Globalisation of business, raising of capital from international institutions / markets has substantially increased in the last couple of decades and has become the order of the day.  To accommodate the demands of investors and fund raisers, Foreign Financial Institutions have dramatically changed the various products through which funds are lent and new products are being introduced to meet the specific requirements of customers.  The opening of Indian Economy has also given opportunity for investments in India by foreign investors. 

International investment brings 2 types of risks: Primarily The risk of the asset itself and secondarily the risk of forex rate fluctuations.  Eventhough the basic principles of financial management i.e. efficient allocation of resources and raising at the economic costs continued to remain the same, the environment (viz. Political risks, tax structures, forex risks, sources of finance etc.) in which this is happening has changed.  Risk is managed through various techniques like Hedging, Derivatives, Netting, Options, Futures, Interest Rate Swaps, invoicing in home currency, Operating EEFC account etc.

Forex Market is a 24 X 7 market working for 5 days in a week.  Participants in forex market are:

• Tourists, importers, exporters, etc.
• Commercial banks,
• Commercial brokers, arbitragers, speculators, Authorised Dealers and money changers.
• Governments through their Central Banks.

Apart from Forex Market, there are Payment Gateways which operate on 24x7x365 days and work on Real Time Basis for international credit card transactions and others.

Basic Aspects of Trading in Forex Markets

Exchange rate simply means the price of one nation’s currency in terms of another nation’s currency. Eg. EUR 1 = INR 105

Spot rate, cash spot rate & tom rate: Spot rate is the rate at which the currencies are expected to be exchanged. Though spot trades in forex market are intended for immediate settlement, actual settlement is to be made within 2 business days excluding the trade day.  This is commonly referred as T + 2 settlement and the date is called settlement or value date.  A rate as per which the cash is to be settled on the same day is called cash spot rate and on which cash can be settled the following day is called tom rate.

Spot rate quotations: The quotes / terms in forex market are used as per standard conventions viz. A C I (Association Cambiste International) conventions which are followed in interbank market.  As per these conventions:

A pair of currencies is represented by the (5) Five letter SWIFT (Society for Worldwide Interbank Financial Telecommunication) codes separated by ‘/’  (oblique) or ‘-‘ (hyphen). Eg. USD / INR spot (or USD – INR spot) 89.00 / 90.00

In a pair, the first currency is called as base currency and the second currency as quoted currency Viz. USD & INR in the eg. Above.

(Caution:  This convention is not being strictly followed in actual usage and inferences may have to be drawn from other available information also.)

The exchange rate quotation reflects the number of units of quoted currency to a unit of base currency Viz. INR 89.00 / 90.00 to a unit one USD.  Further, the first amount INR 89.00 is called banks Bid rate (or buy rate) and the second INR 90.00 is called the Ask rate (or sell rate) i.e. the bank is willing to buy dollars at Rs. 89 and is willing to sell dollars at Rs. 90.  Further, bid of one currency becomes the ask of another currency and vice versa.  The difference of Re. 1 (i.e. 90-89) is called as Spread.

If a quote is expressed as:

INR   90.1234/48         15/17                 20/23                 20/15             per USD

It is to be read as: 

USD 1 = INR 90.1234 / 90.1248    Spot Rate

USD 1 = INR 90.1249 / 90.1265    Forward 30 days

USD 1 = INR 90.1254 / 90.1271    Forward 90 days

USD 1 = INR 90.1214 / 90.1233    Forward 180 days

The pair 15/17, 20/23 etc. are called points.  If they are in ascending order, it is to be treated as premium and added to the initial (i.e. the first) value given.  In case they are in descending order, it is to be treated as discount and deducted from initial value.  Forex quotes are given upto 4 or even 5 decimals.

PIP is the smallest movement a price can make.

