Accounting Standard (AS) 11: The Effects of Changes in Foreign Exchange Rates
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.
In accounting for transactions in foreign currencies.
In translating the financial statements of foreign operations.
This Statement also deals with accounting for foreign currency transactions in the nature of forward exchange contracts.
This Standard does not:
- Specify the currency in which an enterprise presents its financial statements.
- 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’.
- Deal with exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.
- 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.
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.
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
- non-monetary carried at fair value
Foreign currency monetary items should be reported using the closing rate.
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.
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.
The contingent liability denominated in foreign currency at the balance sheet date is disclosed by using the closing rate.
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 between the transaction date and the date of settlement of any monetary items arising from a foreign currency transaction.
When the transaction is settled within the same accounting period as that in which it occurred, all the exchange difference is recognised in that period. However, when the transaction is settled in a subsequent accounting period, the exchange difference recognised in each intervening period up to the period of settlement is determined by the change in exchange rates during that period.
Exchange Differences Arising on Reporting of Long-Term Foreign Currency Monetary Items
Exchange differences relate to the acquisition of a depreciable capital asset, can be added to or deducted from the cost of the asset and should be depreciated over the balance life of the asset, and in other cases, can be accumulated in the Foreign Currency Monetary Item Translation Difference (FCMITD) Account and should be written off over the useful life of the assets.
Classification of Foreign Operations as Integral or Non-integral
The method used to translate the financial statements of a foreign operation depends on the way in which it is financed and operates in relation to the reporting enterprise.
An integral foreign operation carries on its business as if it were an extension of the reporting enterprise’s operations.
It dependts on:
- Sell goods imported from the reporting enterprise and remits the proceeds to the reporting enterprise.
- Effect on the reporting enterprise’s cash flow from operations.
- Accumulates cash and other monetary items, incurs expenses, generates income and perhaps arranges borrowings, all substantially in its local currency.
- While the reporting enterprise may control the foreign operation, the activities of the foreign operation are carried out with a significant degree of autonomy from those of the reporting enterprise.
- Transactions with the reporting enterprise are not a high proportion of the foreign operation’s activities.
- The activities of the foreign operation are financed mainly from its own operations or local borrowings rather than from the reporting enterprise.
- Costs of labour, material and other components of the foreign operation’s products or services are primarily paid or settled in the local currency rather than in the reporting currency.
- The foreign operation’s sales are mainly in currencies other than the reporting currency.
- Cash flows of the reporting enterprise are insulated from the day-to-day activities of the foreign operation rather than being directly affected by the activities of the foreign operation.
- Sales prices for the foreign operation’s products are not primarily responsive on a short-term basis to changes in exchange rates but are determined more by local competition or local government regulation.
- There is an active local sales market for the foreign operation’s products, although there also might be significant amounts of exports.
Translation of Foreign Integral Operations
The individual items in the financial statements of the foreign operation are translated as if all its transactions had been entered into by the reporting enterprise itself.
The cost and depreciation of tangible fixed assets is translated using the exchange rate at the date of purchase of the asset or, if the asset is carried at fair value or other similar valuation, using the rate that existed on the date of the valuation.
The cost of inventories is translated at the exchange rates that existed when those costs were incurred. The recoverable amount or realisable value of an asset is translated using the exchange rate that existed when the recoverable amount or net realisable value was determined. For example, when the net realisable value of an item of inventory is determined in a foreign currency, that value is translated using the exchange rate at the date as at which the net realisable value is determined.
The rate used is therefore usually the closing rate.
Translation of Non-Integral Foreign Operations
- The assets and liabilities, both monetary and non-monetary, of the non- integral foreign operation should be translated at the closing rate;
- Income and expense items of the non-integral foreign operation should be translated at exchange rates at the dates of the transactions; and
- All resulting exchange differences should be accumulated in a foreign currency translation reserve until the disposal of the net investment.
For practical reasons, a rate that approximates the actual exchange rates, for example an average rate for the period is often used to translate income and expense items of a foreign operation.
Exchange difference arising on an intra-group monetary item, whether short-term or long-term, cannot be eliminated against a corresponding amount arising on other intra-group balances because the monetary item represents a commitment to convert one currency into another and exposes the reporting enterprise to a gain or loss through currency fluctuations.
Change in the Classification of a Foreign Operation
When a foreign operation that is integral to the operations of the reporting enterprise is reclassified as a non-integral foreign operation, exchange differences arising on the translation of non-monetary assets at the date of the reclassification are accumulated in a foreign currency translation reserve.
When a non-integral foreign operation is reclassified as an integral foreign operation, the translated amounts for non-monetary items at the date of the change are treated as the historical cost for those items in the period of change and subsequent periods. Exchange differences which have been deferred are not recognised as income or expenses until the disposal of the operation.
Tax Effects of Exchange Differences
Gains and losses on foreign currency transactions and exchange differences arising on the translation of the financial statements of foreign operations may have associated tax effects which are accounted for in accordance with AS 22.
Forward Exchange Contract
An enterprise may enter into a forward exchange contract or another financial instrument that is in substance a forward exchange contract, which is not intended for trading or speculation purposes, to establish the amount of the reporting currency required or available at the settlement date of a transaction.
The premium or discount arising at the inception of such a forward exchange contract should be amortised as expense or income over the life of the contract.
Exchange differences on such a contract should be recognised in the statement of profit and loss in the reporting period in which the exchange rates change. Any profit or loss arising on cancellation or renewal of such a forward exchange contract should be recognised as income or as expense for the period.
A forward exchange contract intended for trading or speculation purposes, the premium or discount on the contract is ignored and at each balance sheet date, the value of the contract is marked to its current market value and the gain or loss on the contract is recognised.
- The amount of exchange differences included in the net profit or loss for the period.
- Net exchange differences accumulated in foreign currency translation reserve as a separate component of shareholders’ funds, and a reconciliation of the amount of such exchange differences at the beginning and end of the period.
When the reporting currency is different from the currency of the country in which the enterprise is domiciled, the reason for using a different currency should be disclosed. The reason for any change in the reporting currency should also be disclosed.
When there is a change in the classification of a significant foreign operation, an enterprise should disclose:
- The nature of the change in classification;
- The reason for the change;
- The impact of the change in classification on shareholders’ funds; and
- The impact on net profit or loss for each prior period presented had the change in classification occurred at the beginning of the earliest period presented.