ICAI Notes- Unit 3: Accounting Standards Based on Items Impacting Financial Statements | Advanced Accounting for CA Intermediate PDF Download

 Page 1


a
 
 
 
ADVANCED ACCOUNTING 
7.28 
 
 
LEARNING OUTCOMES 
UNIT 3: ACCOUNTING STANDARD 11 THE EFFECTS 
OF CHANGES IN FOREIGN EXCHANGE RATES 
 
 
After studying this unit, you will be able to comprehend the – 
? Foreign Currency Transactions  
• Initial Recognition  
• Reporting at Subsequent Balance Sheet Dates 
• Recognition of Exchange Differences  
? Net Investment in a Non-integral Foreign Operation  
? Classification of Foreign Operations  
• Integral Foreign Operations 
• Non-integral Foreign Operations 
• Disposal of a Non-integral Foreign Operation  
• Change in the Classification of a Foreign Operation  
• Accounting for Forward Exchange Contracts  
• Disclosures 
 3.1 INTRODUCTION  
An enterprise may carry on activities involving foreign exchange in two ways. It 
may have transactions in foreign currencies (e.g., export sales in denominated in 
USD) or it may have foreign operations (e.g., foreign branch of reporting entity 
outside India). At the time of preparing the financial statements, these 
transactions and/or operations must be reported by the entity in the reporting 
currency i.e., INR. Hence, such foreign currency transactions and foreign 
operations should be translated into the reporting currency (i.e., INR) in order to 
be included in the financial statements of the entity. 
© The Institute of Chartered Accountants of India
Page 2


a
 
 
 
ADVANCED ACCOUNTING 
7.28 
 
 
LEARNING OUTCOMES 
UNIT 3: ACCOUNTING STANDARD 11 THE EFFECTS 
OF CHANGES IN FOREIGN EXCHANGE RATES 
 
 
After studying this unit, you will be able to comprehend the – 
? Foreign Currency Transactions  
• Initial Recognition  
• Reporting at Subsequent Balance Sheet Dates 
• Recognition of Exchange Differences  
? Net Investment in a Non-integral Foreign Operation  
? Classification of Foreign Operations  
• Integral Foreign Operations 
• Non-integral Foreign Operations 
• Disposal of a Non-integral Foreign Operation  
• Change in the Classification of a Foreign Operation  
• Accounting for Forward Exchange Contracts  
• Disclosures 
 3.1 INTRODUCTION  
An enterprise may carry on activities involving foreign exchange in two ways. It 
may have transactions in foreign currencies (e.g., export sales in denominated in 
USD) or it may have foreign operations (e.g., foreign branch of reporting entity 
outside India). At the time of preparing the financial statements, these 
transactions and/or operations must be reported by the entity in the reporting 
currency i.e., INR. Hence, such foreign currency transactions and foreign 
operations should be translated into the reporting currency (i.e., INR) in order to 
be included in the financial statements of the entity. 
© The Institute of Chartered Accountants of India
 
 
13.29 a
   
 
7.29 
 
AS BASED ON ITEMS IMPACTING FINANCIAL 
STATEMENTS 
The standard deals with the issues involved in accounting for foreign currency 
transactions and foreign operations i.e., to decide which exchange rate to use and 
how to recognise the financial effects of changes in exchange rates in the 
financial statements.  
Scope 
This Standard should be applied:  
(a) In accounting for transactions in foreign currencies. 
(b) In translating the financial statements of foreign operations. 
(c) This Statement also deals with accounting for foreign currency transactions 
in the nature of forward exchange contracts. 
This Standard does not: 
(a) Specify the currency in which an enterprise presents its financial statements. 
However, an enterprise normally uses the currency of the country in which it 
is domiciled. If it uses a different currency, the Standard requires disclosure 
of the reasons for using that currency. The Standard also requires disclosure 
of the reason for any change in the reporting currency. 
 For example, all Indian companies are required to present their financial 
statements in INR. Thus, for such entities, INR is the reporting currency. 
Alternatively, in case an Indian company is a subsidiary of a company 
located in the United States, the parent may require the company to present 
the financial statements in USD. In such cases, the company is required to 
disclose the reasons for presenting the financial statements in USD (a 
currency other than INR, the currency of the place where the company is 
domiciled i.e., India). 
In both the cases discussed above, it may be pertinent to note that 
Accounting Standard 11 does not prescribe the currency to be used to 
present the financial statements. However, for all practical purposes (Income 
Tax Act, Indirect Tax Requirements etc.), every company domiciled in India 
will present financial statements in INR.  
(b) Deal with the presentation in a cash flow statement of cash flows arising 
from transactions in a foreign currency and the translation of cash flows of a 
foreign operation, which are addressed in AS 3 ‘Cash flow statement’. 
© The Institute of Chartered Accountants of India
Page 3


