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FOREIGN EXCHANGE GAIN/LOSS - kamranACA - 03-01-2007
I just want to bring on discussion an issue of practical difficulty to the accountants at exporting units. The members of this forum who are also the students or associate/fellow members of ICAP are specifically requested to comment on the situation. The export sales are normally recognized on disptach of goods to customers i.e. on the bill of lading date by using the foreign currency exchange rate of the said date. In fact, there could be so many exchange rates on a single time as all the banks might have different rates at the same time. Therefore, exporting units recognise the sales by using the rate of the bank from whom E-Form was obtained or where the proceeds are to be received against the shipment either it is on L/C basis or D/A basis. IAS 21 also allows to translate such amounts on week average rates or month average rates to facilitate the practice, if the variation in rates is not enormous.
Apparently, there is a time gap between the sale recognition date in the books of account and the realization date against the shipment and this time gap would eventually result in a foreign currency gain or loss to be recognized in the books of account being the difference between amount debited to the export debtor's account against the said sales and the amount actually received therefrom on realization date.
IAS 21 (para 52) interalia requires the diclosure of the amount of exchnage difference recognised in profit and loss account. We should also keep in mind, that in this area, IAS 21 deals with translation facet of foreign currency and not the conversion thereof. Where translation is used for reporting purpose and conversion is the actual conversion at the time of realization.
The said IAS has not stipulated that in which component of profit and loss account (i.e. Sales or Other Income) such gain or loss should be included. Instead, it simply requires its discloure that could be made by giving merely an explanatary note under any of the components of profit and loss account. This situation leaves the preparer of accounts to use his judgment that where such gain/loss should logically be included. IAS 18 (para 11) explains the term revenue by stipulating that "the amount of revenue is the amount of cash and cash equivalents received or receivable".
It means that whether it is a received amount or receivable amount, in both cases, it would be the part of revenue. Further, logically it has only and only arisen due to selling in foreign currency. If the same sales would have been made in local currency, no such gain/loss would have ever arisen. The driving force behind such income is the sales to export debtors in foreign currency. This can lead to include such income in the amount of export sales. Disclosure could be given in an explanatory note to such amount of export sales appearing in the notes to the accounts. Apparently, IAS 21 does not have any explicit objection on this treatment.
Why such treatment is desired for exporting units? It is now explained. Taxation under Presumptive Tax Regime (PTR) is made under section 169 of Income Tax Ordinance, 2001 where tax is withheld/dedcuted by the banks at the time of receiving of proceeds against the realization. Realization amount for exporter is the amount that is finally received through bank by the exporter after deduction of due tax that is full and final tax for exporter. If the exchange gain (that is a notional figure and has nothing to do with actual cash and cash equivalent received) is included in other income, the tax authorties would never leave it untaxed. It is commonly known that in Pakistan the so-called tax authorities have nothing to do with common sence and they tax the exporters under Normal Tax Regime (NTR) for whatever income figure that might be appearing in the other income component of the profit and loss account. Such behaviour and very very common practice of tax authorities would call for un-necessary appeals, costs, documentation, explanations and wastage of time for the exporters. This would lead to double taxation of the same income; once under PTR and again under NTR that is totally against the law and is only a burden on the exporters in either way.
Now the issue is that the Technical advisory committee of the Institute of Chartered Accountants (ICAP) has issued a selected opinion (volume 1) in 1993 that such gain should be included in OTHER INCOME instead of trading results. I understand that so many pronouncements have changed over the period but selected opinions are never withdrawn because these have no legal effect; these are simply the opnions which can differ from professional to professional. Now IAS 1 after recent revision has even eliminated the requirement to identify the profit from operating activities and profit from other activities. (we are doing this becoz 4th Sch. to CO 84 requires it). It has also eliminated the requirement to identifiy the extra ordinary and ordinary activities etc.
Although the said opinions have no legal effect and even ICAP does not take responsibility for such opinions, still, the auditors of the companies in exporting sector require them to follow this opinion while no such requirement could be seen in IAS 21.
