1.9 Query: Accounting for loss on exchange.
1. The querist is engaged on export of canalised minerals and non-canalised items and import of canalised metals, fertilizers, industrial raw materials and non-canalised items.
2. The querist has stated that the payments for all imports are made by the corporate office only and consequent on the directive from the Ministry of Finance, all the payments for imports are covered under ‘Bankers Acceptance Facility’ (BAF). Under BAF, bank account is debited for payment after 180 days or 360 days on roll-over. As per the accounting policy on rate of exchange, amounts recoverable and payable as at the close of the year in foreign currency are accounted for at the current rate of exchange prevailing on 31st March. However, the querist has clarified that, where the final sales prices accounted in books are based on forward cover rates, the corresponding debtors (accounts receivable) are also booked on forward cover rates. Further, whereas the final selling prices for all the shipments made are fixed, based on forward cover rates, the payments for only some of the shipments received are covered by forward cover rates. Payments for all other shipments received are made at the rates of exchange prevailing at the time of the payment.
3. The querist has further stated that the government audit team, while auditing their accounts for 1990-91, made the following observations:
“On import of phosphoric acid, the purchases are booked at the average rate of exchange prevailing during the month and the sale of phosphoric acid is on high seas basis. Since, the payments are covered under BAF, the sale price is factual payments made at the rate of exchange prevailing at that time. As the accounts for 1990-91, were not finalised by that time, the final sale prices for the above shipment have been fixed taking into accounts the loss on exchange on forward cover rate because the loss on exchange on account of payment under BAF could be passed to the actual users of the imported material, as approved by the ministry. The sales were accordingly revised in the accounts for 1990-91. But as the actual payments for these shipments were not made as on 31st March, the additional purchase liability was provided by converting the purchase price in foreign currency at the rate of exchange as on 31st March, 1991, in accordance with the accounting policy. The difference between the original purchases booked during April, 1990 to September, 1990 and the revised purchases payable as on 31st March has been accounted as loss on exchange.”
4. The querist has explained that the observation of the auditors is that the sales and profit before tax are overstated to the extent of loss on exchange not booked in the accounts for 1990-91, as the final sale prices include an element of loss on exchange upto May-June 91 but the loss on exchange has been accounted for only upto 31st March, 1991. The querist has further clarified that consequently the debtors are also converted at the forward rate, i.e., the rate adopted for conversion of sales. The querist is of the view that the loss on exchange arising after 31st March should be accounted for in the next financial year irrespective of the rate of exchange adopted for finalisation of selling prices.
5. The querist has illustrated the accounting procedure adopted by them in this context and auditors’ objection in respect thereof by following entries:
(i) 14.6.90 Phosphoric Acid Purchase Dr Rs. 43907060.91 To Loans under BAF Rs. 43907060.91
(At the time of authorising the banks to make payments to foreign suppliers at rate of exchange 1 $ = Rs. 17.48 or US $ 5.721 = Rs. 100)
(ii) 30.9.90 Sundry Debtors A/c Dr Rs. 46124252.73 To Phosphoric Acid Sales Rs. 46124252.73
(Provisional sales at the rate of Rs. 7088 per MT)
(iii) 31.3.91 Loss in exchange Dr Rs. 5587433.47 To Loans under BAF Rs. 5587433.47
(As at the year end, the payable converted at the rate of exchange as on 31.3.91 US $ 5.075 = Rs. 100)
(iv) 31.3.91 Sundry Debtors A/c Dr Rs. 6064870.71 To Phosphoric Acid Sales Rs. 6064870.71
(At the final sale price of Rs. 8020 per MT fixed after taking into A/c the forward rate element of Rs. 20.60 per 1 $ or US $ 4.854 = Rs. 100)
(Rs. 52189123.44 – Rs. 46124252.73)
The Government Audit Party’s objection in the above case is that the sale value has been taken as Rs. 52189123.44 including the element of forward rate while fixing the final sale price whereas the loss in exchange is accounted to the extent of Rs. 5587433.47, i.e., difference between US $ @ Rs. 17.48 and US $ @ Rs. 19.70 in the financial year 1990-91. The loss on exchange, i.e., difference between 31st March, 1991 rate of US $ 1 = Rs. 19.70 and the forward rate of US $ 1 = Rs. 20.60 included in the fixation of final sale price should have been provided for in the accounts for the financial year 1990-91 itself.
In the above example, the following entry will be passed in the next financial year, viz., 1991-92.
10.4.91 Loans under BAF Dr Rs. 49494494.38 Loss on exchange Dr Rs. 97718.65 To Bank Rs. 49592213.03
(At the time of payment at the rate of exchange of US $ 5.065 = Rs. 100).
The querist has further stated that the loss on exchange incurred in respect of each commodity is being shown in the respective trading accounts, as an item of cost of sales.
