BRANCH ACCOUNTS MEANING The dictionary meaning of the word branch is a ny subordinate division of a business, subsidiary shop, office etc. Acc to t o the provisions contained in s ec29 of the Companies Act 1956 it would appear appear that a branch branc h is any establishment carrying on either the same or substantially the same activity as t hat carried on by head office of the company. company. OBJECTS OF BRANCH ACCOUNTS The following are the main objects of maintaining branch accounts: (i) Profit or loss of each branch can be found out (ii) They help in controlling branches bra nches (iii) Actual financial position of the business can be found out on the basis of head office and branch accounting acc ounting periods. periods. (iv) Branch requirements of goods and cash can be estimated (v) Suggestions Suggestions for increasing incr easing the efficiency of the branch can be sent on the basis of branch accounts. (vi) They help in complying with the requirements of law because acc to c ompanies act 1956. TYPES OF BRANCHES From the accounting point of view, branches may be classified into (1) Dependent Branch (2) Independent Branch (3) Foreign Branch
The following is the text of Accounting Standard (AS) 11, 'Accounting for the Effects of Changes in Foreign Exchange Rates', issued by the Council of the Institute of Chartered Charter ed Accountants of India. This Standard will come into effect in respect r espect of accounting periods commencing on or after 1.4.1995 and will be mandatory in nature. Objective An enterprise may have transactions in foreign branches. Foreign currency currenc y transactions transactions should be expressed in the enterprise's reporting r eporting currency currency and the financial statements of foreign branches should be translated into the enterprise's r eporting eporting currency in order to include them in the financial statements of the enterprise. The principal issues in accounting for foreign currency tra nsactions and foreign branches are to decide which exchange rate to use and how to recognize in the financial statements the financial effect of changes in exchange rates. * This Standard has again been revised in 2003. The revised AS 11 (2003) comes into effect in respect of accounting periods commencing on or after 1-4-2004 and is mandatory in nature from that date. The revised revis ed Standard (2003) supersedes supersedes AS 11 (1994), (1994), except that in respect of accounting acc ounting for transactions in foreign currencies entered
into by the reporting enterprise itself or through its branches before the date the revised AS 11 (2003) comes into effect, AS 11 (1994) continues to be applicable. The revised Standard (2003) is published elsewhere in this Compendium. 1 Attention is specifically drawn to paragraph 4.3 of the Prefac e, according to which Accounting Standards are intended to apply only to items which are mat erial. 2 Reference may be made to the section titled 'Announcements of the Council regarding status of various documents issued by the Institute of Chartered Accountants of India' appearing at the beginning of this Compendium for a detailed discussion on the implications of the mandatory status of an accounting standard. Scope
1. This Statement should be applied by an enterprise : a. in accounting for transactions in foreign currencies; and b. in translating the financial statements of foreign branches for inclusion in 3 the financial statements of the enterprise.
3 The Council of the Institute of Chartered Accountants of India has clarified that this Standard is not applicable to forward exchange transactions which are entered into by authorised foreign exchange dealers, in view of the fact that the natur e of such transactions has certain special features which need to be addressed specifically. The Standard shall, however, apply to translation of financial statements of foreign branches of the foreign exchange dealers. (see 'The Chartered Accountant', April 1999, pp. 78-79.) Definitions
2. The following terms are used i n this Statement with the meanings specified : Reporting currency is the currency used in presenting the financial statements. Foreign currency is a currency other than the reporting currency of an enterprise. Exchange rate is the ratio for exchange of two currencies as applicable to the realisation of a specific asset or the payment of a specific liability or the recording of a specific transaction or a group of inter-related transactions. Average rate is the mean of the exchange rates in force during a period. Forward rate is the exchange rate established by the terms of an agreement for exchange of two currencies at a specified future date. Closing rate is the exchange rate at the balance sheet date. Monetary items are money held and assets and liabilities to be received or paid in ixed or determinable amounts of money, e.g., cash, rec eivables, payables. Non-monetary items are assets and liabilities other than monetary items e.g. fixed assets, inventories, investments in equity shares.
