Accounting Standards
BACKGROUND
Need For Standards
Business activities are varied.
Strenuous task to present the facts intelligibly, in a summarized form.
Methods & Principles adopted by various reporting enterprise are cohernt, not misleading.
Information to the extent possible Uniform & Comparable– Standards are evolved.
It Provides
Discipline
Guidelines [i.e Uniform practices & Common techniques].
Yardsticks for evaluation [i.e Comparative analysis].
Objective
It greatly enhances the users of FS like
• Investor {AS 13},Employees, Lenders, Creditors, Suppliers, Governments.
To eliminate confusing variations in the treatment of several accounting aspects.
To bring Feasibility & Uniformity in presentation.
Other Factors
AS is an authoritative pronouncement of code of practice.
It intend to apply only to material items.
Compilation with Companies Act 1956
As per section 211 of Co’s Act 1956
Sub sec (3A) Every P&L a/c, and Balance Sheet should comply with AS.
Sub sec (3B) if not complied then following should be disclosed:
Deviation from AS
Reason for such deviation {AS1}
Financial effect, if any arising.
Sub sec (3C) AS means as recommended by ICAI
As per section 217 of Co’s Act 1956 sub sec (2AA)
Board’s report shall also include a Directors Responsibility Statement, indicating :
The preparation of Annual Accounts are in compilation of applicable AS’s
As per section 227(3) Powers & Duties Of Auditors
Auditors report shall also state that in his opinion, P&L and Balance Sheet are complied.
EFFECTIVE DATE 01
STAPRIL,2004
Why Foreign Currency transaction (FCT) arises?
OR
Lack of
Technology
Cheap
Manpower
Able to see this picture? No?
Because of following reasons FCT arises;
Dealings of an entity with clients who is in other currency
country.
Activity undertaken through Branch
Business with Associates (AS -23)
Holding/Subsidiary relationship
Business with Joint Ventures (AS -27)
Globalization Holding/Subsidiary/Branches/JV’s/Associate
OR
This AS address two principal issues;
Selection of an appropriate rate to be used for a transaction
Manner in which financial effect of change in exchange rates should be recognized in the separate financial statement of an enterprise, and also in the Consolidated Financial
Statements (AS -21)
•Effects in Changes in Forex Rates
FOREIGN CURRENCY
TRANSACTIONS
TRANSLATING FINANCIAL
STATEMENTS OF FOREIGN
OPERATIONS FORWARD
EXCHANGE
CONTRACTS TAX EFFECTS OF
EXCHANGE
DIFFERENCES DISCLOSURE
1.INITIAL
RECOGNITION.
2.REPORTING AT SUBSEQUENT BALANCE SHEET DATES.
3.RECOGNITION OF EXCHANGE
DIFFERENCES.
1.CLASSIFICATION INTO INTEGRAL &
NON INTEGRAL.
2.DISPOSAL OF NON INTEGRAL
OPERATIONS.
3. CHANGE IN CLASSIFICAION.
4.TRANSLATION PROVISIONS.
Note: AS 11 does not deal with the re-statement
of the Financial Statements in different currency
Required because of Required because of
following Transactions;- following Transactions;-
Buying & Selling of Goods & Services Borrowing & Lending Money.
Acquiring or Disposing of Fixed Assets.
The above Transactions should be recorded by applying Exchange Rates. In some cases Average Rates are also applied. Reporting Entity should normally establish an appropriate accounting policy and disclose the same in Financial Statements.
For Reporting at the end of the each accounting period, items in Balance Sheet required to be classified into following:-
Monetary Items
Money held and assets and liabilities to be
received or paid in fixed or determinable
amounts of money.
Non Monetary Items
Assets and Liabilities other than monetary items.
Examples ; Cash, Debtors, Creditors.
Examples ; Fixed Assets, Inventories and
Investments in Equity Shares.
FOR TRANSLATION OF BALANCE SHEET ITEMS THAT ARE DENOMINATED IN FOREIGN CURRENCY, THE FOLLOWING PRINCIPLES APPLY:
CLOSING RATE FOR THE FOLLOWING:-
1.Monetary Items,
excepting that restrictions on remittances etc.