Direct quote is the one where the home currency is quoted per unit of foreign currency (eg. USD 1= INR 90) and vice versa is the indirect quote i.e where the foreign currency is quoted per unit of home currency (eg. INR 1= USD 0.01111).  Further, a direct quote of one country becomes an indirect quote for another country and vice versa.  Direct quote is from home country point of view and indirect quote is from foreign country point of view.

Cross currency rate is the exchange rate of two currencies of which none of them is the home currency of the country in which it is quoted.

Forward rate quotations: A forward rate occurs when buyers and sellers of currencies agree for delivery of the currency at a future date. However, they agree for the amount of foreign currency, the exchange rate and the future date of delivery. 

Usually the forward rate differs from the spot rate and includes a premium or discount to the spot rate.  The premiums or discounts are represented in annual percentages unless otherwise stated. If the currency is costlier in future, it is said to be at premium and when it is cheap it is said to be at discount. Further, between any two currencies, if one currency is at premium, then other currency is impliedly at a discount and vice versa. 

Accounting Aspects of Forex Transactions as per Ind As 21 

As we dive into the detailed aspects of Ind AS provisions, we need to know the meanings of certain words / phrases with which they have been used in the Standard.

Functional Currency is the currency of the primary economic environment in which the entity operates.  Economic environment is the one in which the entity generates and spends cash.  This is normally the currency of the country where it operates.  In certain cases, it can be a different currency also.

An entity measures all its Assets, Liabilities, Equity, Income and Expenses in the Functional Currency.  This currency is to be decided by the entity based on the following indicators:

         Primary Indicators:

1. The Currency:

2. That mainly influences Sales Prices for its goods and services and the Currency in which they are denominated             

3. Of the country whose competitive forces and regulations mainly determine the Sales Prices of its Goods and Services.

4. The currency that mainly influences Material, Labour and other costs of providing goods and services and the Currency in which they are denominated and settled

Secondary Indicators:  These are the factors that provide additional evidence in determining the Functional Currency which are:

1. The currency in which funds from Financing activities like Equity, debt etc. are generated;

2. The currency in which receipts from operations are retained.

Additional Indicators:  These are applicable to Foreign Operations of an Entity.

1. Whether the activities of Foreign Operations are carried out as an extension of Reporting Entity (like Foreign Operation selling goods imported from only the Reporting entity and remitting the funds) OR Autonomously working (like accumulating cash and other monetary items, incurring expenses, generating income, arranging borrowings etc. in local currency);

2. Whether transactions of Foreign Operation are at a High or Low with Reporting Entity;

3. Whether cash flows from Foreign Operations directly affect the operations of Reporting entity and are readily available for remittance;

4. Whether cash flows of Foreign Operation are sufficiently enough to discharge its obligations without reliance on Reporting Entity.

Usually (but not always), the Functional Currency of a Foreign Operation will be same as that of the Reporting Entity. Identifying the Functional Currency depends on case to case basis.  While fixing Functional Currency, Management has to give weightage Primary Indicators and then to other indicators.

 Foreign Currency is the currency other than the Functional Currency.

Presentation Currency is the currency in which the Financial Statements are presented and can be different from the entity’s Functional Currency. 

Foreign operation is an entity that is a Subsidiary, Associate, Joint Venture, Branch of the Reporting Entity, the activities of which are based or conducted in a country or currency other than those of the Reporting entity.

   1.  Applicability:

   This standard applies to:

1. Accounting of all transactions and balances except for derivative transactions and balances covered under Ind AS 109 (Financial Instruments).  Currency derivatives are not covered under Ind AS 109 are covered under this Standard.  This Standard also applies to translation of derivative amounts from Functional Currency to Presentation Currency. 

2. In translating the results of Financial Position of Foreign Operations that are included in the Financial Statements of the entity by Consolidation, Proportionate Consolidation or the Equity method.

3. In translating the Entity’s Results and Financial Position to Presentation Currency

This Standard does not apply to:

1. Hedge Accounting for Foreign Currency items including hedging of net investment in Foreign Operation to which Ind AS 109 (Financial Instruments) applies.

