FCMITDA, Foreign Operation and Forward exchange Contract AS 11 (PART2)

Foreign Currency Monetary Item Translation Difference Account:

For long term monetary items which were used to purchase fixed assets, the exchange difference on that will be added or deducted from that asset and depreciation will be applied on them.

For long term monetary items used for other purpose, the exchange difference will be transfer to FCMITDA and from there we should written off the amount each year according to the life of asset or liability.

According to the recent notification, FCMITDA should come on the component of shareholder’s fund of an enterprise.

Foreign Operation:

Foreign operation means doing business in the country other than the country of reporting enterprise. It can be its subsidiary, joint venture, associate or branch.  The foreign operation is of two types:

Integral Foreign Operation:

It means the foreign operation which is the main part of the reporting enterprise. It is the extension of reporting enterprise. Goods are supplied from reporting enterprise’s country to other country where foreign operation is going on and they sell those goods there in foreign country. In short, transaction is huge between them and all the activities are carried on and guided by the reporting enterprise.

Suppose, Tata steel ltd, after doing business for 5 years decided to open its subsidiary named, Tata Xian ho co., in Japan. Here Tata steel ltd is a reporting enterprise and Tata Xian ho co. is its integral foreign operation.

Translation:

·         The cost and deprecation of fixed assets is translated using the exchange rate at the date of purchase of the assets.

·         The cost of inventories is translated at the rate existing at the time of incurring of cost- that is, opening stock at opening rate and closing stock at closing rate.

·         All the income and expenses should be recorded at rate prevailing at the time of transaction or sometimes average rate is used where there is no significant changes in exchange rate.

·         The monetary items are translated using closing rate.

Exchange difference arises on the monetary items of an integral operation should be recognized as in come or an expenses in the statement of profit and loss account in the period in which they arise.

Non-Integral Foreign Operation:

This is not the main part of the reporting enterprise; all the works in foreign operation are done by themselves, major decision are taken by themselves and they have the autonomy of doing business; and no major transaction takes place between reporting enterprise and foreign operating enterprise.

Translation:

·         All the assets and liabilities- both monetary and non monetary are recorded at closing rate.

·         All the income and expenses should be recorded at rate prevailing at the time of transaction or sometimes average rate is used where there is no significant changes in exchange rate.

·         Exchange difference arises will be accumulate in the Foreign Currency Translation Reserve until the disposal of the “net investment” in non integral foreign operation.

·         Any goodwill or capital reserve arises on the acquisition of non integral operation are recorded at closing rate.

Points to be remembered:

·         Whether it’s integral or non integral foreign operation, assets and liabilities must be recorded in the books of reporting enterprise but the difference is –In integral operation non monetary items are recorded at historical cost and In non integral operation,  non monetary items are recorded at closing rate and exchange difference for this have to create Foreign Currency Translation Reserve.

·         The exchange difference of integral operation are recognized in the income statement of the reporting enterprise and exchange difference of non integral should be accumulate in the Foreign Currency Translation Reserve.

        Change in the classification:

If integral becomes non integral, then on the date of reclassification, exchange difference of non monetary items would be recorded in the Foreign Currency Translation Reserve and non monetary items would be recorded at closing rates.

If non integral becomes integral, then on the date of reclassification, the non monetary items would be recognized in the balance sheet at historical cost and the foreign currency translation reserve which have been deferred would not be recognized in the statement of p/l account until the disposal of operation.

Forward Exchange Contract:

It is an agreement to exchange different currencies at a fixed rate in specific future date.

Suppose, current exchange rate is Rs45/$ and a company entered into a contract of purchasing some asset at 50/$ after 6 months. This is the forward exchange contract because they have agreed to purchase and sell asset at a specific future date and at a specific exchange rate. Now if the exchange rate be 35/$ or 65/$ the purchasing company would have to pay 50/$. This is the total concept of Forward Exchange Contract.

It is created for two purposes first, for speculation and second, to know the exact money which will be required at the time of settlement so that they can arrange it up to that date.

When the contract is not for speculation:

The premium or discount in the beginning will be amortized as expense or income over the contract life. Forward rate (minus) spot rate is used to determine amount of income or expense.

When it is for speculation:

The contract price (minus) sale price is to be done to determine profits or loss and ignored premium or discount in the beginning.

Disclosures:

An enterprise should disclose-:

(i)                  Amount of exchange difference included in the net profit or loss for the period.

(ii)                Net exchange difference accumulated in the foreign currency translation reserve as separate component of shareholder’s fund.

(iii)               When there is a change in classification of foreign operation enterprise should disclose:

a)      Nature of change in classification, b) impact of change in classification on shareholder’s fund

This was the complete concept of Foreign Exchange; If you reader have any questions  or suggestion regarding this Accounting Standard, please write in the comment box below.