1.2  Query:   

         Accounting for Foreign Currency Transactions

1.  A government company undertakes projects in India and abroad in all fields of telecommunications. The querist has stated that as per the Exchange Control Regulations, for each project abroad, the company is required to maintain separate project accounts. However, in case of the countries where as per the local laws, accounts are required to be maintained in that country itself, the company maintains parallel project-wise accounts at head office also. For maintaining the accounts at head office on parallel basis, the company gets the floppies containing cash and bank transactions as well as the journal vouchers alongwith certified photocopies of the vouchers.  From these floppies, the company prepares cash book, bank book and other accounting records required. For the other countries, where the maintenance of books of account in that country is not necessary, the company gets the statement of accounts alongwith original cash and bank vouchers and prepares books of account on computer. At head office these vouchers and accounts are scrutinised and the company passes the necessary journal vouchers for adjustment at the head office in the project accounts. These project accounts, as per the querist, are maintained in three currencies, namely, local currency of the country, US dollars and Indian rupees. The transactions are recorded in the currency in which they take place. The querist has stated that the site offices opened for project execution at project are not treated as branches for Company Law purposes and project-wise accounts are maintained at head office in the three currencies mentioned above. At the year-end, these project accounts are converted into Indian rupees as per the accounting policy of the company as stated below:

“For the Financial Statement of the Company at the end of year, foreign currencies are translated as below: -

Revenue Expenditure : At the average of exchange rate of the official opening rate of Ist and the unified closing rate of last day of the accounting year.

Fixed Assets : At the official exchange rate of the date of purchases. In case of non-availability of rate of exchange of the date of purchase, available rate in the month of purchase.

Depreciation of Fixed Assets: At the rates used for translation of Fixed Assets.

Stores & WIP : For the purpose of Balance Sheet valued at closing rate and for Profit & Loss Account at average rate of exchange.

Current Assets & Liabilities : At the closing unified exchange rate as on 31^st March.

Remittances from foreign countries & foreign currencies purchases in India: At the actual exchange rate at which foreign currencies converted and received or purchased in India.

In case, where the conversion rate of a foreign currency is mentioned in the agreement, such rate is taken for the purpose of translation of that currency.

Gain on account of foreign currency translation is taken to Foreign Currency Translation Difference Reserve in the Balance Sheet and in view of the nature not treated as income as per past practice and the loss on this account is adjusted against the same. In the absence of the said Reserve, the translation loss is charged directly to the Profit & Loss Account.”

This policy, as per the querist, is being followed by the company consistently and has been accepted in past by statutory auditors as well as government auditors.

2. The querist has stated that for the purposes of translation of foreign currency transactions, the company takes exchange rates from State Bank of India, New Delhi, and wherever these rates are not available, the rates are taken from State Bank of India, London. For currencies for which rates are not available with SBI London also, rates to dollar are taken from banks of these countries. As per the querist, as most of the company’s projects are in under-developed countries, the direct rates to Indian rupees for local currencies are generally not available. Therefore, for all currencies except US dollar, Sterling, French Frank and DEM, all rates are taken through US dollar and then converted into Indian rupees.

3.  As per the querist, the auditors of the company have given the following observations on currency translations in their report on accounts for the year 1992-93:

“The translation of foreign currencies disclosed in the accounting policies was not based on sound and prudent accounting principle, because no satisfactory explanation was available nor impact determined in regard to (a) Applying indirect rates even where direct rates were available, (b) applying rates of 26.04.1993 of State Bank of India, London, (c) applying current year average rate in valuing dormant and nominal balances like provision for doubtful debts and advances, unclaimed old provisions and liabilities, write offs and write backs, provision for project performance and carried over balances of opening work-in-progress, (d) applying current year average rate for opening stores rather than opening rates, (e) not applying weighted average rates more so, since the opening rates were taken at only official rates and not official and market rates, (f) taking gain on account of foreign currency translation to reserve and not to profit and loss account.”

