Expert Advisory Committee
ICAI-Expert Advisory Committee
Options:

1.2   Query:     

Accounting treatment of exchange rate difference arising on settlement of a transaction.

 

1. A company imports raw materials under usance L/Cs. The usance period varies between 180 to 360 days. The raw materials are initially valued at the exchange rate prevailing at the time of import. At the time of settlement of import bill (180/360 days later), exchange currency fluctuation (ECF) arises.

 

This ECF is divided between:

 

-           ECF relating to items already consumed, and

 

-           ECF relating to items in stock.

 

ECF relating to items consumed is charged off to the profit and loss account, while ECF relating to items in stock is loaded on to stocks.

 

2. The querist has drawn the attention of the Expert Advisory Committee to paras 22 and 24 (a) 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, as follows:

 

“22.      Gains or losses on settlement of transactions within the same accounting period should be recognised in the profit and loss statement of the period except in case of ……”

 

“24(a)  ……..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.”(emphasis supplied)

 

3. The use of two different words- ‘charged’ and ‘recognised’ is not clear to the querist. The querist wants to know whether the use of the word ‘charged’ means that in case of year-end revaluation of current assets/liabilities, the overall loss should be written-off to the profit and loss account.

 

4. The querist has sought the opinion of the Expert Advisory Committee as to whether the method of identifying ECF on usance import bills separately for items consumed and items in stock is correct.

 

                                                                        Opinion                       March 2, 1994

 

The Committee notes that the Institute of Chartered Accountants of India had, in 1989, issued Accounting Standard (AS) 11 (hereinafter referred to as old AS-11) on Accounting for the Effects of Changes in Foreign Exchange Rates, which is the subject of the above query. However, due to convertibility of rupee and other related developments, the Council of the Institute decided to revise the old AS-11 in June, 1992. Accordingly, in August 1993, the old AS-11 was withdrawn and an exposure draft of the revised AS-11 was issued. The Committee also notes that the query primarily pertains to the year ending as on March 31, 1992. The Committee has decided to give its opinion in two parts. The first part (Part A) contains the opinion as per old AS 11 and is relevant for the accounts closing before the withdrawal of old AS11. The second part (Part B) contains the opinion as per the Exposure Draft of Revised AS-11 and is applicable to the accounting period ending on or after August 1993. However, in the view of the Committee , in cases where accounts for any accounting period closing before August 1993 are finalised after August, 1993, the opinion in Part B may be followed for such accounts also.

 

PART A:         Opinion as per Accounting Standard (AS) 11, issued by the Institute of Chartered Accountants of India in 1989.

 

1. The Committee notes from para 1 of the query that although the querist has raised the query in respect of the exchange currency fluctuation arising at the time of settlement of the transaction, it would also be relevant to consider the translation of foreign currency balances at the balance sheet date in respect of such a transaction where the date of the transaction and the date of the settlement fall in different accounting periods. In this context, the Committee notes paras 22, 23, 24 (a) and 26 of Accounting Standard (AS) 11, issued by the Institute of Chartered Accountants of India, which read as follows:

 

“22.      Gains or losses on settlement of the transactions with in the same accounting period should be recognised in the Profit & 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 & 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.”

 

“26.      Gains or losses on settlement, in a subsequent period, of transactions entered into in an earlier period should be credited or charged to the Profit and Loss Statement, 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.”

 

2. The Committee is accordingly of the opinion that the company should convert, at each balance sheet date, the liability relating to the import of raw materials alongwith all other current assets and current liabilities. If the result of such conversion is overall gain, such gain should not be taken into account. However, if the result is an overall loss the current assets and current liabilities should be restated & the loss should be recognised in the profit & loss account. In the period when the said liability is finally settled, the difference between the book value of the liability and the value at which it is finally settled should be recognised in the profit and loss account of that period. In no situation it can be included in the carrying amount of inventories.

 

3. With regard to the issue raised at para 3 of the query, the Committee is of the view, that recognition of an item of income or expense is the process of incorporating such items in the profit and loss account, whereas the term ‘charge’ is normally used for incorporating an item of expense in the profit and loss account. Therefore, in the view of the Committee , in the accounting terminology, the term ‘recognition’ has a wider connotation than, and includes a reference to, the term ‘charge’.

 

PART B:       Opinion as per Exposure Draft of Revised Accounting Standard (AS) 11, issued by the Accounting Standards Board of the Institute of Chartered Accountants of India in August, 1993.*

 

1. The Committee notes from para 1 of the query that although the querist has raised the query in respect of the exchange currency fluctuation arising at the time of settlement of the transaction, it would be relevant to consider the translation of foreign currency balances at the balance sheet date in respect of such a transaction where the date of the transaction and the date of the settlement fall in different accounting periods. In this context, the Committee notes paras 7(a), 9 and 10 of the Exposure Draft of revised Accounting Standard (AS) 11, issued by the Accounting Standards Board of the Institute of Chartered Accountants of India, which read as follows:

 

“7.        At each balance sheet date:

 

(a)        monetary items denominated in a foreign currency (e.g., foreign currency notes, balances in bank accounts denominated in a foreign currency, and receivables, payables and loans denominated in a foreign currency) should be reported using the closing rate. However, in circumstances where the closing rate does not reflect with reasonable accuracy the amount in reporting currency that is likely to be realised from, or required to disburse, the foreign currency item at the balance sheet date, a rate that reflects approximately the likely realisation or disbursement as aforesaid should be used.

 

9.         Exchange differences arising on foreign currency transactions should be recognised as income or as expenses in the period in which they arise, except as stated in paragraph 10 below.

 

10.       The carrying amount of fixed assets should, to the extent not already so adjusted or otherwise accounted for, be adjusted to account for any increase or decrease in the liability of the enterprise, as expressed in the reporting currency by applying the closing rate, for making payment towards the whole or a part of the cost of the assets or for repayment of the whole or a part of the monies borrowed by the enterprise from any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring those assets.”

 

2. The Committee is, accordingly, of the opinion that the company should report the balance of liability relating to import of raw materials using the closing rate of exchange. Any difference, loss or gain, arising on conversion of said liability at closing rate, should be recognised in the profit and loss account for the reporting period. In the period when the said liability is finally settled, the difference between the book value of the liability and the value at which it is finally settled should be recognised in the profit and loss account of that period. In no situation it can be included in the carrying amount of inventories.

 

3. With regard to the issue raised at para 3 of the query, the Committee notes that this question would not arise in view of the fact that in the exposure draft of revised AS-11, only the word ‘recognised’ has been used.

________________________________________________________

 

* The Committee wishes to draw attention to the fact that the opinion is based on the recommendations made in Exposure Draft of Revised Accounting Standard (AS) 11, issued by the Accounting Standards Board of the Institute of Chartered Accountants of India, published in ‘The Chartered Accountant’, August, 1993. It is, thus, possible that this opinion may change upon issuance of revised Accounting Standard (AS) 11.

___________________________