2. Presentation of cash flows from transactions in a Foreign Currency or to translation of cash flows of a Foreign Operation in the Statement of Cash flows (Covered under Ind AS 107, Statement of Cash Flows)

3. Long term Foreign Currency Monetary items for which an entity has opted for exemption under Ind AS 101, First Time Adoption of Ind AS.

2. Accounting for Foreign Currency Transactions:

   Initial Recognition at Transaction Date:

A Foreign Currency transaction is a transaction that is denominated or requires to be settled in Foreign Currency. Initial Recognition is made by translating at the exchange rate on the date of transaction into Functional Currency.

Subsequent Recognition at the end of Each Reporting Period:

For this first we need to identify between Monetary and Non Monetary Items.

Monetary items are assets and liabilities to be received or paid in a fixed or determinable amount. Examples are:

• Cash on hand and bank balances;

• Trade receivables (debtors) and payables (creditors);

• Loans given or received;

• Lease liabilities;

• Pension and other employee benefits to be paid in cash;

• Provisions that are to be settled in cash;

• Cash dividends recognised as liability; 

• Most of the Debt securities as payment and tie are fixed;

Non Monetary Items are assets and liabilities that do not involve the right to receive or to pay a fixed are deliverable units of currency.  Examples are:

• Goodwill

• Intangible assets

• Inventories

• Property Plant and Equipment

• Investments in Equity Shares

• R O U of Assets

• Prepayment for Goods or Services

• Deferred revenue/contract liabilities where the obligation is to deliver goods or services and not CASH.

Monetary Items are Translated at Closing Rate of Reporting Period

Non Monetary items measured at historical cost are Translated at the Rate on the date of transaction.

Non Monetary items measured at Fair Value are Translated at the Rate on the date of Fair Valuation.

The carrying amount of the items are first determined as per relevant Accounting Standard. Eg. For PPE it can be Historical cost or Fair Value as per Ind AS 16; for Inventories it can be lower of Cost or NRV as per Ind AS 2.  After determination of carrying cost whether on Historical basis or Fair Value basis, if the carrying amount happens to be in Foreign Currency, then it is converted to Functional Currency as per the rules above this para.

If an asset is Non Monetary and measured in Foreign Currency, the carrying amount is determined by comparing:                       

1. The cost or carrying amount, as appropriate, translated at the rate as on the date of transaction (Historical Cost) and

2. NRV or recoverable amount, as appropriate translated at the exchange rate at the date when the value was determined.

This may result in an impairment loss in the Functional Currency but not in Foreign Currency.

Eg.  An asset of Euros 10000 is recorded at the date of purchase when Euro 1 = Inr 95 at Rs. 9,50,000.  If the asset value on Reporting date is Euros 6000 and the exchange rate on this Reporting date is Euro 1 = Inr 105, then the carrying value of the asset is recognised as Rs. 6,30,000.  Foreign Currency impairment loss of Euros 4000 is ignored and not recognised.

In case a country has multiple exchange rates, the rate that is used is that at which the future cash flows represented by the transaction that could have been settled if that cash flows have occurred on measurement date.

If exchange rate between 2 currencies is temporarily not available, then the rate used is the first subsequent rate at which exchanges can be made.

3. Recognition of Forex Gains / Losses:

   When the transaction occurs and settles within same accounting period, then all exchange difference is recognised in the same period. However, when transaction occurs in one period and settlement occurs in the following period(s), then exchange difference is recognised in each period till settlement is made based on the respective periods exchange rates.

Monetary Items: Gains / Losses with regard to Monetary Items are recognised to Profit or Loss account except:

1. For accounting of Exchange Differences with regard to Hedge Accounting under Ind AS 109 (Financial Instruments).   For eg. Exchange Differences on Monetary items qualifying as Hedge Instruments in Cash Flow Hedge are to be first recognised in OCI to the extent the Hedge is effective as per Ind AS 109.