Settlement date is the date at which a receivable is due to be collected or a payable is due to be paid. Recoverable amount is the amount which the enterprise expects to recover from the uture use of an asset, including its residual value on disposal. Foreign
Currency Transactions Exchange Rate
3. A multiplicity of foreign exchange rates is possible in a given situation. In such a case, the term 'exchange rate' refers to the rate which is applicable to the particular transaction. 4. The term 'exchange rate' is defined in this Statement with reference to a specific asset, liability or transaction or a group of inter-related transactions. For the purpose of this Statement, two or more transactions are considered inter-related if, by virtue of being set off against one another or otherwise, they affect the net a mount of reporting currency that will be available on, or required for, the settlement of those transact ions. Although the exchange rates applicable to realisations and disbursements in a foreign currency may be different, an enterprise may, where legally permissible, partly use the receivables to settle the payables directly, in which case the payables and receivables are reported at the exchange rate as applicable to the net amount of receivable or payable. Further, where realisations are deposited into, and disbursements made out of, a foreign currency bank account, all the transactions during a period (e.g. a month) are reported at a rate that approximates the actual rate during that period. However, where transactions cannot be considered inter-related as stat ed above, by set-off or otherwise, the receivables and payables are reported at the rates applicable to the respective amounts even where these ar e receivable from, or payable to, the same foreign party. Recording Transactions on Initial Recognition 5. A transaction in a foreign currency should be recorded in the reporting currency by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction, except as stated in para 4 above in respect of inter-related transactions.
6. A transaction in a foreign currency is recorded in the financial records of an enterprise as at the date on which the transaction occurs, normally using the exchange rate at that date. This exchange rate is often referred to as t he spot rate. For practical reasons, a rate that approximates the actual rate is often used, for example, an average rate for all transactions during the week or month in which the transactions occur. However, if exchange rates fluctuate significantly, the use of the average rate for a period is unreliable. Reporting Effects of Changes in Exchange Rates Subsequent to Initial Recognition 7. At each balance sheet date :
a. monetary items denominated in a foreign currency (e.g. foreign currency notes, balances in bank accounts denominated in a foreign currency, and receivables, payables and loans denominated in a foreign currency) s hould be reported using the closing rate. However, in certain circumstances, the closing rate may not reflect with reasonable accuracy the amount in reporting currency that is likely to be realised from, or required to disburse, a foreign currency
monetary item at the balance sheet date, e.g., where there are restrictions on remittances or where the closing rate is unrealistic and it is not possible to effect an exchange of currencies at that rate at the balance sheet date. In such circumstances, the relevant monetary item should be reported in the reporting currency at the amount which is likely to be realised from, or required to disburse, such item at the balance sheet date; b. non-monetary items other than fixed assets, which are carried in terms of historical cost denominated in a foreign currency, should be reported using the exchange rate at the date of the transaction; c. non-monetary items other than fixed assets, which are carried in terms of fair value or other similar valuation, e.g. net realisable value, denominated in a foreign currency, should be reported using the exchange rates that existed when the values were determined (e.g. if the fair value is determined as on the balance sheet date, the exchange rate on the balance sheet date may be used); and d. the carrying amount of fixed assets should be adjusted as stat ed in paragraphs 10 and 11 below. Recognition of Exchange
Differences
8. Paragraphs 9 to 11 set out the accounting treatment required by this Statement in respect of exchange differences on foreign currency transactions. 9. Exchange differences arising on foreign currency transactions should be recognised as income or as expense in the period in which they arise, except as stat ed in paragraphs 10 and 11 below. 10. Exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which are carried in ter ms of historical cost, should be adjusted in the carrying amount of the respective fixed assets. The carrying a mount of such fixed assets should, to the extent not already so adjusted or otherwise accounted for, also be adjusted to account for any increase or decrease in the liability of the enterprise, as expressed in the reporting currency by applying the closing rate, for making payment towards the whole or a part of the cost of the assets or for repayment of the whole or a part of the monies borrowed by the enterprise from any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring those assets. 11. The carrying amount of fixed assets which are carried in t erms of revalued amounts should also be adjusted in the manner described in paragraph 10 above. However, such adjustment should not result in the net book value of a class of revalued fixed assets exceeding the recoverable amount of assets of that class, t he remaining amount of the increase in liability, if any, being debited to the revaluation reserve, or to the profit and loss statement in t he event of inadequacy or absence of the revaluation reserve.
12. An exchange difference results when there is a change in the exchange rate between the transaction date and the date of settlement of any monetary items arising from a foreign currency transaction. When the transaction is settled within the same accounting period as that in which it occurred, the entire exchange difference arises
in that period. However, when the transaction is not settled in the same accounting period as that in which it occurred, the exchange difference arises over more than one accounting period. Forward Exchange Contracts
13. An enterprise may enter into a forward exchange contract, or another financial instrument that is in substance a forward exchange contract, to establish the amount of the reporting currency required or available at the settlement date of a tr ansaction. The difference between the forward rate and the exchange rate at date of the transaction should be recognised as income or expense over the life of the contract, except in respect of liabilities incurred for acquiring fixed assets, in which cas e, such difference should be adjusted in the carrying amount of the respective fixed assets.
