As 11 (with taxation aspect)
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[email protected] AS–11 AN UNDERSTANDING OF By Rahul Yadav THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE (With taxation aspect)
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Transcript of As 11 (with taxation aspect)
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AS–11 AN UNDERSTANDING OF
By Rahul Yadav
THE EFFECTS OF CHANGES
IN FOREIGN EXCHANGE (With taxation aspect)
ABOUT AS – 11
Accounting Standard 11 explains the methods/ways to do accounting
& reporting of transactions related to foreign exchange entered by
the Indian entity.
To understand this AS 11 we should know its objectives, which are
specified in following three points:
To do accounting of expenses made & incomes earned in foreign
currency.(objective 1)
To value the assets & liabilities at the end of year, which are
going to be realized or settled in foreign currency in
future.(objective 2)
To recognize the foreign exchange differences in books of
accounts.(objective 3)
Above mentioned three points are main objectives of this AS on
which it focuses to explain.
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TYPES OF TRANSCATION
RELATING TO FOREIGN EXCHANGE Before going through the explanation of objectives we should
understand which are the transactions related to foreign exchange.
Transactions related to foreign exchange are of two types:
Foreign exchange transactions:
These are the transactions in which any entity has entered in
foreign currency, while accounting is done in domestic currency.
Example 1:
Service provided to foreign entity & money received in foreign
currency.
Foreign operations:
When any business activity has undertaken outside India, it means
that a branch or entity of Indian entity is set up in foreign & it is
performing business operations their either independently from
Indian entity or depending on Indian entity.
Example 2:
ICICI has its branch in Doha (Qatar), it would be taken as foreign
operations & accounting would be done in manner prescribed
under this AS for foreign operations.
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Difference between foreign exchange transactions & foreign
operations
Foreign exchange transactions are basically few transactions of any
entity in foreign currency, there is no branch set up in foreign or an
undertaking by Indian entity.
Whereas if we talk about foreign operation, there is a branch or
undertaking set up in foreign who is handling business in foreign for
Indian entity.
Example 3:
HCL Ltd. has ordered 500 chipsets from Samsung Hong Kong & at
the same time HCL Hong Kong branch also ordered 200 chipsets
from Samsung Hong Kong.
In this example the 1st part would be considered as foreign
exchange transaction as it is transaction between Indian entity with
other unassociated foreign company. It is just like any other
transaction but the difference is that it is in foreign currency.
Whereas the 2nd transaction would be considered as foreign
operations as the HCL Hong Kong branch is doing business in Hong
Kong for HCL Ltd. This transaction is not going to affect the books
of HCL Ltd. directly, but HCL branch’s transactions would be
affecting the financial statements at end. Later we would learn on
method/ways to recognize the HCL Hong Kong branch’s operations
in HCL Ltd.
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RECOGNITION OF FOREIGN
TRANSACTION: In this section we would understand the 1st & 2nd objective of this
AS, i.e. recognition of foreign incomes, expenses, assets & liabilities
in domestic currency.
Foreign exchange transactions are recognized at two levels, which
are:-
Initial recognition (1st objective):
The recognition of transaction which is done at the time of
transaction between Indian entity & foreign entity at the spot
rate (i.e. rate prevailing in market for foreign exchange) is
Initial recognition.
It is mainly done to value the foreign incomes & expenses in
domestic currency at the actual time of transaction.
Example 4:
Accenture India has provided consultancy service to a business
entity of Singapore for $20,000. Now how to recognize this
income in books of accounts?
Accenture India will now recognize this $20,000 as its income
by converting it into rupees at the spot rate.
Let us assume that the spot rate is Rs. 62/dollar on the date of
recognition of income. Income would be recorded as Rs.
1,240,000.
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Subsequent recognition(2nd objective):
When the books of accounts are finalized, the monetary items
are to be revalued at closing rate to show most appropriate
value of assets & liabilities.
Monetary items are those items which:
are assets & liabilities
going to realize or settled in foreign currency
amount to be paid or to be taken is fixed under
contract.
Example 5:
If we continue with our example 4 of Accenture India & enter a
situation that the half of fees is still pending on 31st march &
books need to be finalized, then what value should we show in
books of this debtor?
$10000 @ 62 or
$10000 @ 60 (rate as on 31st march)
As per AS-11 we should revalue the debtor at closing rate i.e.
60.
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RECOGNITION OF FOREIGN
OPERATION: In this part we would understand that how foreign operations are
recognized in books of accounts of Indian entity.
