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 Ms. Farat shaikh

External Examiner

Vice Principal Prof. A.N. Kutty

PILLAIS COLLEGE OF ARTS, COMMERCE & SCIENCE

Internal assessment : Project 40 Marks

Name of Student First Name: SUNITA KUMARI Fathers Name: B.B.S Surname: YADAV

Class

Division

Roll Number.

M COM PART I

1890

Subject: Advanced Financial Accounting Topic for the Project: Study on Foreign Exchange Rate AS-11

Mark Awarded 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)

Signature

TOTAL MARKS (Out of 40)

CONTENTS
CHAPTER NO. 1. Introduction MEANING Definition Objectives Scope TOPIC PAGE NO. 1 3 4 5 6

2.

Foreign Currency Transaction

3.

Financial Statement Of Foreign Operation

12 12

Classification of Foreign Operation

Integral Non-Integral Change in the classification of Foreign Operation

13 14 16

4.

Tax Effect Of Exchange Difference

16

5.

Forward Exchange Contract

17

6.

Conclusion

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Foreign exchange rate AS-11 Currency exchange rate refers to the value of foreign nations currency in terms of the home nations 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.

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.

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 countrys 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.

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).

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 enterprises reporting currency and the financial statements of foreign operations must be translated into the enterprises 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.

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 al s o 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.

This Standard does not deal with the restatement of an enterprises 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).

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 n s a c t i o n should be recorded, o n 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.

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 Stock on 1.1.2005 Purchases and sales Debtor and creditor Bill of exchange Wages and salaries Rent, rates and taxes Sundry charges Furniture and fixtures Bank balance London office Total 180800 Dr. 12600 75000 39000 10400 4800 3600 1500 4910 28990 33200 180800 Cr. 112500 26000 9100

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 31.12.2004 31.12.2005 RATE Rs. 14 per 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 To opening stock To purchases To gross profit c/d

900 6250 4725 11875

Particular By sales By closing stock

9375 2500 11875

To wages and salaries To rent, rates and taxes To sundry expenses To net profit

400 300 125 3900 4725

By gross profit b/d

4725

4725

Balance sheet of Calcutta branch as at 31st December 2005 Liabilities London office account: Balance existing 2280 Add: profit 3900 Stock Creditors 2000 Furniture and fixtures Bills payable 700 8880 10 8880 2500 350 6180 Debtors 3000 Bill receivable 800 Assets Bank 2230

Working notes: WN-1 Particular Rate per Dr. Rs. 1 Stock 1.1.2005 Purchase and sales Debtors and creditors Bill of exchange Wages and salaries Rent, rates and taxes Sundry charges Furniture & fixtures Bank balance London office 13 12 12 12 13 10400 4800 3600 1500 4910 28990 180800 33200 180800 9100 800 400 300 125 350 2230 14355 2280 14355 700 14 12 13 12600 75000 39000 112500 26000 900 6250 3000 9375 2000 Cr. Rs. Dr. Cr.

WN-2 Stock on 31st December 2005 Rs.32500; @ Rs.13 to 1 it is 2500

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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 enterprises 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 enterprises 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 enterprises 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 enterprises 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.

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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.

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 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 nonmonetary 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.

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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.

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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.

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