be recorded at the official rate of exchange and the difference of the official rate of exchange and the market rate of exchange on 60% of the value of despatches may be recorded as “Premium on convertible rupee element of exports” and revenue income of the foreign branches, viz., sales, other income, etc. can be translated at the official rate of exchange.
The querist has further clarified that a suitable disclosure will be made in the notes forming part of the accounts under ‘Significant accounting policies’, depending upon the opinion of the Committee received in respect of issues raised in para 8(a) to 8(d) above.
Opinion* October 7, 1992
1. The Committee notes paras 13, 28 to 32 and 34 of Accounting Standard (AS) 11 on ‘Accounting for the Effects of Changes in Foreign Exchange Rates’, issued by the Institute of Chartered Accountants of India, which state as below:
“13. In certain special circumstances, a weighted average rate is considered more appropriate for the translation of revenue items in the financial statements of foreign branches. Examples of such circumstances would be:
(a) When the income or expenditure is not earned or incurred evenly during the accounting period, e.g., in seasonal businesses.
(b) When there are exceptionally wide fluctuations in exchange rates during the accounting period.”
“28. Revenue items, except opening and closing inventories and depreciation, should be translated into Indian Rupees at an average rate or the closing rate. In the circumstances mentioned in paragraph 13 above, weighted average rate may be applied. Opening and closing inventories should be translated at the rates prevalent at the commencement and close respectively of the accounting period. Depreciation should be translated at the rates used for the translation of the values of the assets on which depreciation is calculated.
29. Current assets and current as well as long-term liabilities should be translated at the closing rate.
30. Fixed assets should be translated at the original rate. However, any material difference between the amount at which liabilities related to fixed assets are stated using the closing rate and amount at which such liablities were stated at the end of the previous accounting period, should be regarded as an adjustment of cost and included in the carrying amount of related fixed assets.
31. Balance in ‘head office account’ in branch books should be translated into Indian rupees at the corresponding balance appearing in the ‘branch account’ in the books of the head office after adjusting for unresponded transactions.
32. The net exchange difference resulting from the translation of items in the financial statements of a foreign branch should be charged or credited to the Profit and Loss Statement, except to the extent adjusted in the carrying amount of the related fixed assets in accordance with paragraph 30 above.”
“34. The following disclosures should be made with regard to accounting of foreign currency transactions or translation of financial statements of foreign branches:
(a) The methods used in (i) converting closing balances of assets and liabilities related to foreign currency transactions remaining unsettled at the end of the accounting period and (ii) translating financial statements of foreign branches.
(b) The accounting treatment of exchange difference, showing separately (i) the amount of loss recognised in the Profit and Loss Statement (ii) the amount of loss or gain included in the carrying amount of fixed assets and (iii) the amount deferred in respect of loss related to long-term liabilities.”
2. The Committee further notes that para 2 of Accounting Standard 11, defines the term exchange rate as follows:
“Exchange Rate: The rate quoted by a bank or other authorised dealer in foreign exchange at which the Rupee may be exchanged for a unit of a foreign currency or a foreign currency may be exchanged for a unit of the rupee.”
3. The Committee also notes the following paras 11 and 12 of Accounting Standard (AS) 5 on Prior Period and Extraordinary Items and Changes in Accounting Policies, issued by the Institute of Chartered Accountants of India:
“11. A change in an accounting policy should be made only if the adoption of a different accounting policy is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements of an enterprise.
12. Any change in an accounting policy which has a material effect should be disclosed. The impact of, and the adjustments resulting from, such change, if material, should be shown in the financial statements of the period in which such change is made to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact should be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.”
4. On the basis of the above the Committee is of the view that the exchange rate for the purpose of Accounting Standard 11 means rate of exchange at which one can exchange a unit of foreign currency into Indian Rupee. This rate may be quoted by the Reserve Bank of India or any other authorised dealer. Hence, the definition of exchange rate, as stated in para 2 above, covers both official rate of exchange (quoted by the RBI) as well as the market rate of exchange (quoted by the Foreign Exchange Dealers Association of India).
5. In respect of the issue emerging from the partial convertibility of the rupee the Committee is of the view that Accounting Standard 11, requires the conversion of foreign currency transactions into Indian rupees using the relevant exchange rate, i.e., the rate at which the corporation can exchange a unit of foreign currency into Indian rupee in India. Hence, the rate to be adopted for the purpose of conversion of foreign exchange transactions or translation of financial statements of the foreign branches would depend on the fact that at which rate the company can acquire the foreign currency to pay its foreign exchange liabilities or can get its foreign exchange receipts converted into Indian rupees.
6. The Committee assumes that there is no change in the value of the items of opening stock, as expressed in terms of relevant foreign currency, included in closing stock of the company and the query regarding valuation of such items of closing stock relates only to the rate of exchange to be adopted for conversion of such items of closing stock which were also part of the opening inventory of the company.
7. On the basis of the above, the Committee is of the following opinion, in respect of the issues raised by the querist in para 8 of the query:
(a) The procedure followed by the company and the disclosures made as stated in the query are broadly in accordance with AS 11.
(b) The whole of closing stocks should be valued at the rate prevailing on the balance sheet date irrespective of the fact that it may include some items out of the opening stocks. The obsolescence, if any, in the old inventory items would be taken care of in case the inventories are valued at the lower of cost and net realisable value.
(c) Yes, the company can apply weighted average rates for the purpose of translating the revenue items of branch’s financial statements subject to the recommendations made in paras 13 and 14 of AS 11 and paras 11 and 12 of Accounting Standard 5, as reproduced in above.
(d) (i) In case of revenue receipts, for arriving at the average rates, such exchange rate(s) should be used at which each unit of foreign currency received or receivable was or can be converted into Indian rupee. Similarly, in case of revenue expenditure such rate(s) should be used at which each unit of foreign currency was or can be obtained for the amount paid/payable in respect thereof.
(ii) In respect of conversion of current assets, that rate(s) of exchange should be used at which the realisation thereof, if received on the balance sheet date, would get converted into Indian rupees. Similarly, in case of current liabilities, such rate(s) should be applied at which the company will have to acquire foreign exchange, for paying such liabilities, on the balance sheet date.
(iii) Yes.
(iv) The despatches of trading stocks from the head-office to branches could be recorded at rupee value in the books of the head office. If this is done, there would be no need to translate this item. However, in case the despatches are recorded in the foreign currency, the conversion should be made at the official rate applicable in respect of 40% of despatches and at the market rate in respect of the remaining despatches.
*It may be mentioned, that in view of the partial convertibility of the rupee and other related developments in the changed economic environment, the Council of the Institute of Chartered Accountants of India decided to revise Accounting Standard 11. Accordingly, the Council resolved that the mandatory application of this Accounting Standard shall stand postponed to accounts for period commencing on or after 1st April, 1993. Since the recommendatory status of the Standard was in existence at the time of the issuance of the opinion, it formed the basis of the opinion. Subsequently, in August, 1993, the Standard was withdrawn on the issuance of the Exposure Draft of the revised AS 11. _____________________________
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