advance financial accounting
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A
PROJECT
ON
“Study on Foreign Exchange Rate AS-11”
In the subject Advanced Financial Accounting
SUBMITTED TO
UNIVERSITY OF MUMBAI
FOR SEMESTER-I OF
MASTER OF COMMERCE
BY
SUNITA KUMARI YADAV
MCOM PART-I AND ROLL NO- 1890
UNDER THE GUIDANCE OF
Ms. FARAT SHAIKH
YEAR 2012-2013
DECLARATION BY THE STUDENT
I, SUNITA KUMARI YADAV student of M COM PART-I Roll Number 1890 hereby
declare that the project for the paper Advanced Financial Accounting Titled,
“Study on Foreign Exchange Rate AS-11”
Submitted by me for semester-I during the academic year 2012-2013, is based on actual
work carried out by me under the guidance and supervision of Ms. Farat shaikh.
I further state that this work is original and not submitted anywhere else for any
examination.
Signature of Student
EVALUATION CERTIFICATE
This is to certify that the undersigned have assessed and evaluated the project on
“Study on Foreign Exchange Rate AS-11”
Submitted by SUNITA KUMARI YADAV student of M COM Part-I.
This project is original to the best of our knowledge and has been accepted for internal
assessment.
Internal Examiner External Examiner Vice Principal
Ms. Farat shaikh Prof. A.N. Kutty
PILLAI’S COLLEGE OF ARTS, COMMERCE &
SCIENCE
Internal assessment : Project 40 Marks
Name of Student Class Division Roll
Number.
First Name: SUNITA
KUMARI
M COM
Father’s Name: B.B.S
PART I 1890
Surname: YADAV
Subject: Advanced Financial Accounting
Topic for the Project: “Study on Foreign Exchange Rate AS-11”
Mark Awarded
Signature
DOCUMENTATION
Internal Examiner
(Out of 10 Marks)
External Examiner
(Out of 10 Marks)
Presentation
(Out of 10 Marks)
Viva and Interaction
(Out of 10 Marks)
TOTAL MARKS (Out of 40)
CONTENTS
CHAPTER
NO.
TOPIC PAGE
NO.
1. Introduction 1
• MEANING 3
• Definition 4
• Objectives 5
• Scope 6
2. Foreign Currency Transaction 8
3. Financial Statement Of Foreign Operation 12
• Classification of Foreign Operation 12
• Integral 13
• Non-Integral 14
• Change in the classification of Foreign
Operation
16
4. Tax Effect Of Exchange Difference 16
5. Forward Exchange Contract 17
6. Conclusion 18
Foreign exchange rate AS-11
• Currency exchange rate refers
to the value of foreign nation’s
currency in terms of the home
nation’s currency.
• The exchange rate between
two currencies determines how
much one currency is worth in
terms of the other.
• There is always fluctuation in exchange rates. Different factors such as social,
political and economical factors tend to affect the currency exchange rates in the
currency market.
• The article below shares brief introduction to exchange rate and the types of
currency exchange rate. So, read on to get information about currency rate
exchange.
• There are two types of currency exchange rates.
1. The first one is the spot exchange rate that denotes the current exchange
rate.
2. While the other one is the forward exchange rate.
• Forward exchange rate basically refers to an exchange rate that is quoted and
traded today but for delivery and payment on a specific future date.
1
• Just going ahead with the introduction to online currency exchange rate, an
exchange system quotation is given by stating the number of units of quote
currency that can be exchanged for one unit of base currency.
• However, there is a market convention that determines which is the base
currency and which is the term currency.
• Direct quotation or price quotation in currency exchange rate basically refers to
the quotes that use a country's home currency as the price currency while
indirect quotation specifically refers to the quotes that use a country's home
currency as the unit.
• If a currency is free-floating, its exchange rate is allowed to vary against that of
other currencies and is specified by the market forces of supply and demand.
• Exchange rates for such currencies are likely to change almost constantly as
quoted on financial markets mainly by banks.
2
• In finance, an exchange rate (also known as the foreign-exchange
rate, FOREX rate or FX rate) between two currencies is the rate at which one
currency will be exchanged for another.
• It is also regarded as the value of one country’s currency in terms of another
currency.[1] For example, an interbank exchange rate of 91 Japanese yen (JPY,
¥) to the United States dollar (US$) means that ¥91 will be exchanged for each
US$1 or that US$1 will be exchanged for each ¥91.
• Exchange rates are determined in the foreign exchange market,[2] which is open
to a wide range of different types of buyers and sellers where currency trading is
continuous: 24 hours a day except weekends, i.e. trading from 20:15 GMT on
Sunday until 22:00 GMT Friday.
