Query No.45

Subject:

Exchange rate for foreign currency transactions.[1]

A. Facts of the Case

1.  A government company is engaged in operation and maintenance of a fleet of helicopters for transporting men and materials to both off‑shore and on‑shore locations.  The company also caters to the needs of some other PSUs, state governments and remote areas like north-east sector.

2. The company’s accounting policy regarding the transactions in foreign exchange states that the cost of imported fixed assets/inventories/services is converted into Indian rupees at the rate of exchange prevailing on the date of payment.

3. Accounting Standard (AS) 11, ‘Accounting for the Effects of Changes in Foreign Exchange Rates’, issued by the Institute of Chartered Accountants of India, provides the following in paragraphs 5 and 6 in respect of recording foreign exchange transactions on initial recognition:

“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, except as stated in paragraph 4 above in respect of inter-related transactions.

 

“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.”

4. According to the querist, it is practically impossible for the company to record the transactions at the exchange rate prevailing on the date of each import transaction.  The transactions are being effected throughout the month in large numbers. If the company strictly follows the provisions of AS 11, it will require daily rates (spot exchange rate) relevant to each date of transaction and thereafter identify variance between the rates of actual payment and date of transaction in order to quantify exchange variation for hundreds of such import transactions.

5. As per the querist, to cope with the practical difficulties with regard to import transactions, AS 11 itself provides leverage which allows using of average rate for recording of all transactions during the week or month in which the transactions occur. The average rate being used should approximate the actual rate.

6. The majority of import transactions of the company are covered by letters of credit payable on sight with a condition that supplier should claim the payment within 21 days from the date of despatch of the goods (i.e., the date of transaction). Majority of payments are released within such period. Hence, as per the querist, the exchange rate prevailing on the actual date of payment by banker is generally near to the exchange rate prevailing on the date of transaction. As per the querist, this amply complies with the requirements of AS 11.

7.The government auditors, while reviewing the annual accounts for the financial year 1997‑98 considered the company’s accounting policy and were of the view that recording foreign exchange transactions at rates based on actual payments is not in conformity with AS 11. They observed that a transaction in 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 prevailing at the date of transaction only. Hence, the company's accounting policy, in their view, deviates from AS 11.  According to the querist, the government auditors have perhaps not considered the leverage as provided in AS 11 as to the use of an average rate of exchange for all transactions during the week or month in which the transactions occur which is primarily aimed to meet the practical difficulties generally faced in recording of import transactions of such frequency and magnitude as in the case of the company.

B.  Queries

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

(a)  Whether the company’s accounting policy of recording foreign exchange transactions on the basis of rate of exchange prevailing on the respective dates of payment, keeping in view the leverage provided by AS 11, is in conformity with AS 11.

 

(b)  If not, what is the most suitable accounting treatment to comply with the provisions of AS 11, keeping in view the regular frequency and magnitude of import transactions of the company.

 

C. Points Considered by the Committee

9.  The Committee notes paragraphs 5 and 6 of AS 11 as reproduced in paragraph 3 above.

10. The underlying principle of recording transactions in foreign currency is that these should be recorded at the exchange rate at the date of transaction.  The Committee notes that AS 11 contemplates the use of average rate only in case where the average rate approximates the exchange rate at the date of transaction.  It is only in cases where there are a large number of transactions that keeping in view the practical difficulties, the use of average rate is justifiable.  The use of exchange rate prevailing on the date of payment can not be construed as the average rate as it does not approximate the actual rate on the date of transaction.

11. In this context, the Committee further notes that AS 11 contemplates that the difference between the rate of exchange prevailing on the date of the transaction and the date of settlement thereof should be accounted for as specified in the Standard.  In other words, the Standard recognises that exchange rate prevailing on the date of payment cannot be construed to be the rate prevailing on the date of transaction.  The Committee 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”.  However, “exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which are carried in terms of historical cost, should be adjusted in the carrying amount of the respective fixed assets” (paragraph 10).  The Committee also notes paragraph 12 of AS 11 which states as below:

“12. An exchange difference results when there is a change in the exchange rate between the transaction date and the date of settlement of any monetary items arising from a foreign currency transaction. When the transaction is settled within the same accounting period as that in which it occurred, the entire exchange difference arises in that period. However, when the transaction is not settled in the same accounting period as that in which it occurred, the exchange difference arises over more than one accounting period.”

12. From the above, the Committee is of the view that the transactions in foreign currency should be recorded at the exchange rates on the dates of respective transactions.  An average rate may be used only when it approximates the exchange rates on the dates of respective transactions.  Any exchange differences arising on the settlement of the dues should be recognised as income or expense in the period in which they arise, with the exception of the exchange differences arising on account of settlement of liabilities in respect of fixed assets which should be adjusted in the carrying amount of the respective fixed asset.

D.  Opinion

13. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 8:

(a)   The accounting policy followed by the company is not in accordance with AS 11.  

      

(b)   Please refer to paragraph 12 above.

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