4. The querist has further stated that the company follows percentage of completion method for revenue recognition on its projects, as per Accounting Standard (AS) 7, issued by the Institute of Chartered Accountants of India. For these projects, as per para 9.6 of AS 7, the company makes a provision for project performance @ 2% on topping up principle, as suggested by the Expert Advisory Committee in one of its earlier opinions. The querist has explained the above by way of the following example: -

The company had 5 project (A), (B), (C),(D), and (E) in 1991-92. Each project had a turnover of US $ 1000 and the total accumulated turnover was thus US $ 5000. On this, the company made a provision for project performance at 2%, i.e., US $ 100 and translated in the books at the closing rate- say Rs.25 for the balance sheet purposes and accordingly the provision stood at Rs.2500 on 31.03.1992. Further, during the year ending 31.03.1993, for all these projects the turnover during the year was US $ 1000 each and as such, the cumulative turnover was US $ 10000. As per the policy, a provision at 2%, i.e., US $ 200 was required out of which provision of US $ 100 @ Rs.25 was already existing as on 31.03.1992. As such, on 31.03.1993, the closing rate being Rs. 31, the provision should be Rs.6200. As the provision as on 31.03.1992 was Rs.2500, the further provision to be created is Rs.3700/-. Since out of US $ 200 (provision in dollar terms), US $ 100 is being carried forward from last year for which in Indian rupees provision is Rs.2500. Rs.600 (31-25 = 6 X 100) is on account of exchange fluctuation over last year. Accordingly, the company passed the following entry:

Profit and loss account                        Debit                            3100

Currency fluctuation reserve             Debit                              600

            To Provision for project performance                                         3700

5.  The querist has stated that as per the existing policy of the company, gains on translations of currencies are transferred to currency fluctuation reserves and the losses are set off against these balances. In case no balance is available, the same is charged to the profit and loss account. This policy is followed till the projects are closed and remittances are made to India for the projects executed.

Considering the fact that most of the projects of the company are in under-developed countries, in the view of the querist chances of adverse fluctuations are more till all balances are repatriated to India and as such, taking gains to the profit and loss account in early stages will be detrimental to the interest of the company as it would be paying the tax on these notional profits also which on close of the year may not actually be there.

However, as per the querist, if there is a balance in currency fluctuation reserve, the company debits Rs.600/- to currency fluctuation reserve and in case there is no reserve, the same is charged to the profit and loss account.

6.  The querist has sought the opinion of the Expert Advisory Committee on the following matters arising from the above: -

(a) Whether the foreign currency translation policy followed by the company is correct?

 

(b) As direct rates for many currencies in India even if available are also necessarily be through dollar, is it correct to take the exchange rates indirectly through US dollar SBI, New Delhi/SBI London?

 

(c) Is the policy followed for translating the provision for project performance as stated above in order?

 

(d) Since the company is not a seasonal company and also it is difficult to get the rates as on 31^st March for all the currencies, is it necessary to adopt the weighted average method, i.e., the 12 months average as suggested by the auditors, instead of average of opening and closing rates, as taken by the company at present or the present policy of the company is in order?

 Opinion*                      November 25, 1994

1. The Committee notes that as per the Exposure Draft of revised Accounting Standard (AS) 11 on ‘Accounting for the Effects of Changes in Foreign Exchange Rates’, issued by the Institute of Chartered Accountants of India – “Foreign operations of an enterprise refer to either its branch or its investments in a subsidiary, associate or joint venture etc., the activities of which are based or conducted in a country other than the country of the reporting enterprise.” The Committee thus notes that the said exposure draft envisages two types of foreign operations: (i) Foreign operations carried on as a separate entity, distinct from the reporting enterprise, e.g., a subsidiary or joint venture, etc., and (ii) foreign operations which are merely an extension of the activities of the reporting enterprise, e.g., foreign branch etc. The Committee is, therefore, of the view that for the purposes of foreign currency translation, the foreign projects of the company should be treated as foreign branches, even though for the Companies Act purposes they may not be treated so.

2.The Committee notes paras 6, and 17 to 23 Exposure Draft of revised Accounting Standard (AS) 11, which read as follows:

“6. A transaction in a foreign currency is recorded in the financial records of an enterprise as at the date on which the transaction occurs, normally using the exchange rate at that date. This exchange rate is often referred to as the spot rate. For practical reasons, a rate that approximates the actual rate is often used, for example, an average rate for all transactions during the week or month in which the transactions occur. However, if exchange rates fluctuate significantly, the use of the average rate for a period is unreliable.