a
 
 
 
ADVANCED ACCOUNTING 
7.28 
 
 
LEARNING OUTCOMES 
UNIT 3: ACCOUNTING STANDARD 11 THE EFFECTS 
OF CHANGES IN FOREIGN EXCHANGE RATES 
 
 
After studying this unit, you will be able to comprehend the – 
? Foreign Currency Transactions  
• Initial Recognition  
• Reporting at Subsequent Balance Sheet Dates 
• Recognition of Exchange Differences  
? Net Investment in a Non-integral Foreign Operation  
? Classification of Foreign Operations  
• Integral Foreign Operations 
• Non-integral Foreign Operations 
• Disposal of a Non-integral Foreign Operation  
• Change in the Classification of a Foreign Operation  
• Accounting for Forward Exchange Contracts  
• Disclosures 
 3.1 INTRODUCTION  
An enterprise may carry on activities involving foreign exchange in two ways. It 
may have transactions in foreign currencies (e.g., export sales in denominated in 
USD) or it may have foreign operations (e.g., foreign branch of reporting entity 
outside India). At the time of preparing the financial statements, these 
transactions and/or operations must be reported by the entity in the reporting 
currency i.e., INR. Hence, such foreign currency transactions and foreign 
operations should be translated into the reporting currency (i.e., INR) in order to 
be included in the financial statements of the entity. 
© The Institute of Chartered Accountants of India
 
 
13.29 a
   
 
7.29 
 
AS BASED ON ITEMS IMPACTING FINANCIAL 
STATEMENTS 
The standard deals with the issues involved in accounting for foreign currency 
transactions and foreign operations i.e., to decide which exchange rate to use and 
how to recognise the financial effects of changes in exchange rates in the 
financial statements.  
Scope 
This Standard should be applied:  
(a) In accounting for transactions in foreign currencies. 
(b) In translating the financial statements of foreign operations. 
(c) This Statement also deals with accounting for foreign currency transactions 
in the nature of forward exchange contracts. 
This Standard does not: 
(a) Specify the currency in which an enterprise presents its financial statements. 
However, an enterprise normally uses the currency of the country in which it 
is domiciled. If it uses a different currency, the Standard requires disclosure 
of the reasons for using that currency. The Standard also requires disclosure 
of the reason for any change in the reporting currency. 
 For example, all Indian companies are required to present their financial 
statements in INR. Thus, for such entities, INR is the reporting currency. 
Alternatively, in case an Indian company is a subsidiary of a company 
located in the United States, the parent may require the company to present 
the financial statements in USD. In such cases, the company is required to 
disclose the reasons for presenting the financial statements in USD (a 
currency other than INR, the currency of the place where the company is 
domiciled i.e., India). 
In both the cases discussed above, it may be pertinent to note that 
Accounting Standard 11 does not prescribe the currency to be used to 
present the financial statements. However, for all practical purposes (Income 
Tax Act, Indirect Tax Requirements etc.), every company domiciled in India 
will present financial statements in INR.  
(b) Deal with the presentation in a cash flow statement of cash flows arising 
from transactions in a foreign currency and the translation of cash flows of a 
foreign operation, which are addressed in AS 3 ‘Cash flow statement’. 
© The Institute of Chartered Accountants of India
a
 
 
 
