A.  Facts of the Case

1.  A public sector company operates under the administrative control of Ministry of Defence.  During the course of its operations, the undertaking executes orders for another public sector undertaking.  For executing the order, the undertaking receives payments partly in foreign currency (US Dollars) and partly in Indian rupees. With a view to avoid the losses arising due to difference in buying and selling currency rates and also adverse exchange rate fluctuations due to time lag between receipts in foreign currency and payments in foreign currency, the company opens a ‘Foreign Currency Account’ for each project with the prior approval of the Reserve Bank of India.  The approval entitles the company to retain the money received in foreign currency in the specific bank account to meet the expenditure to be incurred in foreign currency for the relevant project.  This facilitates the company to remit/utilise the funds in foreign currency for discharging its obligations of payment to foreign suppliers/contractors without purchasing the foreign currency from the market.

2. The company’s accounting policy with regard to accounting for foreign exchange transactions is as follows:

“(i)   In respect of loans and deferred liabilities, rupee values of the foreign exchange liabilities are updated (except where forward covers exist), based on the exchange rates prevailing on the date of the balance sheet or the latest notified exchange rates wherever applicable.  If the liabilities are against procurement of capital assets, the differences, due to exchange variations are included in the cost of the respective capital assets. If the liabilities are against revenue expenditure, the differences due to exchange variation are accumulated separately and out of it, the amount proportionate to the liabilities discharged during the year is written off/ written back to revenue during the year.

 

(ii)   In other cases, the liabilities as at the close of the year are updated as stated at (i) above. The consequential differences are written off/written back to the revenue account except when they relate to capital asset in which case they are included in the cost of respective capital assets.

 

(iii)   In respect of bank balances held in foreign currency, the same are converted into rupees as stated at (i) above and the consequential differences are written off/written back to the revenue account.

 

(iv)  The balances in foreign currency accounts opened for specific projects and corresponding foreign currency liabilities of the company are accounted at the same exchange rates prevailing at the time of receipt in foreign currency from the customer. The gain or loss arising out of these transactions is accounted on actual conversion of foreign currency into rupees.”

 

3.   The accounting method followed by the company to account for the transactions in the ‘Foreign Currency Account’ is as below:

 

(i)   The amounts received in foreign currency from the customer are credited to the foreign currency account by bank without converting into rupees. However, for the purpose of accounting transactions in Indian rupees, money so received in foreign currency is converted into Indian rupees at the rate based on the rate adopted by the customer for TDS purposes.

 

(ii)   Whenever the payment is made out of this foreign currency account, the same is accounted for in Indian rupees by converting the amount at the rates applicable for the various receipts in foreign currency account on FIFO basis.

 

(iii)  At the year-end, the following treatment is given for the balances outstanding in foreign currency account and the liabilities which are likely to be discharged from the amounts available/receivable in this account :

 

(a)  Liabilities to the extent covered by the balances in foreign currency account are valued on FIFO basis.

 

(b)  In case liabilities exceed the balances, such excess amounts are provided for by converting foreign currency amount into Indian rupees at the TT selling rate prevailing as on 31st March.

 

(c)  The balances available in foreign currency account, are retained at the original conversion rate, on FIFO basis.

 

4.  The querist has also informed that generally, the foreign currency account is closed after completion of the project and settlement of the account with customer/contractor whose payment is required to be made in foreign currency. The surplus available at the time of closing of the bank account is transferred to rupee account by the bank at the rate applicable on the date of such transfer.  The profit or loss arising out of such conversion is accounted as foreign exchange gain/loss in the year of actual conversion.  In some circumstances, certain amounts are converted into rupees from the foreign currency account.  This conversion is based on the evaluation of the funds requirement.  The profit on foreign exchange conversion is accounted for on the basis of the rates applicable on the date of conversion of foreign currency into Indian rupees.

B.  Queries

5.   The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a)  Whether the foreign currency transactions through Foreign Currency Account are covered by Accounting Standard (AS) 11, ‘Accounting for the Effects of the Changes in Foreign Exchange Rates’, and  if so,

 

(i)  whether the method of accounting for the transactions of payment from the foreign currency account as followed by the company would meet the requirements of AS 11;

 

(ii)   whether the accounting treatment being followed by the company at the end of the year in respect of the balances in foreign currency account and liabilities as explained in paragraph 3 (iii) above meets the requirements of AS 11.