• The spot exchange rate refers to the current exchange rate. The forward
exchange rate refers to an exchange rate that is quoted and traded today but for
delivery and payment on a specific future date.
3
• A foreign exchange rate is the relative value between two currencies. In
particular, the exchange rate is the quantity of one currency required to buy or
sell one unit of the other currency
• Example:-
In travel, the exchange rate is
defined by how much money, or
the amount of a foreign currency,
that you can buy with one US
dollar. The exchange rate defines
how many pesos, euros, or baht
you can get for one US dollar (or
what the equivalent of one dollar
will buy in another country).
4
• An enterprise may carry on activities involving foreign exchange in two
ways. It may have transactions in foreign currencies or it may have foreign
operations.
• In order to include foreign currency transactions and foreign operations in the
financial statements of an enterprise, transactions must be expressed in the
enterprise’s reporting currency and the financial statements of foreign
operations must be translated into the enterprise’s reporting currency.
• The principal issues in accounting for foreign currency transactions and foreign
operations are to decide which exchange rate to use and how to recognize in
the financial statements the financial effect of changes in exchange rates.
5
a) This Standard should be applied:
(a) In accounting for transactions in foreign currencies;
and
(b) In translating the financial statements of foreign
operations.
In respect of accounting for transactions in foreign currencies entered into by the
reporting enterprise itself or through its branches before the effective date of the
notification prescribing this Standard under Section 211 of the Companies Act, 1956,
the applicability of this Standard would be determined on the basis of the Accounting
Standard (AS) 11 revised by the ICAI in 2003.
The Effects of Changes in Foreign Exchange Rates
• This Standard also deals with accounting f o r foreign currency
transactions in the nature of forward exchange contracts
• This Standard does not specify the currency in which an enterprise resents
its financial statements. However, an enterprise normally uses the currency of
the country in which it is domiciled.
• If it uses a different currency, this Standard requires disclosure of the
reason for using that currency. This Standard also requires disclosure of the
reason for any change in the reporting currency.
6
• This Standard does not deal with the restatement of an enterprise’s financial
statements from its reporting currency into another currency for the
convenience of users accustomed to that currency or for similar
purposes statements from its that currency or for similar purposes.
• This Standard does not deal with the presentation in a cash flow statement of
cash flows arising from transactions in a foreign currency and the translation
of cash flows of a foreign operation (see AS 3, Cash Flow Statements).
• This Standard does not deal with exchange differences arising from foreign
currency borrowings to the extent that they are regarded as an adjustment to
interest costs (see paragraph 4(e) of AS 16, Borrowing Costs).
7
A foreign currency transaction is a transaction which is denominated in or requires
settlement in a foreign currency, including transactions arising when an enterprise
either:
• Buys or sells goods or services whose price is denominated in a foreign currency;
• Borrows or lends funds when the amounts payable or receivable are denominated in a foreign currency
• Becomes a party to an unperformed forward exchange contract
• Otherwise acquires or disposes of assets, or incurs or settles liabilities, denominated in a foreign currency.
A foreign currency t r a nsac t i on 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.
8
Question:
On 31st December 2005 the following balances appered in the books of the Calcutta
branch of an English firm having its head office in London:
Particular Dr. Cr.
Stock on 1.1.2005 12600 -
Purchases and sales 75000 112500
Debtor and creditor 39000 26000
Bill of exchange 10400 9100
Wages and salaries 4800
Rent, rates and taxes 3600
Sundry charges 1500
Furniture and fixtures 4910
Bank balance 28990
London office 33200
Total 180800 180800
Stock on 31.12.2005 was Rs. 32500. Calcutta branch account in the books of London
office showed a debit balance of £ 2280 on 31.12.2005. Fixtures and furniture were
acquired from a remittance received from London of £ 350 which exactly covered the
cost of such fixtures etc.
The rate of exchange may be taken at
DATE RATE
31.12.2004 Rs. 14 per £
31.12.2005 Rs. 13 per £
The average rate for the year 2005 may be taken at Rs.12 per £
Prepare the trading and profit and loss account and balance sheet relating to Calcutta
branch in the London books.