ADVANCED ACCOUNTING 
7.30 
 
(c) Deal with exchange differences arising from foreign currency borrowings to 
the extent that they are regarded as an adjustment to interest costs. 
(d)  Deal with the restatement of an enterprise’s financial statements from its 
reporting currency into another currency for the convenience of users 
accustomed to that currency or for similar purposes. 
 Considering the example above, the Indian subsidiary of the US Parent will 
present its financial statements in INR for the Indian regulators. However, 
since the US parent needs to consolidate the Indian subsidiary, it will 
require the Indian company to also restate the INR Financial Statements to 
USD. Such restatement is not covered under Accounting Standard 11. 
  3.2 DEFINITIONS OF THE TERMS USED IN THE  
 STANDARD 
A foreign currency transaction is a transaction which is denominated in or 
requires settlement in a foreign currency, including transactions arising when an 
enterprise either:  
(a) Buys or sells goods or services whose price is denominated in a foreign 
currency.  
(b) Borrows or lends funds when the amounts payable or receivable are 
denominated in a foreign currency.  
(c) Becomes a party to an unperformed forward exchange contract or  
(d) Otherwise acquires or disposes of assets, or incurs or settles liabilities, 
denominated in a foreign currency. 
Monetary items are money held and assets and liabilities to be received or paid 
in fixed or determinable amounts of money. For example, cash, receivables and 
payables. 
Non-monetary items are assets and liabilities other than monetary items. For 
example, fixed assets, advances for purchase of goods / fixed assets, inventories 
and investments in equity shares. 
© The Institute of Chartered Accountants of India
Page 4


a
 
 
 
ADVANCED ACCOUNTING 
7.28 
 
 
LEARNING OUTCOMES 
UNIT 3: ACCOUNTING STANDARD 11 THE EFFECTS 
OF CHANGES IN FOREIGN EXCHANGE RATES 
 
 
After studying this unit, you will be able to comprehend the – 
? Foreign Currency Transactions  
• Initial Recognition  
• Reporting at Subsequent Balance Sheet Dates 
• Recognition of Exchange Differences  
? Net Investment in a Non-integral Foreign Operation  
? Classification of Foreign Operations  
• Integral Foreign Operations 
• Non-integral Foreign Operations 
• Disposal of a Non-integral Foreign Operation  
• Change in the Classification of a Foreign Operation  
• Accounting for Forward Exchange Contracts  
• Disclosures 
 3.1 INTRODUCTION  
An enterprise may carry on activities involving foreign exchange in two ways. It 
may have transactions in foreign currencies (e.g., export sales in denominated in 
USD) or it may have foreign operations (e.g., foreign branch of reporting entity 
outside India). At the time of preparing the financial statements, these 
transactions and/or operations must be reported by the entity in the reporting 
currency i.e., INR. Hence, such foreign currency transactions and foreign 
operations should be translated into the reporting currency (i.e., INR) in order to 
be included in the financial statements of the entity. 
© The Institute of Chartered Accountants of India
 
 
13.29 a
   
 
7.29 
 
AS BASED ON ITEMS IMPACTING FINANCIAL 
STATEMENTS 
The standard deals with the issues involved in accounting for foreign currency 
transactions and foreign operations i.e., to decide which exchange rate to use and 
how to recognise the financial effects of changes in exchange rates in the 
financial statements.  
Scope 
This Standard should be applied:  
(a) In accounting for transactions in foreign currencies. 
(b) In translating the financial statements of foreign operations. 
(c) This Statement also deals with accounting for foreign currency transactions 
in the nature of forward exchange contracts. 
This Standard does not: 
(a) Specify the currency in which an enterprise presents its financial statements. 
However, an enterprise normally uses the currency of the country in which it 
is domiciled. If it uses a different currency, the Standard requires disclosure 
of the reasons for using that currency. The Standard also requires disclosure 
of the reason for any change in the reporting currency. 
 For example, all Indian companies are required to present their financial 
statements in INR. Thus, for such entities, INR is the reporting currency. 
Alternatively, in case an Indian company is a subsidiary of a company 
located in the United States, the parent may require the company to present 
the financial statements in USD. In such cases, the company is required to 
disclose the reasons for presenting the financial statements in USD (a 
currency other than INR, the currency of the place where the company is 
domiciled i.e., India). 
In both the cases discussed above, it may be pertinent to note that 
Accounting Standard 11 does not prescribe the currency to be used to 
present the financial statements. However, for all practical purposes (Income 
Tax Act, Indirect Tax Requirements etc.), every company domiciled in India 
will present financial statements in INR.  
(b) Deal with the presentation in a cash flow statement of cash flows arising 
from transactions in a foreign currency and the translation of cash flows of a 
foreign operation, which are addressed in AS 3 ‘Cash flow statement’. 
© The Institute of Chartered Accountants of India
a
 