6. In this context, the querist has sought the opinion of the Committee in respect of following issues arising on account of imports of phosphoric acid:
(i) Since the final sale prices accounted in 1990-91 accounts include an element of loss on exchange as per forward cover rate for April/May, 1991, whether the loss on exchange after 31st March, 1991 to April/May, 1991 should be provided in the accounts for 1990-91 or not?
(ii) In case provision is to be made for such loss on exchange, should it be disclosed as part of statement on accounting policy on rate of exchange, as follows:
“Wherever forward rates have been taken into account for fixation of sale prices, the purchase value payable in foreign currency is accounted for at the same rates of exchange”.
(iii) Where no forward cover is taken, but, the sale prices are fixed taking into account the forward quotations (at a premium), should the anticipated depreciation in rupee (when liabilities in foreign currency mature for payment) be provided for in the accounts of the year in which sales are accounted or suitable disclosure by way of a not quantifying the likely additional liability would be sufficient?
(iv) As the loss on exchange in respect of each commodity is being shown in respective trading accounts, as an item of cost of sales, whether the loss on exchange should be taken as an element of cost price (part of purchase cost) in valuation of stocks or is to be treated as a financing charge and excluded from stock valuation?
(v) (a) Wherever forward cover rates are taken for payments, at which rate the liability, viz., loan under BAF, should be converted? and
(b) Wherever no forward cover rates are taken for payments, which rate should be adopted for conversion of liability viz., loans under BAF?
Opinion* October 7, 1992
1. The Committee notes paragraphs 20, 21, 23, 24 (a) and 34 of the Accounting Standard (AS) 11 on Accounting for the Effects of Changes in Foreign Exchange Rates, issued by the Institute of Chartered Accountants of India, as reproduced below:
“20. A transaction in a foreign currency should, except as provided in paragraph 21, be recorded in rupees by applying to the foreign currency amount the exchange rate existing at the time of the transaction or a standard rate.
21. When forward exchange contracts are entered into to establish the amounts of rupees required or available at the settlement dates of the foreign currency transactions, the forward rates specified in the related foreign exchange contracts may be used as the basis for measuring and reporting the transactions.
22. Gains or losses on settlement of the transactions within the same accounting period should be recognised in the Profit and Loss Statement of the period except in the case of exchange differences relating to amounts incurred for the acquisition of fixed assets, which should be adjusted in the carrying amount of related fixed assets.
23. At each balance sheet date, there may be items of foreign currency assets and liabilities, i.e., items to be received or paid in foreign currency, in respect of transactions not settled within the same accounting period. An exercise should be carried out to perceive the impact of converting such items at the closing rate. This conversion process should be carried out separately for the following two categories of items – (a) Current assets and current liabilities and (b) Long-term liabilities. The results of the conversion should be dealt with in the manner described in paragraphs 24 and 25.
24. (a) In case of current assets and current liabilities (other than those related to fixed assets), if the result of conversion at the closing rate is an overall net gain, such gain should not be taken into account and the assets and liabilities should continue to appear in the books at the rates at which they were originally recorded. On the other hand, if the result is a net loss, the current assets and current liabilities should be restated and the loss should be charged in the Profit and Loss Statement.”
“34. The following disclosures should be made with regard to accounting of foreign currency transactions…..
(a) ……..
(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 is of the view that wherever forward exchange contracts are entered into by an enterprise and the corresponding receivables and payable have been booked, by considering such forward rates, these items should not be converted at the time of closing the book for the period as in this case. These would be appearing in the books at the value at which these are to be finally settled. In other words, such receivables and payable already appear at the relevant rupee values and are no more, strictly speaking, foreign exchange assets and liabilities. In the present case, this has not been done. The Committee notes that in the present case, the sales in question have been booked at an amount which includes loss on exchange at forward rate since the same can be claimed from the debtors. Keeping in view the matching principle of accounting, since the sales have been booked inclusive of the loss on exchange, a corresponding debit for provision for loss on exchange should be made in the profit and loss account.
3. On the basis of the above, the opinion of the Committee on the issues raised by the querist in para 6 of the query is as follows:
(i) The provision for loss on exchange should be made in the accounts for 1990-91 to the extent the said loss is included in the figure of sales for the year on the basis of the forward rate.
(ii) Liabilities for purchases should be converted at the closing rate as per AS 11 unless the transaction is covered by a forward rate. The provision as per (i) above should be made separately and a suitable disclosure made in accounting policies.
(iii) If sale prices are fixed in Indian rupees after taking into account the forward quotations (at a premium) the anticipated loss on account of corresponding purchases should be provided for as in (i) above.
(iv) Where sales in respect of the relevant purchases have been recognised, the question of valuation of inventories does not arise. Where the sales have not been recognised and in case the purchases are covered by the forward rate, the relevant inventories should be translated at that rate and, if not, the inventories should be translated at the closing rate.
(v) (a) Where forward cover is taken, the liability should be converted at the forward rate as per AS 11.
(b) Where forward cover is not taken, the liability should be converted as per the recommendations contained in para 24(a) of AS 11. _______________________
*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 |