9
Solution :-
Calcutta branch
Trading and profit and loss account
(For the year ended on 31.12.2005)
Particular £ Particular £
To opening stock 900 By sales 9375
To purchases 6250 By closing stock 2500
To gross profit c/d 4725 -
11875 11875
To wages and salaries 400 By gross profit b/d 4725
To rent, rates and taxes 300
To sundry expenses 125
To net profit 3900
4725 4725
Balance sheet of Calcutta branch as at 31st December 2005
10
Liabilities £ Assets £
London office
account:
Bank 2230
Balance existing
2280
Bill receivable 800
Add: profit
3900
6180 Debtors 3000
Stock 2500
Creditors 2000 Furniture and
fixtures
350
Bills payable 700
8880 8880
Working notes:
WN-1
Particular Rate per £
1
Dr. Rs. Cr. Rs. Dr. £ Cr. £
Stock 1.1.2005 14 12600 900
Purchase and sales 12 75000 112500 6250 9375
Debtors and
creditors
13 39000 26000 3000 2000
Bill of exchange 13 10400 9100 800 700
Wages and salaries 12 4800 400
Rent, rates and taxes 12 3600 300
Sundry charges 12 1500 125
Furniture & fixtures - 4910 350
Bank balance 13 28990 2230
London office - - 33200 - 2280
- 180800 180800 14355 14355
WN-2
Stock on 31st December 2005 Rs.32500; @ Rs.13 to £ 1 it is 2500
11
Classification of foreign operation
The method used to translate the financial statements of a foreign operation
depends on the way in which it is financed and operates in relation to the
reporting enterprise. For this purpose, foreign operations are classified as either
“integral foreign operations” or “non-integral foreign
• A foreign operation that is integral to the operations of the reporting enterprise
carries on its business as if it were an extension of the reporting enterprise’s
operations.
• For example, such a foreign operation might only sell goods imported from
the reporting enterprise and remits the proceeds to the reporting enterprise.
In such cases, a change in the exchange rate between the reporting currency
and the currency in the country of foreign operation has an almost
immediate effect on the reporting enterprise’s cash flow from operations.
• Therefore, the change in the exchange rate affects the individual monetary
items held by the foreign operation rather than the reporting enterprise’s
net investment in that operation.
• In contrast, a non-integral foreign operation accumulates cash and other
monetary items, incurs expenses, generates income and perhaps arranges
borrowings, all substantially in its local currency.
• It may also enter into transactions in foreign currencies, including transactions
in the reporting currency. When there is a change in the exchange rate
between the reporting currency and the local currency, there is little or no
direct effect on the present and future cash flows from operations of either
the non-integral foreign operation or the reporting enterprise.
• The change in the exchange rate affects the reporting enterprise’s net
investment in the non-integral foreign operation rather than the individual
monetary and non-monetary items held by the non-integral foreign
operation.
12
• Integral Foreign Operations
• The financial statements of an integral foreign operation should be translated
using the principles and procedures in paragraphs 8 to 16 as if the
transactions of the foreign operation had been those of the reporting
enterprise itself.
• The individual items in the financial statements of the foreign operation
are translated as if all its transactions had been entered into by the reporting
enterprise itself.
• The cost and depreciation of tangible fixed assets is translated using the
exchange rate at the date of purchase of the asset or, if the asset is carried
at fair value or other similar valuation, using the rate that existed on the
date of the valuation.
• The cost of inventories is translated at the exchange rates that existed
when those costs were incurred. The recoverable amount or realisable
value of an asset is translated using the exchange rate that existed when the
recoverable amount or net realisable value was determined. For example,
when the net realisable value of an item of inventory is determined in a
foreign currency, that value is translated using the exchange rate at the date
as at which the net realisable value is determined.
• The rate used is therefore usually the closing rate. An adjustment may be
required to reduce the carrying amount of an asset in the financial statements
of the reporting enterprise to its recoverable amount or net realisable value
even when no such adjustment is necessary in the financial statements of
the foreign operation.
• Alternatively, an adjustment in the financial statements of the foreign operation
may need to be reversed in the financial statements of the reporting
enterprise.
• 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.
13
• Non-integral Foreign Operations
• In translating the financial statements of a non-integral foreign operation for
incorporation in its financial statements, the reporting enterprise should use the
following procedures:
(a) the assets and liabilities, both monetary and non-monetary, of the non-integral
foreign operation should be translated at the closing rate;
(b) income and expense items of the non-integral foreign operation should be
translated at exchange rates at the dates of the transactions; and
(c) all resulting exchange differences should be accumulated in a foreign
currency translation reserve until the disposal of the net investment.
• For practical reasons, a rate that approximates the actual exchange rates, for
example an average rate for the period is often used to translate income and
expense items of a foreign operation.
• The translation of the financial statements of a non-integral foreign operation
results in the recognition of exchange differences arising from:
(a) Translating income and expense items at the exchange rates at the dates of
transactions and assets and liabilities at the closing rate;
(b) T ranslating the opening net investment in the non-integral foreign operation at an
exchange rate different from that at which it was previously reported.