 
 
ADVANCED ACCOUNTING 
7.30 
 
(c) Deal with exchange differences arising from foreign currency borrowings to 
the extent that they are regarded as an adjustment to interest costs. 
(d)  Deal with the restatement of an enterprise’s financial statements from its 
reporting currency into another currency for the convenience of users 
accustomed to that currency or for similar purposes. 
 Considering the example above, the Indian subsidiary of the US Parent will 
present its financial statements in INR for the Indian regulators. However, 
since the US parent needs to consolidate the Indian subsidiary, it will 
require the Indian company to also restate the INR Financial Statements to 
USD. Such restatement is not covered under Accounting Standard 11. 
  3.2 DEFINITIONS OF THE TERMS USED IN THE  
 STANDARD 
A foreign currency transaction is a transaction which is denominated in or 
requires settlement in a foreign currency, including transactions arising when an 
enterprise either:  
(a) Buys or sells goods or services whose price is denominated in a foreign 
currency.  
(b) Borrows or lends funds when the amounts payable or receivable are 
denominated in a foreign currency.  
(c) Becomes a party to an unperformed forward exchange contract or  
(d) Otherwise acquires or disposes of assets, or incurs or settles liabilities, 
denominated in a foreign currency. 
Monetary items are money held and assets and liabilities to be received or paid 
in fixed or determinable amounts of money. For example, cash, receivables and 
payables. 
Non-monetary items are assets and liabilities other than monetary items. For 
example, fixed assets, advances for purchase of goods / fixed assets, inventories 
and investments in equity shares. 
© The Institute of Chartered Accountants of India
 
 
13.31 a
   
 
7.31 
 
AS BASED ON ITEMS IMPACTING FINANCIAL 
STATEMENTS 
Foreign operation is a subsidiary, associate, joint venture or branch of the 
reporting enterprise, the activities of which are based or conducted in a country 
other than the country of the reporting enterprise. 
Integral foreign operation is a foreign operation, the activities of which are an 
integral part of those of the reporting enterprise. A foreign operation that is 
integral to the operations of the reporting enterprise carries on its business as if it 
were an extension of the reporting enterprise's operations. 
Non-integral foreign operation is a foreign operation that is not an integral 
foreign operation. When there is a change in the exchange rate between the 
reporting currency and the local currency, there is little or no direct effect on the 
present and future cash flows from operations of either the non-integral foreign 
operation or the reporting enterprise. The change in the exchange rate affects the 
reporting enterprise's net investment in the non-integral foreign operation rather 
than the individual monetary and non-monetary items held by the non-integral 
foreign operation. 
‘Net investment in a non-integral foreign operation’ is the reporting enterprise’s 
share in the net assets of that operation. 
Forward exchange contract means an agreement to exchange different 
currencies at a forward rate. 
Forward rate is the specified exchange rate for exchange of two currencies at a 
specified future date. 
‘Foreign currency’ is a currency other than the reporting currency of an enterprise . 
  3.3 INITIAL RECOGNITION 
A foreign currency transaction should be recorded, on initial recognition in the 
reporting currency, by applying to the foreign currency amount the exchange rate 
between the reporting currency and the foreign currency at the date of the 
transaction.  
A rate that approximates the actual rate at the date of the transaction is often 
used, for example, an average rate for a week or a month might be used for all 
transactions in each foreign currency occurring during that period. However, if 
exchange rates fluctuate significantly, the use of the average rate for a period is 
unreliable. 
© The Institute of Chartered Accountants of India
Page 5


a
 
 
 
