1.25     Query

Accounting policy regarding treatment of exchange variation.

1.A Government of India undertaking is rendering consultancy services in India and abroad. The company is executing a number of overseas projects ranging from 6 months to 3 to 4 years.

2.The foreign currency accounts are converted at various rates as per the accounting policy followed by the company in this regard which is given below:

                        (a) Items of income and revenue expenditure are translated at average rate.

(b) Current assets and current liabilities are translated at the closing rate, while fixed assets are translated at the rates in force when the transactions take place.

(c) Exchange rate variations resulting from the above are transferred to provision for exchange variation account and if the balance at the end of the year in the said account is debit, the same is charged to profit and loss account.

(d) In respect of non-convertible currencies the transactions are converted at the rates indicated above. However, in the cases where the conversion rates in US Dollars/pounds are specified in the agreement itself, the same are converted in US Dollars/pounds at that rates.

3. The credit balance of the exchange variation is kept under the heading: “Provision for exchange variation” and is reflected under the head ‘Current Liabilities and Provisions’. The balance in this account is accumulated over a period of time.

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

(a) Whether the treatment given to foreign currency translation, as stated in paragraph (2) above, is in order; and

(b) at what point of time the provision for exchange variation, as explained in para (3) above, should be written back.

                                                                                 Opinion                        September 27, 1988

1.The Committee notes that the nature of the foreign operations of the undertaking in question are such that the assets, liabilities, income and expenses accounts are maintained in foreign currencies concerned. In the view of the Committee, therefore, the query relates to translation of the said accounts into rupees. In view of this, the problem is akin to translating the financial statements of a foreign entity.

2.In this regard, The Committee notes that paras 13 and 14 of the Statement on Accounting for Foreign Currency Translation, issued by the Institute of Chartered Accountants of India, provides the following:

“13. In incorporating the financial statements of a foreign entity, revenue items can be incorporated either at the current rate or at the average rate. In normal circumstances, the use of the average rate is preferable since (a) it gives recognition in the revenue statement to the changes which have taken place in the exchange rate during the accounting period and (b) it records separately the profit or loss arising as a result of such changes instead of merging the profit or loss in the individual items of income and expenditure for the period. The use of the current rate or the average rate would however be inappropriate in respect of the following items in the revenue statement: -

(a)       Opening and closing inventories which should be translated at the current rate at the commencement and close respectively of the accounting period and

(b)       Depreciation which should be translated at the rate used for the translation of the values of the assets on which depreciation is calculated.

14. The average rate may also not be appropriate for the translation of revenue items in the financial statements of foreign entities in certain special circumstances. Examples of such circumstances would be: -

(a)       When the income/expenditure is not earned/incurred evenly during the accounting period e.g. in seasonal businesses.

(b)       When there are exceptionally wide fluctuations in exchange rates during the accounting period.

(c)       Where profit remittances have been received from a branch or loss remittances have been made to a branch at a rate which is significantly different from the average rate.

            In such cases a weighted average rate may be more appropriate.”

3. With regard to translation of fixed assets, the Committee notes that para 17 of the aforesaid Statement provides that, “Non-current assets are normally translated at the original rate, consistent with the historical cost concept.”

4.The Committee also notes that since the company translated the fixed assets at the rates in force when the transactions took place, no exchange rate variation was possible with regard to fixed assets.

5. Regarding translation of current assets and current liabilities, the Committee notes that para 16 of the aforesaid Statement provides as follows:

“Current assets (both monetary and non-monetary) and short-term liabilities are normally translated at the current rate. When, however, the exchange risk has been eliminated by a forward exchange contract, the translation should be at the rate mentioned in the contract. A short-term liability which consists of that part of a long-term liability which is due for repayment within one year of the balance sheet date may be treated for the purposes of translation as on a par with the long-term liability of which it forms a part.”

6. The Committee also notes that para 24 of the said Statement provides the following with regard to exchange rate variation resulting from the translation of current assets and current liabilities:

“The translation difference arising on the translation of current assets and short-term liabilities should be charged to the profit and loss account of the year in which the difference arises. However, if the difference arises in respect of assets and liabilities in a country from which remittance of profits or funds is not possible, the charge to the profit and loss account, if a net gain, should be deferred and transferred to a separate reserve account. Any loss arising on the subsequent translation of the assets or liabilities in the same currency can be debited to this reserve. If the difference is a net loss, it must be charged to the profit and loss account in all cases.”

7. On the basis of the above, the Committee is of the opinion that:

(a)       Items of income and revenue expenditure can be translated at average rate except in the situations listed in paras 13 and 14 of the Statement on Accounting for Foreign Currency Translation (reproduced in para 2 above). It is in order for the company to translate current assets and current liabilities at the closing rate and fixed assets at the rates in force when the transactions take place. The company should treat exchange rate variations resulting from transaction of current assets and current liabilities in accordance with para 24 of the aforesaid Statement which has been reproduced under para 6 above.

(b)       Since the credit balance in the exchange variation account has arisen on account of translation of current assets and current liabilities, and income and expenditure of revenue nature, it should be taken to profit and loss account. However, the exchange variation reserve should be created only in the situation stated in para 24 of the said Statement, i.e., where the exchange rate gain arises in respect of assets and liabilities in a country from which remittance of profits or funds is not possible. This reserve cannot be written-back in the profit and loss account but can be used to adjust any subsequent translation of assets and liabilities as per the aforesaid para 24.

___________________________