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    ICDS-VI-Effects of Changes in Foreign Exchange Rates

    Introduction:

    • Section 145(2) of the Income Tax Act,1961 (“the Act”) grants power to Central Government to notify Income Computation Disclosure Standards.
    • So far 10 ICDS were notified by Central Government on 31stMarch,2015. However, they are made applicable from the Assessment Year 2017 -18 with a specified deferment period of one year from date of its implementation.
    • ICDS are NOT for maintenance of books of accounts, they are only for the purpose of
    • Income Computation &
    • Disclosure (Notification S.O.892(E) dated 31.03.2015)

    Note: In the case of conflict between the provisions of the Act and the ICDS, the provisions of the Act shall prevail to that extent.

     

    Applicability:

    ICDS is applicable to assessees

    • Having income under head “Profits and gains of business or profession” or “Income from other sources” AND
    • Following mercantile system of accounting.

    But it is not applicable to assessees

    • Who is Individual or HUF and who are not required to get their books get audited u/s 44AB of the Act.
    • Following cash system of accounting

    ICDS-VI-Effects of Changes in Foreign Exchange Rates:

    This standard discusses about taxation of income earned through foreign currency transactions.

    Scope:

    1. Treatment of Transactions in foreign currencies.
    2. Translating the Financial Statements of foreign operations.
    3. Treatment of Foreign currency transactions in nature of forward exchange contract.

    Definitions:

    • Average rate - The mean of the exchange rates in force during the particular period.
    • Closing rate - The exchange rate existing at the last day of the previous year.
    • Exchange difference - The difference resulting from converting the same number of units of a foreign currency into the reporting currency of a person at different exchange rates.
    • Exchange rate - The rate at which two currencies are exchanged.
    • Foreign currency - Currency other than the reporting currency of a person.
    • Reporting currency - Indian Currency as per ICDS-VI. 

    In order to include the exchange differences in the total income the following classification is to be followed:

    • All Assets and Liabilities are classified into Monetary Items & Non- Monetary Items:
    • Monetary items: These are money held and assets to be received or liabilities to be paid in fixed or determinable amounts of money.

    The following are the monetary items:

    • Money held i.e. cash and cash equivalents held by the entity.
    • Assets which are receivable in terms of money.
    • Liabilities which are payable in terms of money.
    • Non-monetary items: Non-monetary items are those other than monetary items.

    The classification of Assets and Liabilities into Monetary item & Non-monetary items depends            upon a question:

    Q: If there is a right or obligation to deliver fixed or determinable amounts of currency units?

    Receivable in money or Payable in money=Monetary Item

     

     

    A: If yes, then it is a monetary item. 

    The words receivable in money and payable in money are to be focused.

    Examples:

    Particulars

    Monetary / Non-monetary

    Reason

     

    Fixed Assets

     Non-monetary

    These are held by the entity and these are not receivable or payable to any as on balance sheet date.

     

     

      Current Assets:

     

    Particulars

    Monetary / Non-monetary

    Reason

     

    Cash in hand & Bank

    Monetary

    It is the money held by the entity

    Trade receivables,

     Bills receivables

    Monetary

    These are receivable from customers in terms of money

    Investments:

     

    Particulars

    Monetary / Non-monetary

    Reason

     

    Investments in equity shares

     

    Non-monetary

    These are held by the entity and these are not receivable or payable to any as on balance sheet date.

     

    Investment in Debentures, Government Bonds etc.

    Monetary

    Receivable from issuing entity

     Equity and Liabilities:

    Particulars

    Monetary / Non-monetary

    Reason

     

    Debentures

    Monetary

    Payable in terms of money

    Convertible Debentures

    Non-monetary

    Entity issues shares and is not liable to pay money

    Share Capital

    Non-monetary

    It is held by the entity

    Trade payables, Bills payables

    Monetary

    Payable in terms of money

    Provisions for income tax

    Monetary

    Payable in terms of money

    Treatment of Foreign currency Transactions directly entered by the entity:

    • What is a “Foreign currency transaction”?
    • It is a transaction which is denominated in (or) requires settlement in a foreign currency.

                     It includes the following:

    • buying or selling of goods or services,
    • borrowing or lending of funds,
    • becomes a party to an unperformed forward exchange contract,
    • acquisition or disposal of assets,
    • incurs or settles liabilities, denominated in a foreign currency.