ADVANCED ACCOUNTING 
7.28 
 
 
LEARNING OUTCOMES 
UNIT 3: ACCOUNTING STANDARD 11 THE EFFECTS 
OF CHANGES IN FOREIGN EXCHANGE RATES 
 
 
After studying this unit, you will be able to comprehend the – 
? Foreign Currency Transactions  
• Initial Recognition  
• Reporting at Subsequent Balance Sheet Dates 
• Recognition of Exchange Differences  
? Net Investment in a Non-integral Foreign Operation  
? Classification of Foreign Operations  
• Integral Foreign Operations 
• Non-integral Foreign Operations 
• Disposal of a Non-integral Foreign Operation  
• Change in the Classification of a Foreign Operation  
• Accounting for Forward Exchange Contracts  
• Disclosures 
 3.1 INTRODUCTION  
An enterprise may carry on activities involving foreign exchange in two ways. It 
may have transactions in foreign currencies (e.g., export sales in denominated in 
USD) or it may have foreign operations (e.g., foreign branch of reporting entity 
outside India). At the time of preparing the financial statements, these 
transactions and/or operations must be reported by the entity in the reporting 
currency i.e., INR. Hence, such foreign currency transactions and foreign 
operations should be translated into the reporting currency (i.e., INR) in order to 
be included in the financial statements of the entity. 
© The Institute of Chartered Accountants of India
 
 
13.29 a
   
 
7.29 
 
AS BASED ON ITEMS IMPACTING FINANCIAL 
STATEMENTS 
The standard deals with the issues involved in accounting for foreign currency 
transactions and foreign operations i.e., to decide which exchange rate to use and 
how to recognise the financial effects of changes in exchange rates in the 
financial statements.  
Scope 
This Standard should be applied:  
(a) In accounting for transactions in foreign currencies. 
(b) In translating the financial statements of foreign operations. 
(c) This Statement also deals with accounting for foreign currency transactions 
in the nature of forward exchange contracts. 
This Standard does not: 
(a) Specify the currency in which an enterprise presents its financial statements. 
However, an enterprise normally uses the currency of the country in which it 
is domiciled. If it uses a different currency, the Standard requires disclosure 
of the reasons for using that currency. The Standard also requires disclosure 
of the reason for any change in the reporting currency. 
 For example, all Indian companies are required to present their financial 
statements in INR. Thus, for such entities, INR is the reporting currency. 
Alternatively, in case an Indian company is a subsidiary of a company 
located in the United States, the parent may require the company to present 
the financial statements in USD. In such cases, the company is required to 
disclose the reasons for presenting the financial statements in USD (a 
currency other than INR, the currency of the place where the company is 
domiciled i.e., India). 
In both the cases discussed above, it may be pertinent to note that 
Accounting Standard 11 does not prescribe the currency to be used to 
present the financial statements. However, for all practical purposes (Income 
Tax Act, Indirect Tax Requirements etc.), every company domiciled in India 
will present financial statements in INR.  
(b) Deal with the presentation in a cash flow statement of cash flows arising 
from transactions in a foreign currency and the translation of cash flows of a 
foreign operation, which are addressed in AS 3 ‘Cash flow statement’. 
© The Institute of Chartered Accountants of India
a
 
 
 
ADVANCED ACCOUNTING 
7.30 
 
(c) Deal with exchange differences arising from foreign currency borrowings to 
the extent that they are regarded as an adjustment to interest costs. 
(d)  Deal with the restatement of an enterprise’s financial statements from its 
reporting currency into another currency for the convenience of users 
accustomed to that currency or for similar purposes. 
 Considering the example above, the Indian subsidiary of the US Parent will 
present its financial statements in INR for the Indian regulators. However, 
since the US parent needs to consolidate the Indian subsidiary, it will 
require the Indian company to also restate the INR Financial Statements to 
USD. Such restatement is not covered under Accounting Standard 11. 
  3.2 DEFINITIONS OF THE TERMS USED IN THE  
 STANDARD 
A foreign currency transaction is a transaction which is denominated in or 
requires settlement in a foreign currency, including transactions arising when an 
enterprise either:  
(a) Buys or sells goods or services whose price is denominated in a foreign 
currency.  
(b) Borrows or lends funds when the amounts payable or receivable are 
denominated in a foreign currency.  
(c) Becomes a party to an unperformed forward exchange contract or  
(d) Otherwise acquires or disposes of assets, or incurs or settles liabilities, 
denominated in a foreign currency. 
Monetary items are money held and assets and liabilities to be received or paid 
in fixed or determinable amounts of money. For example, cash, receivables and 
payables. 
Non-monetary items are assets and liabilities other than monetary items. For 
example, fixed assets, advances for purchase of goods / fixed assets, inventories 
and investments in equity shares. 
© The Institute of Chartered Accountants of India
 
