Accounting for Foreign Branches
Foreign branches of a company have its operations and transactions in foreign currency and thus, the books are maintained in the foreign currency. The trial balance, trading and profit and loss account and balance sheet are all made in foreign currency. These cannot be directly incorporated in the HO books as there is a difference in the currency.
Therefore, the HO needs to convert the foreign currency into the currency of the HO. But this is little complicated due to the fluctuations in the foreign exchange rate on a daily basis.
Table of Content
The trading and profit and loss account in the books of the HO would look as shown below:
In the Books of Head Office
Trading and Profit and Loss account
For the year ended 31st December _
|Purchases||By Goods sent|
|Gross profit||By Stock|
Types of Foreign Exchange Fluctuations
The foreign exchange fluctuations can be classified in three types:
- Stable currency which means there is no fluctuation
- Moderate Fluctuation which means it fluctuates within moderate limits
- Wide fluctuation which means fluctuations are beyond any defined limit
Let us now study about each of these foreign exchange fluctuations.
In this case, it is assumed that the foreign exchange rate between two countries is stable and the currency of the foreign branch is converted at a fixed rate called the official rate. There are a few exceptions to this. Branch remittances are converted at actuals and the HO account in branch books is taken at the figure that appears in the branch account of the HO books.
This will leave a negligible difference in the books of the HO. And this difference is put on the column and written as a difference in exchange and then transferred to the branch profit and loss account.
As there is a moderate fluctuation, the accounts of the HO and the branch will not tally. There will be a difference as the trial balance of the foreign branch is converted into the currency of the HO. This difference is accounted under the heading “Difference in Exchange”.
There are often gains and losses resulting from such fluctuations and are included in the calculation of profits and losses. A foreign fluctuation account is maintained and if there is a profit or loss, it is adjusted against the previous profits and losses.
When fluctuations vary above and below certain limits, it becomes risky for the company. It may give high gains but at the same time, it also poses a threat of great losses. The rate of exchange between these countries varies considerably from the official rate due to foreign exchange fluctuations.
Here, in the books of the head office and the branch, the receipts or payments (as the case may be) are entered and converted at an imaginary fixed rate. And the difference obtained is transferred to the foreign exchange reserve account. In each set of books, the actual receipts or payments should be entered and these should be converted at an artificial fixed rate. The difference will be transferred to the Exchange Reserve Account.