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AS-11 (REV) Foreign currency transactions

BY

RAMKI

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Latest change- Govt notification Mar 31, 09

• Applicable to companies only

• Applicable from accounting periods commencing on or after 7/12/06 or date from which FC monetary asset is acquired whichever is later

• Exchange diff arising on reporting of Long term FC monetary items at a rate different from those at which they were initially recorded during the period or reported in previous FS relating to depreciable capital asset can be added to or deducted from cost of fixed asset and depreciated over balance life of asset

• In other cases (where not related to fixed assets) can be accumulated in a "Foreign currency Monetary item Translation difference' a/c and amortised over the balance period of long term asset/liability but not beyond 31.3.2011.

– (Other than differences under para 15-non integral foreign operation)

• The past transfers to P&L to be reversed to general reserve.

• Disclosure of option, amount remaining to be amortised

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AS11 (rev) -CHANGES

• Exchange differences arising on repayment of liabilities incurred for acquisition of fixed assets to be charged off and not capitalised. (Old AS 11 required capitalisation)

– However in view of SCH VI of Companies Act, exemption provided for exchange differences arising on repayment of liabilities incurred for imported assets ,which was continued to be capitalised till 6 Dec 06 ; This is no longer allowed after 7 Dec 06 after Companies (Accounting standards rules) 2006. (confirmed by announcement of ICAI in Jul 07)– However even now Reliance Industries continues to take the forex diff to fixed assets based on ‘legal opinion’. (see Jun 07 results)

• AS 11 rev deals with translation of financial statements of all foreign operations including subsidiaries, associates and JV’s also; Old AS 11 covered only foreign branches

• Also AS 11 rev requires classification of foreign operations as integral (part of the enterprise) and non integral (largely independent)

– Temporal method used for former and current rate method used for latter• AS 11 rev deals with forward exchange contracts entered into for the purposes of trading or

speculation

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What are foreign currency transactions?

• Foreign currency transaction is a transaction

• which is denominated in

• or

• requires settlement in a foreign currency.

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Foreign currency transactions

• A foreign currency transaction should be recorded on initial recognition by applying to the FC the exchange rate between the reporting currency and the foreign currency at the date of the transaction.

• For practical reasons a rate that approximates the actual rate at the date of transaction can be used- e.g avg. rate for a week or a month provided exchange rate does not fluctuate significantly

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Date of transaction

• Date on which transaction becomes eligible to be recognised in books of accounts

– E.g for sale it will be date as per AS 9 – date on which risk and reward of ownership are transferred– E.g when advance is given for a fixed asset the translation is done based on date of actual receipt later and not date advance was given

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Restatement at BS date

• If a foreign currency transaction is outstanding at BS date,– Monetary items (cash, receivables, payables etc) should be reported using the closing rate– Non monetary items carried at historical cost to be carried at exchange rate at the date of transaction

• For inst. Inventory- exchange difference should not be added to cost of inventory

– Non monetary assets carried at fair value (say nrv or revalued assets) to be reported at exchange rate that existed when the values were determined

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Monetary and Non monetary

• Monetary– Examples from AS-11- cash, receivables, payables.– Examples from IFRS- pensions and other employee benefits to be paid in cash, cash dividends recognised as liability

• Non monetary-– Examples from AS-11- Fixed assets, investments in equity shares– Examples from IFRS- Prepaid goods and services, goodwill, intangibles, inventory, property and plant , provisions to be settled by delivery of non monetary asset.

• One item with differing opinions is: advance from customers for export and converted into rupees.

– ICAI EAC opinion says it is monetary but IFRS definition suggests it is non monetary

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What rates to use for restatement?

• Current assets excl. cash and bank: Bills buying

• Cash and bank: TT buying

• Liabilities (excl. LT loans) Bills selling

• LT loans TT selling

• Income TT buying

• Expenditure TT selling– Not stated in Standard (in IFRS too) –common practice

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What not to restate?

• All current assets are not to be restated. Only monetary assets

• Monetary assets and liabilities are those for which the amount is receivable/ payable in Foreign Currency and the amount is fixed.

• Thus non refundable advance to a supplier for fixed asset purchase should not be restated.

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Treatment of exchange differences

• Exchange differences on settlement of monetary items or on restatement to be recognised in P&L account except as stated earlier

• Exchange difference amount should be debited to a separate account and the amount disclosed

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Forex gain of doubtful debt

• Any forex gain on a doubtful debt in FC should be recognised as per AS 11

– However a provision should be made for the total receivable

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Forward exchange contracts

• A forward cover may be related to one of following and treatment differs in each case :

• * Hedging where there is an underlying asset or liability/loan (AS 11 applies)

• Speculative or trading contracts

• * Hedging where there is no underlying asset or liability (firm commitment or highly probable forecast transaction)- AS 11 does not apply; ICAI announcement applies; New AS 30 /31 will apply

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Forward exchange contracts AS 11

• Non speculation:– Premium/discount (difference between exchange rate at the date of inception of forward exchange contract and forward rate specified in the contract) to be amortised over life of contract– Exchange differences on such contract to be recognisedin P&L on reporting date– Profit or loss on cancellation to be recognised in P&L