14. The difference between the forward rate and the exchange rate at the inception of a forward exchange contract is recognised as income or expense over the life of the contract. The only exception is in respect of forward exchange contracts related to liabilities in foreign currency incurred for acquisition of fixed assets. 15. Any profit or loss arising on cancellation or renewal of a forward exchange contract should be recognised as income or as expense for the period, except in case of a forward exchange contract relating to liabilities incurred for acquiring fixed assets, in which case, such profit or loss s hould be adjusted in the carrying amount of the respective fixed assets. Depreciation
16. Where the carrying amount of a depreciable asset has undergone a change in accordance with paragraph 10 or paragraph 11 or paragraph 13 or paragraph 15 of this Statement, the depreciation on the revised unamortised depreciable amount should be provided in accordance with Accounting Standard (AS) 6, Depreciation Accounting. Translation of the
Financial
Statements of Foreign Branches
17. The need for foreign currency translation arises in respect of the financial state ments of foreign branches of the parent enterprise. 18.
The financial statements of a foreign branch should be translated using the procedures in paragraphs 19 to 25 of this Statement.
19. Revenue items, except opening and closing inventories and depreciation, should be translated into reporting currency of the reporting enterprise at average rate. In appropriate circumstances, weighted average rate may be applied, e.g., where the income or expenses are not earned or incurred evenly during the accounting period (such as in the case of seasonal businesses) or where there are exceptionally wide fluctuations in exchange rates during the accounting period. Opening and closing inventories should be translated at the rates prevalent at t he commencement and close respectively of the accounting period. Depreciation should be translated at the rates used for the translation of the values of the assets on which depreciation is calculated. 20. Monetary items should be translated using the closing rate. However, in circumstances where the closing rate does not reflect with reasonable accuracy the amount in reporting currency that is likely to be realised from, or required to disburse, the foreign currency item at the balance sheet date, a rate that reflects approximately the likely realisation or disbursement as aforesaid should be used.
21. Non-monetary items other than inventories and fixed assets should be translated using the exchange rate at the date of the transaction.
Fixed assets should be translated using the exchange rate at the date of the transaction. Where there has been an increase or decrease in the liability of the enterprise, as expressed in Indian rupees by applying the closing rate, for making payment towards the whole or a part of the cost of a fixed asset or for repayment of 22. the whole or a part of monies borrowed by the enterprise from any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring a fixed asset, the amount by which the liability is so increased or reduced during the year, should be added to, or reduced from, the historical cost of the fixed asset concerned. 23. Balance in 'head office account', whether debit or credit, should be reported at the amount of the balance in the 'branch account' in the books of the head office after adjusting for unresponded transactions. 24. The net exchange difference resulting from the translation of items in the financial statements of a foreign branch s hould be recognised as income or as expense for the period, except to the extent adjusted in the carrying amount of the related fixed assets in accordance with paragraph 22 above. 25. Contingent liabilities should be translated into the reporting currency of the enterprise at the closing rate. The translation of contingent liabilities does not result in any exchange difference as defined in this Statement. Disclosures
26. An enterprise should disclose -
i. ii. iii.
amount of exchange differences included in the net profit or loss for the period; the amount of exchange differences adjusted in the carrying a mount of fixed assets during the accounting period; and the amount of exchange differences in respect of forward exchange contracts to be recognised in the profit or loss for one or more subsequent accounting periods, as required by paragraph 13.
27. Disclosure is also encouraged of an enterprise's foreign currency risk management policy.
Foreign Branches When a branch is established abroad, it is called a Foreign Branch. The accounting arrangements for a foreign branch are exactly the same as for any independent branch up to the Trial Balance. But in this case accounts are maintained in foreign currency to correspond with the local conditions. The main problem, which the Head Office has to face, is t he restatement of accounts one currency into another. In order to incorporate the Trial Balance of a foreign branch in the books of the Head Office. It must be translated (using appropriate exchange rates) into the currency of the Head Office.
RULES FOR CONVERSION OF BRANCH TRIAL BALANCE WHEN EXCHANGE RATES ARE µSTABLE¶ Exchange rate is said to be stable, when it does not vary to a great ext ent from time to time. In this situation, a fixed exchange rate can be used to convert the branch Trial Balance into the currency of the Head Office with the exception of (a) Remittances, and (b) Head Office Current Account. a. Remittances: These are converted at the actual rates at which they were made. b. Head Office Current Account: The actual figures shown for the Branch Current Account in the books of the Head Office (after taking into consideration in-transit items). When the foreign branch Trial Balance is converted into local currency, a new Trial Balance takes birth known as ³Difference on Exchange Account´ is opened to make the Trial Balance agree. Closing of Difference on Exchange Account i. For debit entry on trial balance Profit and Loss Account Dr. OR Exchange Reserve Account Dr. (if any) To Difference on Exchange Account ii. For credit entry on trial balance Difference on Exchange Account Dr. To Exchange Reserve Account (Big Differences) (If the difference is very small, it can be credited to Profit & Loss Account)
The format of the new Trial Balance of the branch is generally drawn up as follows: Foreign Branch Converted Trial Balance as at 31st December, 2006 Sr. Heads of Accounts No.