2. For Monetary Items that happen to be Reporting Entity’s investment in Foreign Operation.  A monetary item Receivable from or Payable to a Foreign Operation may form part of Net Investment, if such Receivable or Payable is neither planned nor likely to occur in foreseeable future.  Management has to express their intention through a document about the settlement for proper treatment. Just indicating the term of loan is not sufficient unless documented. If not documented, it is treated as planned for settlement in foreseeable future.

   Exchange differences are recognised in the Profit or Loss account in separate financial statements of Reporting Entity and / or Foreign Operation whoever is not adopting Currency of the Item under consideration.                  

   However, in case of CFS, this is considered under OCI initially and then transferred to Profit or Loss upon disposal of net investment.

3. For Long Term Monetary Items, in case the entity has opted for recognising exchange differences on such items in Equity.

Non Monetary Items: Gains / Losses with regard to Non Monetary items are recognised to OCI. If a gain / loss on a non monetary item is recognised in Profit or Loss, then the exchange difference relating to that is also recognised in Profit or Loss.

4. Change in Functional Currency:

Once the Management has determined a Functional Currency, it is not changed unless there is change in the underlying factors like transactions, events and conditions.  In case a change is adopted, then it is done prospectively from the date of change.  For accounting the change in Functional Currency prospectively:

1. All items are translated into New Functional Currency using the Exchange rate as on the date of change. The resulting translated amounts for non monetary items are treated as their Historical Cost.

2. Exchange differences arising from translation of Foreign Operation recognised in OCI will continue to be under OCI till disposal of the Operation.

3. Exchange Gain / Loss from Long term Monetary Items accumulated in Equity (when such option is exercised) are not transferred to Profit or Loss immediately on change in Functional Currency. They will be transferred to Profit or Loss as per original plan only.

    

4. Use of Presentation Currency other than Functional Currency:

   Under Ind AS 21 there is no concept of Group Functional Currency.  Each Group has a Presentation Currency.  Each entity in the group prepares its Financials in its own Functional Currency and then translated to presentation currency for consolidation purposes. While translating to presentation currency, following principles are followed:

5. Assets and Liabilities of each Balance Sheet are translated at the Closing Rate at the date of Balance Sheet.

6. Income and Expenses are translated at exchange rates on the respective dates of transactions. Alternatively, weekly / monthly average rates can also be used, if the rate fluctuations are not wide.

7. All resulting exchange differences are to be recognised in OCI and are presented as separate component of Equity (usually called as Currency Translation Reserve / Adjustment) 

8. Cash flows are translated at rates on respective dates of transactions or weekly / monthly average rates may be used, if the fluctuations are not wide.

9. Accumulated Exchange differences arising from translation relating to Foreign Operation, but not wholly owned, when consolidated, are recognised as part of Non Controlling interest in the Consolidated Balance Sheet.

10. If the Functional Currency of an entity is the currency of Hyper inflationary economy, then the financial results are to be translated into different presentation currency as follows:

    The entity has to restate its Financial Statements as per Ind AS 29 (Financial Reporting in Hyper Inflationary Economy) before adopting the procedure mentioned at a to d above. i.e. the entity has to first translate to stable presentation currency and then above procedure is to be adopted.

6. Translation of Foreign Operations:

   The principles of deciding Functional Currency of Foreign Operation are same as those of the Parent Entity discussed above.

   Further, the translation procedure for translating Foreign Operation are also same which are followed when an Entity presents its Financial Statements in a presentation currency that is different from its Functional Currency.

   In addition to the above, the foreign currency translation reserve may include Exchange differences arising from loans that for part of parent’s net investment in the Foreign Operation and gains and losses related to hedges of net investment in foreign operation.

7. Difference in the Reporting Dates:

   In case of difference in reporting dates, the foreign operation usually prepares additional statements as of the same date of the reporting entity’s financial statements.