TRANSCTION –DATE RATE OR RATE EXISTED ON FAIR VALUE
ESTIMATION:-
1.For Non- Monetary Items
SELECTION OF RATES FOR TRANSLATION IS BASED ON THE FOLLOWING PRINCIPLE
Grouping of Non Monetary Items Stipulation Regarding Exchange Rate
Those that are carried at Historical Cost
Rates applicable on the date on which transaction was originally concluded
Those that are carried in terms of Fair Value or similar
valuation
Rates applicable on the date on which Fair value or similar
valuation was determined.
The rule of “CAPITALISING THE EXCHANGE DIFFERENCE HAS BEEN WITHDRAWN after
companies act adopted AS 11 as its Accounting Standard from Effective Date 07th
December,2006.” ‘The Exchange difference should be charged to Profit & Loss account.’
Three reasons for the change:-
1.RBI’s ability to bring about a turn around in the forex reserves position .
2. Availability of a variety of derivative instruments to enterprises which enable them to hedge their open positions effectively with little strain on managing transaction risk.
3.Need to realign accounting practices in India with International practices.
Important Note.
SPACE BAR SPACE BAR
Z X C V B N M < > ? Z X C V B N M < > ?
1 2 3 4 5 6 7 8 9 01 2 3 4 5 6 7 8 9 0
A B S D F G H J K LA B S D F G H J K L
OBSERVE THIS PICTURE
EXCHANGE DIFFERENCE IS THE DIFFERENCE RESULTING FROM
REPORTING THE SAME NUMBER OF UNITS OF A FOREIGN CURRENCY IN THE REPORTING CURRENCY AT DIFFERENT EXCHANGE RATES.
A Transaction relating to a monetary item being settled at the rate
different from the rate at which it was initially
recorded (initial recognition)
A Transaction being reported at a rate different from the rate
at which it was either initially recorded
(balance sheet reporting)
A Transaction being settled at a rate different from the one
taken for reporting in the last financial statement (settlement)
AS-R LAYS DOWN THE FOLLOWING PRINCIPLE FOR RECOGNITION OF EXCHANGE DIFFERENCES:-
“INCOME or EXPENSE”
in the “PERIOD” in
which they arise Exchange Difference should be
transferred to FCTR - “ NON- INTEGRAL OPERATIONS”
Transaction
Date Intervening
Reporting Date Settlement Date
“Period” in which Exchange Difference
arise
12th
January 31st March 24th April
a) 12th Jan to 31st Mar.
b) 1st Apr to 24th Apr.
15th
September NIL 10th January
15th Sept to 10th Jan since it is in same year.
02nd
October 30th
November 20th December
a) 2nd Oct to 30th Nov.
b) 1st Dec to 20th Dec.
Example
Where an entity has non- integral foreign operations, the exchange differential attributable to some monetary items having specific characteristics should be accumulated in
“FOREIGN CURRENCY TRANSLATION RESERVE ACCOUNT”
Note
NOW WE ARE ENTERING INTO A NEW CONCEPTS WHICH IS INCLUDED IN REVISED AS-11
FOREIGN OPERATIONS Foreign operations is a subsidiary,
Associate, Joint Venture, or Branch of the reporting
enterprise, the activities of which based or conducted in a country other than the country of the reporting enterprise.
Can any bogive the dy examples which we are doing audits
INTEGRAL FOREIGN OPERATIONS
An Integral Foreign Operations is a
foreign operation, the activities of which are an integral part of those of the reporting enterprise.
Can any bogive the dy examples which we are doing audits
NON-INTEGRAL FOREIGN OPERATIONS
This term is defined negatively. It is an operation that is not an integral foreign operation.
Can any bogive the dy examples which we are doing audits
IMPORTANT TO NOTE;
Indian company having foreign branch has been brought into ambit of FOREIGN OPERATIONS.
It is essential to an enterprise to classify all its operations – be it a branch, an associate, a joint venture or a
subsidiary. Into either INTEGRAL OR NON INTEGRAL FOREIGN OPERATIONS.
The objective of this classification into IFO or NIFO is to get the financial statements to
produce results, that are compatible results with effect of the rate changes on company’s cash flows and on its equity.
Classification in the manner will lead to selection of an appropriate method for
translation of foreign operations of an entity for the purpose of reporting.
MANOJ P DESAI
Changes in exchange rates can have a direct effect on the cash flows of
reporting entity. If they do, then they will be “IFO”
Points to be noted in this regard;
1. Nature of overseas operations.
2. Foreign branch carries on its operations as if it were an extended arm of the reporting entity.
3. Forex impact is directly related to on cash flows of reporting entity.
4. Such an impact will arise from and will be relatable to all monetary items.
EXAMPLES FOR IFO’S ARE GIVEN BELOW;
1. Entity Produces raw material or component, and transfers the goods for inclusion in the ultimate product being manufactured by investing company.