This is causing practical difficulties to the exporters and tax authorities are charging tax on such gains that are appearing in other income leading to double taxation of same cash and cash equivalent earned.
I seek to have the views of the members of this forum on this issue.
Best regards,
KAMRAN.
- shezijee - 03-02-2007
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Dear Kamran ACA,
As u know that when there is a conflict between IAS and Companies Ordinance in Pakistan Local Law prevails. so we are still following this practise however tax authorities must consider it regarding concern of double taxation, which is still unspoken by them.
Regards,
Sheeraz Afzal
ACA,APA,ITP
- kamranACA - 03-02-2007
Dear Mr. Sheeraz Afzal (ACA, APA, ITP),
I think you have not gone through my complete message. The querry was never aimed at to get the clarification that has been received from your goodself.
Infact, the question was to compare the requirement of IAS 21 with the stipulations of the SELECTED OPINION of ICAP. You must be well informed that selected opinions are merely the opinions of a committee of ICAP for which even that committee and ICAP, both, dont take any responsibility. In this regard, I refer you to see the INTRODUCTION section of each volume of selected opinions issued by ICAP which says that the opinions are the sole views of the members of the technical advisory committee for which committee does not take any responsibility.
Further, SECP has never endorsed these opinions to make them a binding legal requirement. These opinions are termed as "non-legal gaaps" by some educationists, although this term is not widely known.
Moreover, contrary to the clarification you provided, there is no such explicit requirement in the Companies Ordinance, 1984 for including the foreign currency gains/losses in other income etc.
I understand that local laws always override the international standards but no such local LAW exists which requires such classification/grouping. The problem is of selected opinions which are strictly captured by some auditors to create hardships for their clients in exporting sector and these opinions can never be termed as a local law.
Therefore, clarification is still desired and the querry remains un-answered.
Best regards,
KAMRAN
- Abdur.Rehman - 03-07-2007
A very nice and technical query after quite a long time...
First of all i donot agree with ur saying that, the sole reason for arising of exchange gain/loss is foreign sale, and hence should be a part of revenue.
Here are the arguments against it...
a)matching concept; as per the matching concept, you must match revenue with cost and cost with revenue. Here, if u recognize exchange gain as revenue, what matching cost do u have? So, as per matching concept, all the gains for which we have no related costs are incidental incomes and hence treated as other income and not revenue.
b)When u r recognizing revenue under accrual basis as per IAS 18, u will in most cases recognize revenue before receipt of income. Now if u add the exchange gain to it, it will mount to cash basis. And secondly, as export companies have heavy amounts of debtors, what will u do to account for the exchange gain that will arise in next period out of those debtors. Of course u cannot provide an accrual for exchange gain, as it is not prudent.
c)Thirdly, if there is an exchange loss, u will probably reduce that amount from revenue under ur suggested treatment. In this case, it will mount to netting off of income and expense, which is also not allowed....
So, as per the basic concepts of IAS, this treatment is not suitable....
the only thing u can do is to negotiate with the tax authorities or contact a professional firm who can give u advice in this case...
Im sure that a professional firm will draft ur returns in such a way that, ur other income will come under the PTR and u will not be taxed twice...
I will also ask the personnel of our tax department, as they must have dealt this kind of case before...
- kamranACA - 03-07-2007
Dear,
Thank you very much for your reply. Infact you have given a very focussed clarification as far as accrual basis and cash basis of accounting have been discussed by you. I principally agree to your conclusion.
Still, there are two further things to be elaborated. Firstly, Revenue is explained to be cash or cash equivalent received or receivable by para 11 of IAS 18. This covers both cash received against the revenue and revenue accrued. If we see the order of the transaction then off course accrual comes first and cash comes later. The intention of the aforesaid para may be construed that when some revenue is receivable as cash equivalent (i.e. the amount accrued to be received) then the accured amount would be the revenue to be disclosed in accounts and when the revenue is received as cash then the received amount (actual proceeds) would be the revenue to be disclosed in the accounts. If this is not true then what means by cash and cash equivalent received or receivable? The cost against the realized amount (which includes the portion of currency exchange gain) is the cost of inventories charged to profit and loss account against such sales thus complying the matching principle. Cost against the cash equivalent received is the carrying value of inventories charged.
