Accounting Implication On Foreign Currency Transaction

Accounting Implication on Foreign
Currency Transaction
Abstract
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.
Reference :
Financial Express Newspaper.
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https://www.wikipedia.com

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Accounting Implication on Foreign

A foreign currency transactions is a transactions which is denominated in or requires settlement in

• buys or sells goods or services whose price is 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

Accounting Issues on Foreign Currency Transaction

Accounting for foreign currency transaction

Accounting for Foreign Operation

• Settlement in only one currency

• Fixed exchange rate of exchange to be used.

Accounting implication of Foreign Exchange Forward Contracts

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