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Introduction.............................................................3
Accounting Issues on foreign currency transaction....4
Accounting for foreign currency transaction...................................................................4
Accounting for foreign operation.....................................................................................4
Problem of market determined foreign exchange
value.......................................................................5
Translation Method..........................................................................................................5
Translation at Balance sheet Date....................................................................................6
Approaches to Accounting Transactions....................7
Two transactions – recognize approach...........................................................................7
Two transaction – defer....................................................................................................8
One transaction – recognize.............................................................................................8
Accounting implication of Foreign Exchange Forward
Contracts.................................................................9
Case Study: Infosys Technologies Limited (Annual
Report 2008)..........................................................11
2
Introduction
3
Accounting Issues on foreign currency transaction
The two principal accounting issues common to both types of activities relate
to the choice of the rate of exchange to be issued and the manner of dealing
with the loss or gain arising from the differences in the exchange rates.
However, this solution is not feasible because these options are not available
when company purchase or sales in foreign exchange transactions.
4
Problem of market determined foreign exchange value.
Rs.
Sales 500,000
Cost 300,000
Profit 200,000
The customer pays after two month later when the rate is $ 1 = Rs. 45 and
the company received Rs. 450,000. It has therefore lost of Rs. 50,000, not
from trading, but from the decision to hold a dollar asset (the debt) while the
value of the dollar decreased.
a. Fixing the exchange rate for initially accounting for the transaction.
b. Accounting with the exchange rate gain or loss arising on partial or full
settlement during the same financial year
c. Dealing with the exchange gain or loss on conversion of the foreign
currency monetary item on the date of balance sheet.
Translation Method
5
A transaction in foreign currency may be settled either partly or fully, on a
date later than the date of transaction, by converting rupees in to foreign
currency or vice versa, at a rate different from the transaction rate. This will
result in exchanges difference and such difference either gain or loss is
recognized in the revenue statement of the financial statement in which the
settlement takes place.
When Indian companies submit their balance sheet they translate their
foreign currency items into rupees on balance sheet date by using closing
rate and the resultant exchange difference is recognized in the profit and loss
account.
The spot exchange rates on various dates are as follows. For US$ 1.
6
Approaches to Accounting Transactions
Under this approach the transaction is divided into two aspects one is
purchase aspects and other one is settlement aspects. The second one is
treated as a method of financing and hence, the gain or loss on account of
exchange difference on this monetary component of the transaction is
recognized in the income statement in the manner similar to treatment of
interest. The non-monetary component of the transaction, the inventory is
not distributed for the change in exchange rates. The notional exchange gain
or loss arising on restating the monetary item at the rate prevailing on
balance sheet date is also recognized in the income statement.
7
Two transaction – defer
Under this method the gain or loss on translation on balance sheet date is
deferred and recognized on the date of settlement. Only realized exchange
gain or loss recognized under this method.
Under the third method all events subsequent to the initial transaction are
treated as part of such initial transaction. Hence the loss on February 28 and
March 31 would be adjusted to inventory or cost of goods sold. The again on
April 30 would also be adjusted as above. If the goods are not in stock, the
adjustment will be to retained earnings.
8
Accounting implication of Foreign Exchange Forward Contracts
In open market the spot exchange for a given currency is dependent on the
supply and demand for that currency which in turn is influenced by
international movements involving goods, services and investments and in
some measures currency speculation. To reduce the exchange rate loss risk
many enterprises enter into foreign currency transaction which serves as
hedges. Hedging transactions have a cost either explicit or implicit, the
enterprises has to evaluate the gain and loss from foreign currency due to
non-hedging and cost due to hedging.
9
Accounting entries in the books of Indian company
Next financial year when Indian firm received final payment from US firm
May 1, 2008 Cash 442,000.00
Exchange Loss 5,000.00
To sundry debtors 447,000.00
(payment received from US firm at the spot
rate of Rs. 44.2)
10
months (5000/3)
Infosys one of the giant software company in India who has diversified across
the world. Infosys has its business in Asia, Australia, North America and
Europe. Foreign exchange plays major role in Infosys revenue. Infosys
entered in to forward contracts and hedged contracts to reduce the exchange
risk.
We have analyzed Infosys annual report for 2008 and figured out how this
company shows foreign exchange accounting in the report.
1. Any income of losses by the forward contract had shown under the
head “Other income” in Profit and Loss account. It also showed
average rate as well as period rate for different currency.
2. Foreign Currency account balance had shown under the head “Cash
and Bank Balance”.
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