The point which you highlighted about year-end debtors is of greatest importance becoz it would affect the next year profit and loss account and if it is a gain it would be carried with nil cost and if it would be loss it would be carried with nil revenue, creating problems with matching principle.
As far as adjusting loss against revenue, my view point is that such loss is notional and infact reflects the amount booked as cash equivalent receivable and cash actually received. This is not a setting of two non-similar items of expense and income becoz this does not reflect non-similar accounting estimate like bad debts etc. Therefore, in my view it could be adjusted there-gainst.However, your argument on this area is also very strong.
I understand that basic concept of acounting and framework of standards support the idea to account for such gain as other income. I also understand that consultants and fighting at various forums would turn the table against the tax authorities. I feel you are from Islamabad and you dont know the problems of exporters which are actually located at karachi, lahore and faisalabad. Incurring of substantial costs of consultancy and fighting with tax authroities after paying the demanded tax amounts (that will be piled up for the long runs without any financial return and on which they are paying huge financial charges) make the exporting sector a loss making sector due to very lesser margins in post WTO regime where antidumping is already hitting various industries from 5 percent to above 15 percent sequeezing all profits earned through such deals.
You know IAS 39 is still not implemented for banking sector in Pakistan due to fair valuation problems. {In my view such fair valuation as pointed out in paragraph 41-42 of IAS 39 read with para AG84 of its application guideline, is conflicting with the matching principle of frameowrk of IFRSs that has been discussed. Just a point to be considered} This has been delayed only to save the results of banking sectors from huge fair value adjustments.
If one sector is supposed to be saved by denying/delaying such an important IAS, then why not the exporting units be accomodated by limiting such requirement to the extent of disclosure only where no such specific classification is stipulated by any IFRS clearly. One has to consture the things from framework but nothing has been stipulated as a requirement. Further, there could be more arguments from both sides of the table on this discussion.
Anyways. Your clarification is sound, based upon facts and privides sufficient explanation on the matter.
I am really thankful to you for your valuable contribution.
Best regards.
Kamran.
- Abdur.Rehman - 03-08-2007
I have no disagreement that revenue is cash or cash equivalent, received or receivable...My point was that u will be booking the complete revenue when the cash is received and not when the transaction takes place...and im not convinced that, the cost of goods sold is the cost related to the exchange gain revenue...
Anyhow, what i feel about the whole situation is that ICAP or SECP should not relax the requirements of standards, because it will hamper the consistency and uniformity objectives of IFAC...
The thing in my opinion that can be done is that, the industrialist, exporters and other loss sufferers, should try to negotiate with the CBR on this matter...
- kamranACA - 03-08-2007
Dear,
Yes, your views have convincing weightage and I have already principally agreed to your explanation.
But I think u are not much aware of the behaviour of ICAP and SECP on such issues.
These bodies, besides having a good repo, have done nothing i.r.o the culprits of Mehran Bank Scandle, Crescent Standard Investment Bank and other such cases in leasing sector. Although SECP changed the BOD of one or two of such companies and appointed the administartors, still, the guilty people are never captured and brought to the table. You can even see them (the resposnible persons) within the govermental circles on television on daily basis. SECP so many times left the auditors of such companies in the final trials without any penal action.
Do u really feel that standards, corporate governance code and other such requirements are implemented in their true spirit? I can see the companies where the peons have been given qualification shares to make them directors in order to comply the code of corporate governance. Simply drafting the mission/vision statements will never change our culture. In my view we should follow the international standards as we are now issueing GDRs and for cross border deals, reporting should always comply the international frameworks. I agree to your proposal that standards should not be relaxed.
But in this country, those who are conferred upon the governance, should consider the practical difficulties and play a positive role. CBR is an institution which has never accepted the true results for the sake of enhancing their revenues and broadening their tax base or whatever.
As you recommended, I think CBR should be pursued to direct its machinery to save the tax payers from double taxation.
Best regards,
KAMRAN