In the globalization environment business empire are growing across the borders, entire world is single market for company. Indian business enterprises spreading their activities across the world. Being the part of the world market is not going to be easy there are cultural difference, legal issues and currency and settlement issues. In 1973 International Monetary Fund permitted member of countries to select and maintain an exchange arrangement of their choice. Indian exchange rates were controlled by RBI (Reserve Bank of India ) and at the end of 1992, a dual exchange rate system was introduced and a year later, India moved to a unified market determined exchange rate. In terms of fiscal control we are in the process of moving full convertibility from the present regime of partial convertibility. These changes will force Indian enterprises to face the full impact of exchange risk. This paper deals with accounting implication on foreign exchange transaction.
A foreign currency transactions is a transactions which is denominated in or requires settlement in 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 exchanges contracts: or
Otherwise acquires or disposes of assets or incurs or settles liabilities, denominated in a foreign currency.
In simple word a transaction that requires settlement in a foreign currency is a called foreign currency transaction.
Accounting Issues on Foreign Currency Transaction
If foreign currency transaction is settled in on the date of transaction one can easily record the transaction as per current spot price of foreign exchange but when transaction is carried forward there we need to study the effects of foreign transaction due to changes in foreign currency valuation.
In India for the accounting purpose foreign activities of an Indian enterprise are divided in to two categories.
Accounting for foreign currency transaction
It may enter into transactions which are denominated in foreign currency like import and export of goods or services borrowing or lending of money, acquisitions and sale of securities outside India and subscription by foreign firms to shares issued by Indian companies.
Accounting for Foreign Operation
It may have foreign operations conducted through branches, subsidiaries, associates, etc. The feature of a foreign operation is that it maintains its own accounting records and prepares financial statements in the local currency.
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.
Foreign exchange differences arises because companies record transactions on accruals basis, as per Indian tax law a firm can record entry on received or accrual basis. The companies can avoid the problem of foreign exchanges differences by:
Settlement in only one currency
Recording accounting entries of foreign currency transaction when they are converted in to local currency.
Fixed exchange rate of exchange to be used.
However, this solution is not feasible because these options are not available when company purchase or sales in foreign exchange transactions.
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.
A foreign currency hedge may be in the form of a foreign currency transaction involving acquisition of foreign currency asset like making foreign currency deposit or incurring foreign currency liability by taking foreign currency loan. The hedging cost incurred is normally recorded in the income statement. When a foreign currency liability is accounted for as a hedge of a net investment in an independent foreign operation, the exchange difference on the hedge item is adjusted to the retained earnings of the parent and is recognized in the income statement only on the sale of the investment which is hedge.
A forward exchange contract is a contract to deliver or receive at a specified forward rate and on a stipulated future date. The forward exchange rate usually differs from the spot rate because of different economics factors. By and large this difference is attributable to the difference between the interest rates obtaining in the countries of the currencies under consideration. If the forward rate is more than the spot rate, the difference is called a "Premium" and when forward rate is less than the spot rate the difference is called a "Discount".Forward contracts can be used for hedging or speculative purposes. As a hedging device, forward contracts cover an exposed net asset or liability position, or a net investment in a foreign operation, or an ideal foreign currency commitment. In forward contracts, the accounting issues relate to treatment premium and discounts. Since the forward contract are executory contracts, that is, they are yet to performed on the date the contract is entered into, they need not be accounted like any other transaction.