    Recognition and Measurement of Assets and Liabilities is divided into two phases as below:

    Initial Recognition:

    • A Foreign Currency Transaction (FCT) is initially recorded using the exchange rate on the date of transaction.
    • Example: X ltd purchased goods of $500 from Y ltd of Canada on 02-12-2018.The exchange rate is 1$= Rs60. Describe recognition.
    • Answer: As per this ICDS all the transactions are initially recorded using the rate on the date of transaction. So the purchases are to be recorded at Rs.30,000.
    • In case a person is dealing with number of FCT’s the average rate of week or month shall be taken.
    • If there is a significant fluctuation in the exchange rates the actual rate on the date of transaction shall be taken.

    Subsequent Recognition:

    • If any Asset or Liability continues till the Balance sheet date, then assessee should revalue i.e. remeasure its value on the Balance sheet date.
    • However, its remeasurement depends upon the classification of items as follows:

    Examples of Non-Monetary items that can be measured at fair value or NRV:

    Inventory:

    • As per AS-2 “Valuation of Inventories” inventory is to be measured at cost or NRV whichever is lower.
    • If inventory is to be measured at cost- use the rate on date of transaction.
    • If inventory is to be measured at NRV – use the rate on date of valuation (i.e. Closing rate). Since inventory is valued on balance sheet date, the rate existing on the balance sheet date is to be used.

    Current Investments:

    • As per AS-13 “Accounting for Investments” current investments are measured at cost or fair value whichever is lower.
    • If current investment is valued at Cost- consider the rate on date of transaction. If current investment is measured at Fair value – use the rate on date of valuation.

    Particulars

    Net realisable value/ Fair value

    Cost

    Inventory

    Closing Rate

    Rate on date of transaction 

    Current Investments

    Closing Rate

    Rate on date of transaction 

     

    • Exchange Differences arising as result of conversion or settlement of:
      • Monetary items shall be recorded as income(gain) or expense(loss) in the Previous Year.
      • Non-Monetary Items shall not be recorded as income or expense in the Previous Year.

    Financial Statements of Foreign Operation:

    • Foreign operation of a person refers to overseas Branch of such person whose activities are conducted in a country other than India.

    Foreign Operation = Overseas Branch

    • The same principles (as stated in classification) shall be applied for conversion of Financial Statements of a foreign operation (i.e. Branch) as if the transactions of operation had been those of the person himself.
    • The Assets and liabilities of such branch shall be classified into Monetary items and Non -Monetary Items and the resulting difference (gain or loss) shall be recognised in the profit and loss account as income or expense. 

    Forward Exchange Contract:    

    • Forward exchange contract is an agreement to buy or sell the foreign currency at a pre-determined rate (i.e. Forward Rate) on a specified date.
    • This Forward exchange contract also includes buying or selling of:
      1. Foreign Currency
      2. Foreign Currency Option
      3. A Financial Instrument
    • Forward rate is the rate agreed in forward exchange contract to exchange the two currencies, options or financial instruments at a specified date.
    • These contracts are entered for any of the following purposes:
      • Hedging: This transaction is entered to minimize the loss that may occur due to changes in exchange rates. 

    Example: Swift Ltd. Purchased goods from Switzerland on 25-07-2018 for $6000 with a credit period of one month i.e. on 25-08-2018.No one is aware about exchange rate on date of payment. If the dollar rate increases the liability also increases. So, in order to avoid those losses, the entity enters into a contract called Forward exchange contract. 

    • Trading or speculation purposes: The main objective of this activity is to grab the advantage of changes in exchange rates. 

    Example: In continuation to the above example If Swift Ltd. expects that dollar rate rises to Rs.65 the entity will enter into Forward exchange contract today where dollar rate is Rs.62 to sell the units either at end of credit period or on any day whenever it is profitable to the entity.

    • Other than above two (as per ICDS highly probable forecast transaction)
    • The premium or discount in this contract is measured by the difference between the exchange rate on the date of transaction and forward rate agreed in the contract.
    • The exchange difference of the contract is the difference between closing rate or settlement rate (if settled) and inception rate of contract or opening rate whichever is later.
    • The premium or discount shall be recognised on the Date of Settlement. 

    Comparisons: 

    S.no

    Points of comparison

    ICDS-VI

    AS- 11

    1

    Applicability

    As stated above

    Applicable to level 1,2and 3 entities

    2

    Foreign Operation includes

    Only Branch

    Branch, Associate, Subsidiary

    3

    Types of Foreign Operation

    It does not specify the types

    Foreign operations are divided into: – Integral

    Non – Integral

    4

    Forward Exchange Contract includes

    foreign currency, foreign options, other financial instruments

    only foreign currency

    5

    Disclosure

    No disclosure requirements

    The amount of exchange differences included in Net profit to be disclosed 

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