 

17. The financial statements of a foreign branch should be translated using the procedures in paragraphs 18 to 23 of this Statement.

 

18. Revenue items, except opening and closing inventories and depreciation, should be translated into reporting currency of the reporting enterprise at average rate. In appropriate circumstances, weighted average rate may be applied, e.g., where the income or expenses are not earned or incurred evenly during the accounting period (such as in the case of seasonal businesses) or where there are exceptionally wide fluctuations in exchange rates during the accounting period. 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.

 

19. Monetary items should be translated 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.

 

20. Non-monetary items other than inventories and fixed assets should be translated using the exchange rate at the date of the transaction.

 

21. Where there has been an increase or decrease in the liability of the enterprise, as expressed in Indian rupees by applying the closing rate, for making payment towards the whole or a part of the cost of a fixed asset or for repayment of the whole or a part of monies borrowed by the enterprise from any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring a fixed asset, the amount by which the liability is so increased or reduced during the year, should be added to, or reduced from, the historical cost of the fixed asset concerned.

 

22. Balance in ‘head office account’ in branch books should be translated into the reporting currency of the enterprise at the corresponding balance appearing in the ‘branch account’ in the books of the head office after adjusting for unresponded transactions.

 

23. The net exchange difference resulting from the translation of items in the financial statements of a foreign branch should be recognised as income or as expense for the period, except to the extent adjusted in the carrying amount of the related fixed assets in accordance with paragraph 21 above.”

 

3. The Committee notes that exposure draft of revised Accounting Standard (AS) 11, defines the term ‘exchange rate’ as follows:

“Exchange rate is the ratio for exchange of two currencies as applicable to the realisation of a specific asset or the payment of a specific liability or the recording of a specific transaction or a group of inter-related transactions.”

4.The Committee further notes that the said exposure draft defines the term ‘Average Rate’ to mean “the mean of the exchange rates in force during a period”. It however does not specify as to which exchange rates should be considered for computing the mean rate. The Committee is of the view that the average rate should be such as would represent, as nearly as possible, the various actual rates which were in force during the relevant period. For this purpose, an average of weekly averages of opening and closing rates may be a good indicator. Moreover, if there have been wide fluctuations in the exchange rates during the year, use of weighted average rate would be more reliable.

5.  On the basis of the above, the Committee is of the following opinion in respect of the issues raised at para 6 of the query:

(a) No, the foreign currency translation policy followed by the company is not correct. The company should translate the financial statements of its foreign projects at the rates stated below:

(i) Revenue items except inventories and depreciation: At average rate, calculated as per para 4 above.

(ii) Depreciation: At the rates used for translation of the relevant fixed asset.

(iii) Fixed Assets: At the rates prevailing at the date of purchase.

(iv) Inventories: Opening inventory at the opening rate and closing inventory at the closing rate. Same figures of inventories should be shown both in the profit and loss account and the balance sheet.

(v) Monetary assets: At the closing rate.

(vi) Other non-monetary assets: At the rates prevailing at the date of relevant transactions.

(vii) Remittances from abroad and purchases of foreign currency in India: At the actual conversion rates.

The net difference resulting from the translation of items in the financial statements of foreign projects should be recognised as income or expense, except to the extent it is to be adjusted in the carrying amount of fixed assets as per para 21 of the exposure draft as reproduced at para 2 above. It is not correct to transfer such difference to foreign currency translation difference reserve.

 

(b) For recording the foreign currency transactions for which an exchange rate is available in India, quoted either by the Reserve Bank of India or any authorised dealer, e.g., State Bank of India, the company should use such exchange rates. However, foreign currency transactions for which no exchange rate is available in India, the company may use the rates quoted by an authoritative agency abroad.

 

(c) In the books of the head office, the company should calculate the provision for project performance as a percentage on turnover as translated in Indian rupees. No exchange gain or loss would thus arise on this account. The actual expenditure on performance guarantee should be charged against such provision.

 

(d) It does not appear to be correct to use the average of year’s opening and closing rates as ‘average rate’ for the year. The ‘average rate’ to be used for this purpose should be calculated as per para 4 above.

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