Query No. 36
Subject: Exchange rate applicable for translation of expenses incurred at overseas liaison office.[1] A. Facts of the Case
1. A government company whose main objective is to construct ships has liaison offices abroad. These offices do not carry out any activities that are carried out at the head office. They have been set up with the sole purpose of co-ordinating with various government and non-government agencies abroad and to liaise and follow up with foreign suppliers.
2. The expenses normally incurred at a liaison office abroad are in the nature of salaries of staff, cost of maintaining the liaison office, etc. To meet these expenses, the liaison office submits its funds requirement for the financial year which in turn is submitted to the Ministry concerned for release of foreign exchange. The amount so released is remitted in one or more installments during the financial year to the foreign currency account abroad. The liaison office submits the cash accounts, duly supported by the original vouchers, to head office. The expenses are accounted for at the head office. The rate of exchange for this purpose is taken to be the rate at which the remittances had been effected. At the year-end, the balance in the foreign currency account is valued at the closing rate, i.e. the exchange rate prevailing on the last day of the financial year. The exchange difference (gain/loss) arising out of conversion of balance amount at the end of the year is transferred to profit and loss account. The transactions of the next financial year are booked at the aforesaid closing rate till the balance of foreign currency carried forward is totally spent.
3. According to the querist, to the extent the amount of foreign currency kept abroad is utilised for making payments in that currency, there is no exposure to any risk of exchange rate fluctuation. Therefore, the payments made in the foreign currency are recorded in rupees by applying the exchange rate at which the amount was originally remitted. In this regard, the querist has referred to an earlier opinion of the Expert Advisory Committee published in Compendium of Opinions, Volume XIII (No. 1.7).
4. According to the querist, till the year 1997-98, the above method of accounting was accepted by the statutory auditors as well as the government auditors. However, the statutory auditors for the year 1998-99 made an observation in their report that the above method of accounting for expenditure in foreign currency was not in consonance with Accounting Standard (AS) 11, ‘Accounting for the Effects of Changes in Foreign Exchange Rates’, issued by the Institute of Chartered Accountants of India. According to the auditors, the Standard required that such expenses should be incorporated at the relevant average rate or actual rate prevailing on the dates of transactions and differences arising due to exchange rate fluctuations should be recognised as income/expense for the period. They also observed that the above had no impact on overall profit of the company.
5. As per the querist, the management, in its reply, stated that AS 11 required translation of expenses incurred at a branch at average rate. However, the liaison offices of the company were not branches. The management also referred to certain opinions of the Expert Advisory Committee issued earlier (No. 3.1 of Compendium of Opinions, Volume XIV and No. 1.7 of Volume XIII).
B. Queries
6. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
C. Points Considered by the Committee
7. The Committee notes that paragraph 1 of AS 11 provides as below:
“1. This Statement should be applied by an enterprise:
8. The Committee observes that the procedures prescribed in AS 11 for accounting of foreign currency transactions are, in essence, identical to the procedures prescribed for translating the financial statements of foreign branches. As such, the issue whether the overseas liaison offices are branches of the company or not does not have any bearing on the exchange rate to be used for restatement of expenses incurred at liaison offices in rupee terms. The Committee, however, notes that the liaison offices do not prepare their financial statements and that the expenses incurred by them are being accounted for at the head office.
9. The Committee notes paragraphs 5 and 6 of AS 11 which state as under:
“5. A transaction in a foreign currency should be recorded 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 ...........”
“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.”
10. Based on the above, the Committee is of the view that the expenses of the liaison office in foreign currency should be recorded by the company using either the exchange rate as at the date of the respective transaction, or an average rate in accordance with paragraph 6 of AS 11. Recording of expense transactions in this manner would give rise to an exchange difference, representing the difference in the exchange rates as at the date of remittance and as at the date of the expense transaction.
11.The Committee further notes that paragraphs 7(a) and 9 of AS 11 state as under:
“7. At each balance sheet date:
“9. Exchange differences arising on foreign currency transactions should be recognised as income or as expense in the period in which they arise, except as stated in paragraphs 10 and 11 below.” (Paragraphs 10 and 11 are not relevant in the present case.)
12. The Committee is of the view that the closing balance of foreign currency account should be reported using the closing rate, as required by paragraph 7(a) of AS 11.
13. The Committee is also of the view that, as required by paragraph 9 of AS 11, exchange differences arising on recording of expense transactions (see paragraph 10) and restatement of closing balance of foreign currency account (see paragraph 12) should be recognised in the profit and loss account of the period.
14. The Committee notes that the opinion referred to in paragraph 3 was issued prior to the formulation of the present AS 11. The extant opinion is based on present AS 11. The Committee also wishes to point out that in the case of both the above-referred opinions, the overall impact on the profit and loss account is the same. The other opinion referred to in paragraph 5 is not relevant to the issue under consideration.
D. Opinion
15. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 6:
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[1]Opinion finalised by the Committee on 14.1.2000. |