Do Foreign Currency Transactions impact your Profit?
What is Foreign Exchange Gain/Loss:-
A foreign exchange gain/loss occurs when a company buys and/or sells goods and services in a foreign currency, and that currency fluctuates relative to their home currency. It can create differences in value in the monetary assets and liabilities, which must be recognized periodically until they are settled.
An exchange rate is a rate at which one currency will be exchanged for another currency.
Should we comply with booking of Foreign Exchange Gain / Loss?
The following requirements make it mandatory to book Foreign Exchange Gain / Loss:
1. Accounting Standards: AS-11 which deals with the “Effects of Changes in Foreign Exchange Rates” mentions that accounting foreign exchange gain or loss is required in the following situations:-
- Transactions in Foreign currencies
- Translation of Balance Sheet items as on year end date
- Foreign currency transactions taking place in nature of Forward exchange contracts.
Hence AS-11 makes it mandatory for those companies which are required to comply with accounting standards. IND AS 21 and IFRS 21 also make it mandatory to account for the Foreign Exchange Gain/Loss.
2. Tax Audit: Income Computation and Disclosure Standards (ICDS) VI also provides guidelines computing income tax about the treatment of transactions in foreign currencies, forward contracts involving foreign currencies and translating the financial statements of foreign operations. Reference to Complying with ICDS VI will also be given in the Tax Audit Report. Hence, it is applicable to all taxpayers (corporate/non-corporate or resident/non-resident) irrespective of the turnover or income.
Situations requiring Accounting of foreign exchange gain or loss
1. Transactions in Foreign currencies:
- At the time of initial recognition, the transaction shall be recorded by applying the home currency rate (as on the transaction date) on the foreign currency amount involved in the transaction.
- While receipt/payment the home currency rate (as on the receipt /payment date) will be applied on the foreign currency amount that is received / paid.
- Differences that arise in home currency rates between the dates of initial recognition and receipt/payment will be booked as Realized foreign exchange gain / loss.
2. Translation of Balance sheet items as on year end date:
- This situation occurs when the Transaction date and the Receipt/Payment date are falling in the different accounting periods.
- The foreign assets or liabilities that are existing on balance sheet date must be recorded by applying the home currency rate as on balance sheet date.
- Differences that arise in home currency rates between the dates of initial recognition and balance date will be booked as Unrealized foreign exchange gain / loss..
3. Forward Exchange Contracts: Foreign Exchange Gain or loss on Forward exchange
contracts occurs in the following situations:
- Differences that arise in home currency rates between the dates of inception of the contract and settlement.
- Differences that arise in home currency rates between the dates of inception of the contract and the balance sheet date (if the contract is not settled)
Thereby to conclude, Companies which are mandatorily required to comply with AS-11 should disclose the exchange differences in the net profit or loss account for the financial year end and proper care should be taken while computing foreign exchange gain/loss.