 

(b)   If the answer to (a) (i) and (ii) above is in the negative, what is the correct accounting policy to be followed.

(C)  Points Considered by the Committee

6.  The Committee restricts itself to the particular issues raised by the querist in paragraph 5 above and has not examined any other accounting issue contained in the query.

7.  Paragraph 1 of AS 11, defines the scope of the Accounting Standard as below:

“1.  This Statement should be applied by an enterprise:

(a)   in accounting for transactions in foreign currencies; and

 

(b)   in translating the financial statements of foreign branches for inclusion in the financial statements of the enterprise.”

8.   From the above, the Committee notes that AS 11 applies to all kinds of transactions in foreign currency entered into by an enterprise.

9.   The Committee notes paragraph 5 of AS 11 which states as below:

“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 ....”

10.  From the above, the Committee notes that all transactions, whether involving receipt of foreign currency or payment in foreign currency, should be recorded at the exchange rate on the date of transaction.  The exchange rate at which monies were received in the foreign currency account will have no bearing on the exchange rate applicable to payments made out of that account.

11.  The Committee further notes paragraph 4 of AS 11 which states as below:

“4.   The term ‘exchange rate’ is defined in this Statement with reference to a specific asset, liability or transaction or a group of inter-related transactions.  For the purpose of this Statement, two or more transactions are considered inter-related if, by virtue of being set off against one another or otherwise, they affect the net amount of reporting currency that will be available on, or required for, the settlement of those transactions.  Although the exchange rates applicable to realisations and disbursements in a foreign currency may be different, an enterprise may, where legally permissible, partly use the receivables to settle the payables directly, in which case the payables and receivables are reported at the exchange rate as applicable to the net amount of receivable or payable.  Further, where realisations are deposited into, and disbursements made out of, a foreign currency bank account, all the transactions during a period (e.g., a month) are reported at a rate that approximates the actual rate during that period.  However, where transactions cannot be considered inter-related as stated above, by set-off or otherwise, the receivables and payables are reported at the rates applicable to the respective amounts even where these are receivable from, or payable to, the same foreign party.”

12. From the above, the Committee notes that an average rate may be used for recording transactions through a foreign currency bank account only when it approximates the actual rate.  The use of exchange rates at which payments were received into the foreign currency account for recording disbursements out of that account on FIFO basis is not appropriate.

13. The Committee also notes paragraph 7(a) of AS 11, which states as below:

“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 certain circumstances, the closing rate may not reflect with reasonable accuracy the amount in reporting currency that is likely to be realised from, or required to disburse, a foreign currency monetary item at the balance sheet date, e.g., where there are restrictions on remittances or where the closing rate is unrealistic and it is not possible to effect an exchange of currencies at that rate at the balance sheet date. In such circumstances, the relevant monetary item should be reported in the reporting currency at the amount which is likely to be realised from, or required to disburse, such item at the balance sheet date”.

14. The Committee further notes that monetary items have been defined in AS 11 as “money held and assets and liabilities to be received or paid in fixed or determinable amounts of money, e.g., cash, receivables, payables”.

15.  From the above, the Committee notes that all liabilities and bank balances as on the date of the balance sheet should be reported using the closing rate.  The method being used by the company is not appropriate.

16. The Committee also notes that paragraph 9 of AS 11 provides that “exchange differences arising on foreign currency transactions should be recognised as income or as expense in the period in which they arise”. Therefore, the company should recognise the exchange differences on this basis.

D.  Opinion

17.  On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 5:

(a)  The foreign currency transactions through the foreign currency bank account are covered by AS 11.

 

(i) The method of accounting for the transactions of payment from the foreign currency account as followed by the company does not meet the requirements of AS 11;

 

(ii)  The accounting treatment being followed by the company at the end of the year in respect of the balances in foreign currency bank account and liabilities as explained in paragraph 3 (iii) above does not meet the requirements of AS 11.

 

(b)   Please refer to paragraphs 10, 15 and 16 above.

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1Opinion finalised by the Committee on 17.1.2001.