• Speculation:– Gain/loss computed by multiplying the FC amount of the FE contract by the difference between Forward rate available at reporting date for remaining maturity and the contracted forward rate – The gain/loss accounted in P&L

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Firm commitment/ Highly probable forecast transaction• Clarification of ICAI Jul 07: Pending the issuance of the proposed Accounting

Standard on ‘Financial Instruments: Recognition and Measurement’, which is under formulation, exchange differences arising on the forward exchange contracts entered into to hedge the foreign currency risks of a firm commitment or a highly probable forecast transaction should be recognised in the statement of profit and loss in the reporting period in which the exchange rate changes. Any profit or loss arising on renewal or cancellation of such contracts should be recognised as income or expense for the period.

• The ICAI announcement on this would now be applicable in respect of accounting period(s) commencing on or after April 1, 2008.

• This covers transactions to be entered into in future not transactions already in place. (first issued in Jan 06 and implementation postponed quite a few times)

• This covers exchange difference only and not premium/ discount which should be accounted as per AS 11- rev 2003.

• This announcement now stands withdrawn.

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Derivatives

• After Hexaware one needs to be very careful in this area

• Go through the transactions carefully and obtain management reps.

• Ensure any exposure not marked to market (even if not required because of postponement of announcement ) is disclosed to audit committee

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Derivatives

• Pending new AS in this area Company to disclose some info. In notes on accounts.– category-wise quantitative data about the derivative instruments that are outstanding at the BS date;– the purpose viz. hedging or speculation for which such derivative instruments have been acquired and – the foreign currency exposures that are not hedged by a derivative instrument or otherwise.

• Sample disclosure adapted from Aditya Birla Nuvo Ltd– Derivatives outstanding on BS date:

• Currency and interest rate swap –USD- 22511365• Buyers credit - Jyen- 2986811871• Forward contracts -USD- 22011365

» -do- -Jyen -4245311871– All above for hedging purposes and not speculation

– FC exposures not hedged on BS date:• USD –payable: 27181525; receivable: 10012579• Euro- receivable: 1962527

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Derivatives ICAI new announcement -29/3/08

• AS 30 can be followed by the entities, as the earlier adoption of a standard is always encouraged.

• In case an entity does not follow AS 30, the entity should mark-to-market all the outstanding derivative contracts on the balance sheet date.

• The resulting mark-to-market losses should be provided for keeping in view the principle of prudence as enunciated in AS 1, Disclosure of Accounting Policies.

• The entity needs to disclose the policy followed with regard to accounting for derivatives in its financial statements. In case AS 30 is followed by the entity, a disclosure of the amounts recognised in the financial statements should be made.

• In case AS 30 is not followed, the losses provided for as suggested in paragraph 3 above should be separately disclosed by the entity.

• The auditors should consider making appropriate disclosures in their reports if the aforesaid accounting treatment and disclosures are not made.

• This clarificatory Announcement applies to financial statements for the period ending March 31, 2008, or thereafter.

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Case study- derivatives

• The Arvind mills Ltd –Mar 31, 06– Accounting policy:

• “The derivative instruments for hedging risk arising out of movement in the foreign currency vis-à-vis Indian Re, interest rates and prices in cotton are measured based on available market data wrt spot price of underlying instrument, time duration of the derivative instrument, volatility, interest rates etc, and accepted pricing methods/ models.

• The Company does not measure and recognise open/unsettled derivative instrument while preparing financial statements. The Company recognises the income or expenses arising out of derivative instrument on realisation basis only on the maturity /settlement/ cancellation of the derivative contract.

– Notes:• 9. There is an unrealised gain of Rs 1.14 CR on a/c of exchange

differences arising on forward exchange contracts to hedge the foreign currency contracts to hedge the foreign currency of a firm commitment or a highly probable forecast transaction, which is to be recognised in the accounts of subsequent years.

• 10. ---The Company has borrowed long term as well as short term loans in FC but as the Company is net foreign currency surplus company, there is no unhedged exposure in foreign currency.

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IFRS V (IGAAP)

• IAS 21 , IAS 39, IFRS 7 / (AS 11)

• Functional currency -currency of the primary economic environment- used. (no such concept)

• No distinction in foreign operations that are integral and non integral. (Such distinction there)

• Exchange differences can’t be capitalised. (In India till 7 Dec 06 it was required that exchange differences arising on repayment / restatement of liabilities incurred for imported fixed assets should be capitalised. No longer.)

• Forward exchange contracts and dertivatives etc. are dealt in IAS 39 (Dealt in AS 11 and different from IAS 39; separate announcement covers forward covers for firm commitments and highly probable transactions-but implementation postponed to 1.4.08)

• Deals with when monetary item forming part of an entity is net investment in a foreign operation (not dealt with)

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Convergence with IFRS -status

• Category II-level of preparedness

• No material differences as ‘functional currency’approach gives almost same results as under pre revised IAS 21 which also talked of integral/non integral foreign operations

• Gaining experience before adopting IAS 21