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A. Facts of the Case
1. A public sector company is engaged in the manufacture of power equipments. The company has manufacturing units, power sector regions, service centers and regional offices besides project sites spread all over India and abroad. For executing the orders received, the company receives payments partly in foreign currency and partly in Indian rupees from its customers, both domestic and overseas. The foreign currency receipts, nearly all, from customers are received centrally at Delhi and the outward payments in foreign currency above a threshold (individual payment) are made centrally from corporate office. The small value foreign currency payments are made from the bank account of unit/ region/ regional office. With a view to avoid the adverse exchange rate fluctuations as well as the difference between the buying and selling exchange rate of banks due to time lag between receipts and payments in foreign currency, the company has been maintaining Exchange Earners Foreign Currency (EEFC) accounts in USD and EURO with various banks in line with FEMA regulations. Foreign currency receipts on account of both physical and deemed exports released by customers are credited to the said EEFC accounts. The amount so credited is utilised by the company towards its imports payments to foreign suppliers/contractors without purchasing the foreign currency from the market.
2. The company’s accounting policy with regard to ‘accounting for foreign currency transactions’ is as under:
“Transactions in foreign currencies are recorded at the exchange rates prevailing on the date of the transaction. Foreign currency monetary assets and liabilities are translated at year end exchange rates. Exchange difference arising on settlement of transactions and translation of monetary items are recognised as income or expense in the year in which they arise.”
3. With respect to accounting practice for EEFC accounts and provisions of Accounting Standard (AS) 11 (revised 2003), ‘The Effects of Changes in Foreign Exchange Rates’, the querist has stated that the inwards in foreign currency are credited to EEFC account on the date of receipt and the foreign currency payments are made from EEFC account on daily basis (considering the funds available in the EEFC account). Though the said foreign currency receipts and payments are transacted in foreign currency only but they are to be recorded in bank book in INR. For the purpose of accounting for foreign currency transactions in Rupees, suitable exchange rate needs to be applied. In this respect, the querist has reproduced the following extracts from AS 11:
“9. A foreign currency transaction should be recorded, on initial recognition 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. For practical reasons, a rate that approximates the actual rate at the date of the transaction is often used, for example, an average rate for a week or a month might be used for all transactions in each foreign currency occurring during that period. However, if exchange rates fluctuate significantly, the use of the average rate for a period is unreliable.
11. At each balance sheet date:
(a) foreign currency monetary items should be reported using the closing rate…”
4. The accounting procedure followed by the company for foreign currency transactions routed through EEFC accounts is as under:
(i) Amounts received in USD and EURO are credited to the respective EEFC account without converting the same into Rupees. For accounting, the amount in foreign currency is converted into Indian Rupees at the exchange rates prevailing on the date of credit.
(ii) In case of outward payments from the said EEFC accounts, the same is also converted into Indian Rupees at the exchange rates prevailing on the date of payment.
(iii) Upto a period, State Bank of India (SBI) Card Rates prevailing on the date of actual receipt into and payments from EEFC accounts were being used for reporting the foreign currency amounts into Rupees for the purpose of accounting. Difference between the exchange rates prevailing on the date of payments and the exchange rates prevailing on the date of receipts adjusted on First-in, First out (FIFO) basis was booked to the profit and loss account under the head ‘exchange variation’.
(iv) As SBI Card Rates are different for receipts (assets) and payments (liabilities) which varies from Inter Bank Rate (IBR) on both sides by around 25-30 paisa, the same was resulting into booking of exchange variation gain without any real movement in the exchange rates in the market. Even in case of receipt and payment of same foreign currency amount on a single day, the booking at SBI Card Rates would result into exchange variation gain simply due to significant difference between buying and selling rates (as against the normal 1 paisa spread between Bid and Ask rates).
(v) During the year 2007-08, the volume of forex remittances increased significantly and LCs/bills payable not only at SBI but also with various other banks were paid through the EEFC accounts. Thus, instead of buying foreign currency from each bank for payment of LCs/bills due with them, foreign currency is made available to them through EEFC account maintained with banks. As each bank has its own card rates for foreign currency payments, it was thought appropriate to use one common exchange rate for accounting in Rupees.
(vi) Reserve Bank of India (RBI) issues reference rate on daily basis during the afternoon after taking the prevailing market rates from various banks. As such, the recording of receipts and payments in EEFC account at the RBI reference rate would lead to recording of the foreign currency transactions at a rate prevailing on the date of transaction representing the market closely. Moreover, there is only 1 paisa bid/ask spread between the RBI rates applicable for receipts and payments.
(vii) As such, for the purpose of accounting for foreign currency transactions in EEFC accounts, instead of SBI Card rates it was decided to adopt the exchange rate circulated by RBI which is common for all commercial banks.
5. The querist has stated that the exchange rates adopted for accounting of other foreign currency income, expenditure, assets and liabilities are as below:
(i) EEFC accounts are exclusively maintained by the corporate office, where transactions are made by banks in foreign currency only and bank statement given by the bank is also in foreign currency. Only for the purpose of accounting, exchange rates are applied to convert the foreign currency amount into Rupees. On the other hand, foreign currency transactions at units/regions/divisions are made from their Rupee account at the actual settled exchange rates with banks.