 
13.31 a
   
 
7.31 
 
AS BASED ON ITEMS IMPACTING FINANCIAL 
STATEMENTS 
Foreign operation is a subsidiary, associate, joint venture or branch of the 
reporting enterprise, the activities of which are based or conducted in a country 
other than the country of the reporting enterprise. 
Integral foreign operation is a foreign operation, the activities of which are an 
integral part of those of the reporting enterprise. A foreign operation that is 
integral to the operations of the reporting enterprise carries on its business as if it 
were an extension of the reporting enterprise's operations. 
Non-integral foreign operation is a foreign operation that is not an integral 
foreign operation. When there is a change in the exchange rate between the 
reporting currency and the local currency, there is little or no direct effect on the 
present and future cash flows from operations of either the non-integral foreign 
operation or the reporting enterprise. The change in the exchange rate affects the 
reporting enterprise's net investment in the non-integral foreign operation rather 
than the individual monetary and non-monetary items held by the non-integral 
foreign operation. 
‘Net investment in a non-integral foreign operation’ is the reporting enterprise’s 
share in the net assets of that operation. 
Forward exchange contract means an agreement to exchange different 
currencies at a forward rate. 
Forward rate is the specified exchange rate for exchange of two currencies at a 
specified future date. 
‘Foreign currency’ is a currency other than the reporting currency of an enterprise . 
  3.3 INITIAL RECOGNITION 
A foreign currency transaction should be recorded, on initial recognition in the 
reporting currency, by applying to the foreign currency amount the exchange rate 
between the reporting currency and the foreign currency at the date of the 
transaction.  
A rate that approximates the actual rate at the date of the transaction is often 
used, for example, an average rate for a week or a month might be used for all 
transactions in each foreign currency occurring during that period. However, if 
exchange rates fluctuate significantly, the use of the average rate for a period is 
unreliable. 
© The Institute of Chartered Accountants of India
a
 
 
 
ADVANCED ACCOUNTING 
7.32 
 
 3.4 REPORTING AT EACH BALANCE SHEET 
DATE  
The treatment of foreign currency items at the balance sheet date depends on 
whether the item is: 
• monetary or non-monetary; and  
• carried at historical cost or fair value (for non-monetary items). 
(a) Foreign currency monetary items should be reported using the closing rate. 
However, in certain circumstances, the closing rate may not reflect with 
reasonable accuracy the amount in reporting currency that is likely to be 
realised from, or required to disburse, a foreign currency monetary item at 
the balance sheet date, e.g., where there are restrictions on remittances or 
where the closing rate is unrealistic and it is not possible to effect an 
exchange of currencies at that rate at the balance sheet date. In such 
circumstances, the relevant monetary item should be reported in the 
reporting currency at the amount which is likely to be realised from or 
required to disburse, such item at the balance sheet date.  
(b) Non-monetary items which are carried in terms of historical cost 
denominated in a foreign currency should be reported using the exchange 
rate at the date of the transaction. 
(c) Non-monetary items which are carried at fair value or other similar 
valuation denominated in a foreign currency should be reported using the 
exchange rates that existed when the values were determined. 
(d) The contingent liability denominated in foreign currency at the balance 
sheet date is disclosed by using the closing rate. 
  3.5 RECOGNITION OF EXCHANGE DIFFERENCES 
Exchange differences arising on the settlement of monetary items or on reporting 
an enterprise’s monetary items at rates different from those at which they were 
initially recorded during the period, or reported in previous financial statements, 
should be recognised as income or as expenses in the period in which they arise. 
An exchange difference results when there is a change in the exchange rate 
© The Institute of Chartered Accountants of India