2. Entity acts as a Selling Agents
3. Entity setup to Raise a Finance to help investing entity or for Tax reasons
Translation of FINANCIAL STATEMENTS OF IFO’S;-
ITEMS SELECTION OF RATE
Initial Recognition Rate applicable on the date of transaction
Cost and Depreciation of Tangible Fixed Assets Date of Purchase.
Assets carried at fair value Date on which fair value determined
Assets that are shown at realizable value or recoverable amount Date on which such value or amunt was determined (closing rate)
Contingent liability Closing Rate
Resulting exchange difference to be “RECOGNISED IN THE PROFIT AND LOSS ACCOUNT.”
An NFO accumulates cash and other monetary items, incurs expenses, generates income and arranges
borrowings, all substantially in “local currency”.
Change in forex will not have direct impact on cash flows of reporting entity.
The effect if any would be traceable to a change in the “Net Investment in Foreign Operations” of reporting entity.
Point to be noted in this regard;
The reporting entity to exercise “CONTROL” over foreign operations, is not necessarily a determinant factor.
Indications to test whether the entity is an NFO:
1. Nature, Size, Frequency and materiality of transactions of foreign entity with reporting entity.
2. Extent of Autonomy (Dependent/Independent)
3. Mode of Financing (Local currency borrowings rather from reporting entity) 4. Cost of Production or services being incurred and settled in its local currency.
5. Sales being in currencies other than reporting currency.
The above are indications but still we need to exercise our judgment to decide it as NFO or IFO.
Translation of FINANCIAL STATEMENTS OF NFO’S;-
ITEMS SELECTION OF RATE
Assets and Liabilities (Balance Sheet items) both
monetary and non-monetary Apply “Closing Rate”
Income and Expenses Apply the Rate relevant on the date of Transactions Resulting Forex should be accumulated in “FOREIGN CURRENCY TRANSLATION RESERVE (FCTR), UNTIL DISPOSAL OF NET INVESTMENT OF THAT NFO”.
Goodwill or Capital Reserve arising on acquisition of NFO (Subsidiary) should be translated at
Points to be noted in this regard
1. Normal consolidation procedures such as elimination of intra- group transactions of subsidiary, associate, JV, Etc should be applied.
2. Exchange differences attributable to monetary items should be recognized as INCOME OR EXPENSE in case of IFO and to be accumulated in FCTR in case of NFO.
3. Financial Statements of different reporting dates can be used subject to conditions laid down in AS 21.
4. Principles laid down in AS 23 and AS 27 should also be applied.
TAX EFFECTS OF FOREIGN EXCHANGE RATES:-
Here comes relation to AS 22 (Timing Difference) when a foreign branch is changed its
identity from IFO (Forex recognized in P&L account) to NFO (where Forex is accumulated in FCTR account)
There are two types of transactions as given below;-
ENTERED FOR HEDGING PURPOSES ENTERED FOR SPECULATIVE PURPOSES
This is done in the intention of
managing or minimizing risks a risk associated with changes in Forex Premium (Loss)/Discount (Gain) arising out of contract should be recognized over the tenor of the contract period.
But any “Profit or Loss” arising on
“Cancellation or Renewal” of contract to be recognized as
“Income or Expense” for the
“Period”
The “Gain/Loss” arising out of
“Speculative Contract” to be computed and should be recognized on the “Reporting Date" (Balance Sheet Date)
1. Amount of “Forex” differences included in the “Net Profit or Loss” for the
“Period”.
2. Net “Forex” differences “accumulated in FCTR” (as owner’s equity) 3. If the reporting currency is different from the currency of the country in
which the reporting entity is domiciled (registered office), this should be disclosed with explanatory notes.
4. Reconciliation between opening and closing balance in the said reserve account to be highlighted.
5. A change in classification of significant foreign operation, additional disclosures are called for in the following areas;-
a. Nature of change in classification b. Reasons
c. Impact of such change on shareholders funds d. Impact on P&L account for the period.
Change in Forex occurring after balance sheet date is disclosed in accordance with AS 4.
RELATED IAS IS GIVEN BELOW