(ii) For other foreign currency transactions at units/regions/divisions where exchange rates are only required for accounting, the corporate office circulates exchange rates on monthly, quarterly and annual basis for accounting of foreign currency transactions at the units/regions/divisions. These exchange rates are required for conversion of foreign currency transactions relating to current assets, cash & bank balances, liabilities, income and expenditure, to ensure application of suitable rate depending upon the type of foreign currency transactions. Accordingly, SBI Card Rates are circulated to units separately for Telegraphic Transfer (TT)/Bills Buying and TT/ Bills Selling.
(iii) Over the years, all accounting units in the company have been following SBI Card Rates for translation of foreign currency monetary assets and liabilities.
6. During the accounts closing for the financial year 2007-08, the government auditors have raised a query that individual banks’ exchange rates should have been used while accounting for the transactions in Rupees instead of using RBI rates. During discussion with the government auditors at their Director level, it was pointed out by them that units are accounting for foreign currency transactions on the basis of SBI exchange rates while for EEFC accounts, RBI rates are being used.
B. Query
7. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Since the main objective of operating EEFC accounts is to hedge against fluctuations in the exchange rates of foreign currencies, there should not be any element of gain or loss on account of exchange variation due to operation of the said accounts. As such, whether the company can account for the payments from EEFC accounts at the exchange rates applicable to receipts without considering the exchange rates prevailing on the dates of payment from the accounts. By following this method, no exchange rate variation will be booked for inflow and outflow transactions from EEFC accounts except to the extent applicable on the closing balances which can be converted at the applicable SBI Card Rates. Moreover, in EEFC accounts all transactions take place in foreign currency and for the purpose of recording only, exchange rate is applied to work out the amount in Rupees.
(ii) If the answer to the above is not in the affirmative, and the exchange rates applicable on receipt and payments dates only have to be applied to inflows and outflows respectively, please clarify as to which exchange rates are to be adopted, viz., SBI Card Rates or RBI Reference Rates or any other exchange rates for transactions through EEFC accounts.
(iii) Considering the appropriateness of RBI Reference Rate for EEFC accounts’ transactions and SBI Card Rates for accounting of other foreign currency transactions (due to availability of both buying and selling exchange rates separately), shall it be appropriate to continue applying RBI Reference Rate for EEFC accounts’ transactions during the accounting period to resemble the market rate more appropriately and at the end of the accounting period, the SBI Card Rate would be applied for conversion of EEFC accounts’ balances so as to bring uniformity at company level with the exchange rate applicable for accounting of other foreign currency transactions.
C. Points considered by the Committee
8. The Committee restricts itself to the particular issues raised by the querist in paragraph 7 above and has not examined any other accounting issues that may be contained in the Facts of the Case.
9. The Committee notes paragraphs 9, 10 and 11 of AS 11 reproduced in paragraph 3 above. From the said paragraphs, 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, or at a rate that approximates the actual rate at the date of the respective transactions, e.g., an average rate. Accordingly, the Committee is of the view that a common rate circulated by the corporate office for recording of transactions effected at different branches/regions, etc. through different bank accounts is not appropriate unless it approximates the actual rate. Since the exchange rate used for recording a foreign currency transaction should reflect the actual rate at the date of the transaction, the Committee is of the view that the transactions effected through EEFC accounts should also be recorded at the rate at the date of the transaction. The exchange rate at which monies were received in the EEFC account will have no bearing on the exchange rate applicable to payments made out of that account. The Committee is also of the view that all monetary liabilities and bank balances as on the date of the balance sheet should be reported using the closing rate.
10. With respect to the rate to be used for recording the foreign exchange transactions, the Committee is of the view that the actual exchange rate of the bank through which the transaction is effected would be the appropriate rate. For transactions through the EEFC accounts, the exchange rate of the bank with whom the respective EEFC accounts are maintained, should be used.
D. Opinion
11. On the basis the above, the Committee is of the following opinion on the issues raised in paragraph 7 above:
(i) Keeping in view the requirements of AS 11 and appreciating the intention of paragraph 10 thereof that a rate that approximates the actual rate at the date of transaction should be used for recording foreign exchange transactions, the company cannot account for the payments from EEFC accounts at the exchange rates applicable to receipts without considering the exchange rates prevailing on the dates of payments from the accounts. For transactions through the EEFC accounts, the exchange rate of the bank with whom the respective EEFC accounts are maintained, should be used. The closing balances of the EEFC accounts should be converted at the closing rate of the bank with whom the respective EEFC accounts are maintained.
(ii) The actual exchange rate of the bank through which the transaction is effected should be used for recording foreign currency receipts and payments. For transactions through the EEFC accounts, the exchange rate of the bank with whom the respective EEFC accounts are maintained, should be used.
(iii) The issue raised has been replied in (i) and (ii) above.
1Opinion finalised by the Committee on 8.5.2009.
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