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Derivatives Accounting Treatment

ramya (Account Assistant) (43 Points)

12 April 2011

Dear Members,

Guide me on the Accounting Treatment of Derivatives and recording the purchase and sale transaction of derivatives.

Also what is EFC A/cs maintained in Banks for the Foreign Currency transactions? how should we record it in our books??

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vignesh (B-com CS CA-Final CFA-level 1 candidate) (1053 Points)
Replied 12 April 2011

Accounting for Derivatives as per FAS 133

The standard requires that every derivative instrument should be recorded in the Balance Sheet as assets or liability at fair value and changes in fair value should be recognised in the year in which it takes place.

The standard also calls for accounting the gains and losses arising from derivatives contracts. It is important to understand the purpose of the enterprise while entering into the transaction relating to the derivative instrument. The derivative instrument could be used as a tool for hedging or could be a trading transaction unrelated to hedging. If it is not used as an hedging instrument, the gain or loss on the derivative instrument is required to be recognised as profit or loss in current earnings.

Derivatives used as hedging instruments

Derivative instruments used for hedging the fair value of a recognised asset or liability, are calledFair Value Hedges. The gain or loss on such derivative instruments as well as the off setting loss or gain on the hedged item shall be recognised currently in income.

Example

An individual having a portfolio consisting of shares of Infosys and BSES, may decide to hedge this portfolio using the Sens*x Futures Contract. The gain or loss on the index futures contract would compensate the loss or gain on the portfolio. Both the gains and losses will be recognised in the Profit and Loss Statement. If the hedge is perfect, gains and losses will offset each other and hence will not have any impact on the current earnings. However, if the hedge is not a perfect hedge, there would be a difference between the gain and the compensating loss. This would affect the current reported earnings of the individual.

If the derivative instrument hedges risk of variations in cash flow on a recognised asset and liability, it is called Cash Flow hedge. The gain or loss on such derivative instruments will be transferred to current earnings of the same period or the periods during which the forecasted transaction affects the earnings. The remaining gain or loss on the derivative instrument if any shall be recognised currently in earnings.

Similarly if the derivative instrument hedges risk of exposures arising out of foreign currency transactions or investments overseas or in subsidiaries, it is called Foreign Currency Hedge.

2.Q 1. What is an EEFC Account and what are its benefits?

Ans. Exchange Earners' Foreign Currency Account (EEFC) is an account maintained in foreign currency with an Authorised Dealer i.e. a bank dealing in foreign exchange. It is a facility provided to the foreign exchange earners, including exporters, to credit 100 per cent of their foreign exchange earnings to the account, so that the account holders do not have to convert foreign exchange into Rupees and vice versa, thereby minimizing the transaction costs.

Q 2. Who can open an EEFC account?

Ans. All categories of foreign exchange earners, such as individuals, companies, etc. who are resident in India, may open EEFC accounts.

Q 3. What are the different types of EEFC accounts? Can interest be paid on these accounts?

Ans. An EEFC account can be held only in the form of a current account. No interest is payable on EEFC accounts.

Q 4. How much of one’s foreign exchange earnings can be credited into an EEFC account?

Ans. One can credit up to 100 per cent of his/ her foreign exchange earnings into the EEFC account, subject to permissible credits and debits.

Q 5. Whether EEFC Account can be opened by Special Economic Zone (SEZ) Units?

Ans. No, SEZ Units cannot open EEFC Accounts.

However, a unit located in a Special Economic Zone can open a Foreign Currency Account with an authorised dealer in India subject to certain conditions. SEZ Developers can open EEFC Accounts.

Q 6. Is there any Cheque facility available?

Ans. Yes; Cheque facility is available for operation of the EEFC account.

Q 7. What are the permissible credits into this account?

Ans.
i) Inward remittance through normal banking channels, other than remittances received on account of foreign currency loan or investment received from abroad or received for meeting specific obligations by the account holder;

ii) Payments received in foreign exchange by a 100 per cent Export Oriented Unit or a unit in (a) Export Processing Zone or (b) Software Technology Park or (c) Electronic Hardware Technology Park for supply of goods to similar such units or to a unit in Domestic Tariff Area;

iii) Payments received in foreign exchange by a unit in the Domestic Tariff Area for supply of goods to a unit in the Special Economic Zone (SEZ);

iv) Payment received by an exporter from an account maintained with an authorised dealer for the purpose of counter trade. (Counter trade is an arrangement involving adjustment of value of goods imported into India against value of goods exported from India in terms of the Reserve Bank guidelines);

v) Advance remittance received by an exporter towards export of goods or services;

vi) Payment received for export of goods and services from India, out of funds representing repayment of State Credit in U.S. Dollar held in the account of Bank for Foreign Economic Affairs, Moscow, with an authorised dealer in India;

vii) Professional earnings including directors fees, consultancy fees, lecture fees, honorarium and similar other earnings received by a professional by rendering services in his individual capacity;

viii) Re-credit of unutilised foreign currency earlier withdrawn from the account;

ix) Amount representing repayment by the account holder's importer customer, of loan/advances granted, to the exporter holding such account; and

x) The disinvestment proceeds received by the resident account holder on conversion of shares held by him to ADRs/GDRs under the Sponsored ADR/GDR Scheme approved by the Foreign Investment Promotion Board of the Government of India.

Q 8. Can foreign exchange earnings received through an international credit card be credited to the EEFC account?

Ans. Yes, foreign exchange earnings received through an international credit card for which reimbursement has been made in foreign exchange may be regarded as a remittance through normal banking channel and the same can be credited to the EEFC account.

Q 9. What are the permissible debits into this account?

Ans. i) Payment outside India towards a permissible current account transaction [in accordance to the provisions of the Foreign Exchange Management (Current Account Transactions) Rules, 2000] and permissible capital account transaction [in accordance to the Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000].

ii) Payment in foreign exchange towards cost of goods purchased from a 100 percent Export Oriented Unit or a Unit in (a) Export Processing Zone or (b) Software Technology Park or (c) Electronic Hardware Technology Park

iii) payment of customs duty in accordance with the provisions of the Foreign Trade Policy of the Central Government for the time being in force.

iv) Trade related loans/advances, extended by an exporter holding such account to his importer customer outside India, subject to compliance with the Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulations, 2000.

v) Payment in foreign exchange to a person resident in India for supply of goods/services including payments for airfare and hotel expenditure.

Q 10. Is there any restriction on withdrawal in rupees of funds held in an EEFC account?

Ans. No, there is no restriction on withdrawal in Rupees of funds held in an EEFC account. However, the amount withdrawn in Rupees shall not be eligible for conversion into foreign currency and for re-credit to the account.

Q. 11. Whether the EEFC balances can be covered against exchange risk?

Ans. Yes, the EEFC account balances can be hedged. The balances in the account sold forward by the account holders has to remain earmarked for delivery. However, the contracts can be rolled over

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ramya (Account Assistant) (43 Points)
Replied 12 April 2011

Thanks for the theoritical info but i want the Accounting entries for recording transactions in EEFC A/c and since in this type of Account we dont convert the foreign currencies so do we need to record all the transactions in Rupees or just the closing balance.

Also what about the loss or gain arising out exchange rate difference???????????