   When such statements are not prepared, Ind AS 110 (Consolidated Financial Statements) allows the use of a different date, provided the difference is not greater than 3 months and adjustments are made for the effects of significant transactions or events that occur between the different dates.

   In such a case, the assets and liabilities of the foreign operation are translated at the exchange rate at the end of the reporting period of the Foreign Operation.

   Adjustments are made for significant changes in exchange rates upto to the end of the reporting period of the reporting entity in accordance with Ind AS 110 (Consolidated Financial Statements)

   Similar approach is used in applying equity method to Associates and Joint Ventures as Ind AS 28 (Investments in Associates & Joint Ventures)

8. Intra Group Transactions:

   Following are the principles:

   Intra group balances are eliminated on consolidation. However, any exchange gains / losses will not be eliminated as the exposure to foreign currency prevails at Entity or Foreign operation level persists.

   In CFS, the exchange difference arising on intra group transactions is recognised in profit or loss account.  When the exchange fluctuation arises out of monetary items that forms part of net investment in foreign operation, then it is recognised in OCI.

9. Dividends :

   If a subsidiary pays dividend to the parent, then parent should record the dividend on the date of declaration by subsidiary. Any exchange fluctuation between the date of receipt and date of actual receipt will be taken to profit or loss account and will get reflected in CFS also.

10. Goodwill and Fair Value Adjustments Arising From Business Combination: 

    Any goodwill and any fair value adjustments to the carrying amounts of assets and liabilities arising on a foreign operation’s acquisition are treated as assets and liabilities of foreign operation.

    They are expressed in the Functional currency of Foreign operation and are to be translated at the closing exchange rate as is the case with other assets and liabilities.

11. Disposal or Partial Disposal (loss of control) of Foreign Operation:

    Disposal may arise through sale, liquidation, or repayment of share capital.  Upon disposal of foreign operation, the cumulative exchange difference accumulated in OCI and recognised in equity are reclassified from equity to profit or loss when the gain or loss on disposal is recognised.

    On disposal of a subsidiary that includes foreign operation, the cumulative amount of the exchange differences related to that foreign operation that are related to non controlling interests are derecognised but is not reclassified to profit or loss.

    In case of partial disposal of a subsidiary that includes foreign operation where loss of control is involved, even though it has non controlling interest, it is treated and accounted as disposal.  The entire balance in the translation reserve is taken to profit or loss account.

12. Partial Disposal without loss of control:

    In case of partial disposal without loss of control, proportionate amount OCI is transferred to Profit or loss.

    A write down of the carrying amount of a foreign operation, either because of its own losses or because of an impairment recognised by investor, does not constitute partial disposal.  Hence no part of the exchange gain or loss recognised in the OCI is reclassified to profit or loss account.

13. Disclosures: Following disclosures are to be made as per Ind AS 21:

• Amount of exchange differences recognised in Profit or loss except for those arising on Financial Instruments that are measured at Fair Value Through Profit or Loss as per Ind AS 109, Financial Instruments.

• Net exchange differences recognised in OCI and accumulated in a separate component of equity along with reconciliation of the amount at the beginning and end of the period.

• When the presentation currency is different from functional currency, this fact should be stated along with disclosure of functional currency and the reason for using a different presentation currency.

  In case of change in functional currency of the reporting entity or a significant foreign operation:

  1. Fact of such change

  2. Reason for the change and 

  3. The date of change of functional currency

• If presentation currency is different from functional currency, the financial statements are said to comply with Ind AS only if all Ind AS including the translation method are complied with.  If an entity presents its financial statements or supplementary financial statements in a currency other than functional or presentation currency: 

• The information should be clearly disclosed as supplementary financial information to identify that it is different from the information that complies with Ind AS;

• The currency in which supplementary information is disclosed is to be displayed; and

• The entity’s functional currency and the method of translation used to derive supplementary information are to be disclosed.
  
   

  Written & Compiled by : By CA. P.V. Raam