Foreign operation means any business activity undertaken outside
India. It can be:
Integral foreign operations
Non Integral foreign operations
Few examples of foreign operations are;
Foreign branch
Foreign subsidiary
Foreign Associate
The rates which should be used to revalue the foreign operation
books for preparation of financial statement of Indian entity are:
Particulars Rate
Fixed asset, depreciation, investment
Rate prevailing on the date of transaction
Current assets, current liabilities
Closing rate
Income & Expenditure Date of transaction rate, if available (otherwise aver. rate)
Head office related items Refer the actual value from head office books(i.e. Indian entity)
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RECOGNITION OF EXCHANGE
DIFFERENCE (3rd objective): Exchange differences are the differences which arise on the
settlement of monetary items at rates different from those at which
they were initially recorded & this difference can be recognized by
transferring to:
Profit & loss A/c:
If the difference is considered as income or expense depending
on situation, it will be transferred to profit & loss A/c taking it
as foreign exchange difference gain or loss depending on
situation.
Foreign currency Monetary Item Translation Difference Account:
This is the other option where exchange difference would be
transferred if not considered as income or expense.
This option was earlier allowed till 31st March, 2012.
Example 6:
Let us continue example 5, at the end of year debtors of $
10000 were valued at Rs 60/ dollar. This means that there
would be loss of Rs 2/ dollar on $10000 due to foreign
exchange rates.
Now this loss of Rs 20000 can be treated in two ways:
Transfer to Profit & Loss A/C & treat it as loss in same year
or,
Amortize in foreign currency monetary item translation
difference account. 7
DISCLOSURES REQUIRED:
AS 11 has prescribed certain disclosures which needs to be shown in
financial statement of entity
The AS indicates two disclosures which are:
The amount of exchange difference shown in profit & loss A/c,
by showing a separate expense or income head as exchange
difference income or expense as the case may be.
The amount which is accumulated in foreign currency
translation reserve should be shown as a separate component
of shareholders’ funds.
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AS 11 VS ‘IND AS 21’: Ind AS 21 plays the role of AS11 in Indian AS. It also explains the
same objectives which were discussed earlier. Other than all the
definitions and concepts of AS 11, it also has some additional
concepts which are mentioned below:
Presentation currency:
It’s the currency in which the books of accounts are finalized
and presented for stakeholders.
Functional currency:
In Ind AS the domestic currency or the currency in which
business entity generally deals is called as functional currency.
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TAXATION RELATED TO AS 11: The only thing which can have some impact on tax is foreign
exchange difference gain or loss.
The question is whether the difference gain or loss should be taken
while computing income of assesse or should it be disallowed from
computation?
The query was answered in Supreme Court judgment in the case of
CIT vs. V.S. Dempo & Co Pvt. Ltd in which SC had laid down
following principles:-
A loss arising in the process of conversion of foreign currency
which is part of trading asset of the assesse is a trading loss as
any other loss
If there is loss in a trading asset, it would be a trading loss,
whatever be its cause because it would be a loss in the course
of carrying on the business
Another argument which used to be raised by tax authorities was to
deny the fluctuation loss which was recognized on MTM basis at
the year-end rates and there contention was given that it should be
recognized when actual payment is to be made by the assesse.
This argument was also settled by Supreme Court in the case of CIT
vs Woodward Governor India P. Ltd. The conclusion of the case
was:
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“In conclusion, we may state that in order to find out if an expenditure is deductible the
following have to be taken into account (i) whether the system of accounting followed by
the assesse is mercantile system, which brings into debit the expenditure amount for which
a legal liability has been incurred before it is actually disbursed and brings into credit what
is due, immediately it becomes due and before it is actually received; (ii) whether the same
system is followed by the assesse from the very beginning and if there was a change in the
system, whether the change was bona fide; (iii) whether the assesse has given the same
treatment to losses claimed to have accrued and to the gains that may accrue to it; (iv)
whether the assesse has been consistent and definite in making entries in the account
books in respect of losses and gains; (v) whether the method adopted by the assesse for
making entries in the books both in respect of losses and gains is as per nationally
accepted accounting standards; (vi) whether the system adopted by the assesse is fair and
reasonable or is adopted only with a view to reducing the incidence of taxation.”
In conclusion we can say that the gain/loss from foreign exchange
fluctuation shall be treated as operating gain/loss perhaps it should
be related to operating assets or incidental to operations of
business.
For second argument we can conclude that the gain/loss recognized
by the assesse on the basis of MTM at the year-end rates can’t be
challenged by the authorities if the gain/loss is recognized as per
the provisions of Accounting Standards and books are maintained
as per mercantile method.
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SUMMARY: AS 11 guides on foreign transactions, a summary of which is
presented below:
AS -11
Objective 1 Objective 2 Objective 3
Income &
Expense
Asset &
liability*
Exchange
difference
At spot rate At closing rate
Transfer to P&L
A/C
Amortize in
Balance sheet
*Here current assets & liabilities are only discussed for fixed
asset or non-current liabilities refer to table number 1, which is
mentioned foreign operations part.
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