(c) Other changes to equity in the non-integral foreign operation.
14
These exchange differences are not recognized as income or expenses for the period
because the changes in the exchange rates have little or no direct effect on the
present and future cash lows from operations of either the non-integral foreign
operation or the reporting enterprise. hen a non- integral foreign operation is
consolidated but is not wholly owned, accumulated exchange differences arising from
translation and attributable to minority interests are allocated to, and reported as part
of, the minority interest in the consolidated balance sheet.
• When the financial statements of a non-integral foreign operation are
drawn up to a different reporting date from that of the reporting
enterprise, the non-integral foreign operation often prepares, for purposes of
incorporation in the financial statements of the reporting enterprise,
statements as at the same date as the reporting enterprise.
• When it is impracticable to do this, AS 21, Consolidated Financial Statements,
allows the use of financial statements drawn up to a different reporting
date provided that the difference is no greater than six months and
adjustments are made for the effects of any significant transactions or
other events that occur between the different reporting dates.
• In such a case, the assets and liabilities of the non-integral foreign
operation are translated at the exchange rate at the balance sheet date of
the non- integral foreign operation and adjustments are made when
appropriate for significant movements in exchange rates up to the
balance sheet date of the reporting enterprises in accordance with AS 21.
15
• Change in the Classification of a Foreign Operation
When there is a change in the classification of a foreign operation, the translation
procedures applicable to the revised classification should be applied from the date of the
change in the classification.
The consistency principle requires that foreign operation once classified as integral or
non-integral is continued to be so classified. However, a change in the way in which a
foreign operation is financed and operates in relation to the reporting enterprise may lead to a
change in the classification of that foreign operation. When a foreign operation that is integral
to the operations of the reporting enterprise is reclassified as a non-integral foreign operation,
exchange differences arising on the translation of non-monetary assets at the date of the
reclassification are accumulated in a foreign currency translation reserve. When a non-integral
foreign operation is reclassified as an integral foreign operation, the translated amounts for non-
monetary items at the date of the change are treated as the historical cost for those items in the
period of change and subsequent periods. Exchange differences which have been deferred are
not recognized as income or expenses until the disposal of the operation.
• Gains and losses on foreign currency transactions and exchange differences arising on
the translation of the financial statements of foreign operations may have associated tax
effects which are accounted for in accordance with AS 22, Accounting for Taxes on
Income.
16
An enterprise may enter into a forward exchange contract or another financial
instrument that is in substance a forward exchange contract, which is not intended for
trading or speculation purposes, to establish the amount of the reporting currency required
or available at the settlement date of a transaction. The premium or discount arising at the
inception of such a forward exchange contract should be a mortised as expense or income
over the life of the contract. Exchange differences on such a contract should be recognized
in the statement of profit and loss in the reporting period in which the exchange rates
change. Any profit or loss arising on cancellation or renewal of such a forward exchange
contract should be recognized as income or as expense for the period.
• The risks associated with changes in exchange rates may be mitigated by entering into
forward exchange contracts. Any premium or discount arising at the inception of a
forward exchange contract is accounted for separately from the exchange differences on
the forward exchange contract.
• The premium or discount that arises on entering into the contract is measured by
the difference between the exchange rate at the date of the inception of the forward
exchange contract and the forward rate specified in the contract.
• Exchange difference on a forward exchange contract is the difference between
I. The foreign currency amount of the contract translated at the exchange rate at the
reporting date, or the settlement date where the transaction is settled during the
reporting period,
II. The same foreign currency amount translated at the latter of the date of inception of
the forward exchange contract and the last reporting date.
• In recording a forward exchange contract intended for trading or speculation
purposes, the premium or discount on the contract is ignored and at each balance sheet
date, the value of the contract is marked to its current market value and the gain or loss
on the contract is recognized.
17
The Statement is applied in accounting for transactions in foreign currency and
translating financial statements of foreign operations. It also deals with accounting
of forward exchange contract.
• Initial recognition of a foreign currency transaction shall be by applying the
foreign currency exchange rate as on the date of transaction. In case of voluminous
transactions a weekly or a monthly average rate is permitted, if fluctuation during
the period is not significant.
• At each Balance Sheet date foreign currency monetary items such as cash,
receivables, and payables shall be reported at the closing exchange rates unless there
are restrictions on remittances or it is not possible to affect an exchange of currency
at that rate. In the latter case it should be accounted at realizable rate in reporting
currency. Non monetary items such as fixed assets, investment in equity shares
which are carried at historical cost shall be reported at the exchange rate on the date
of transaction. Non monetary items which are carried at fair value shall be reported
at the exchange rate that existed when the value was determined.
18