L. F Currency Cr. $ Dr. $
Rate of Rupees Exchange Dr. Rs. Cr. Rs.
Example Question Khan Limited a company in Pakistan manufacturing consumer goods, has an overseas branch in Sydney managed by a local agent. The products are sent in bulk to the branch and invoiced at cost plus freight. Packing materials are purchased locally by t he branch. The branch keeps a complete set of books in the local currency ± Dollar The branch Trial Balance as at 31st December, 2006 sent to the Head Office, was as under: Particulars Raw material from Head Office Purchases Raw material Packing Sales Wages General expenses Balance at bank Stock at 1st January, 2006 Raw material Packing Local agent ± balance due from him Head Office Account Balance at 1st January, 2006 Remittance to Head Office on 30th June Remittance to Head Office on 31st December Creditors
$
$ 43,300
43,300 30,240 1,40,800 80 11,530 10,440 29,130 17,640 5,890 18,210 14,900 17,800 20,000 2,04,180
5,180 2,04,180
The currency being relatively stable, a fixed rate of exchange $ 1 = Rs. 40 is adopted for accounting between the Head Office and the branch except for remittances. The rupee value of the remittances at 30th June was Rs. 7,00,000 and on 31st December was Rs. 7,92,000. On 29th December, 2006 Head Office debited the branch with Rs. 1,60,000 in respect of a shipment of raw material which was in-transit on 31st December, 2006. The remittance of $ 20,000 from the branch was not received at Head Office until 3rd January, 2007. The agent is entitled to a 10% commission on the net profit of the branch before charging either such commission or any profit or loss on exchange. Stock at the branch on 31st December, 2006 was: Raw Materials $ 6,560; Packing $6,480. From the above information you are required to: a.Prepare the Branch Profit and Loss Account in rupee for the year ended 31st December, 2006. b.Complete the entries in the Branch Account in the Head Office books, bringing down the balance as at 1stJanuary, 2007.
Solution Sydney Branch Converted Trial Balance as at 31.12.2006 Currency
Rate of Rupees L.F Exchang Dr. $ Cr. $ Dr. Rs. Cr. Rs. e Purchases: Raw Materials 43,300 17,32,000 Packing 30,240 12,09,600 Sales 1,40,80 56,32,000 Wages 11,530 0 4,61,200 General Expenses 10,440 4,17,200 Bank 29,130 11,65,200 Stock: Raw Materials 17,640 7,05,600 Packing 5,890 2,35,600 Local agent (Debtors) 18,210 7,28,400 Head Office Account (Note 1) Actual 8,36,000 Creditors Difference on 20,400 40 40 2,07,200 20,000 ExchangeClosing Stock: Raw 5,180 Materials 1,66,380 1,66,38 66,75,200 66,75,200 0 6,560 2,62,400 Packing 6,480 40 2,59,200
Sr. Heads of Accounts No.
Sydney Branch Trading and Profit and Loss Account for the year ended 31.12.2006 Particulars To Stock: Raw Materials Packing To Purchases: Raw Materials Packing To Wages To Gross Profit c/d To General Expenses To Difference on Exchange To Agent¶s Commission To Net Profit
Rs. 7,05,600 2,35,600 17,32,000 12,09,600 4,61,200 18,09,600 61,53,600 4,17,600 20,000 1,39,200 12,32,80018,09,600
Particulars Rs. By Sales By Closing Stock: 56,32,000 Raw Materials Packing 2,62,400 2,59,200
By Gross Profit b/d
61,53,600 18,09,600 18,09,600
In the Books of Head Office Sydney Branch Account . Date Particulars 31.12.06 To Balance b/d To Goods sent Branch To Goods sent Branch To Net Profit
to to
Rs. Date 5,96,000 17,32,000 1,60,000 12,32,800 37,20,800
Particulars By Remittance By Cash in-Transit By Goods in-Transit By Balance c/d
Rs. 7,00,000 7,92,000 1,60,000 20,68,800 37,20,800
Tutorial Note: Before branch Trail Balance is converted, the Branch Account in the Head Office books should be updated by adjusting transit items. This is required as the figures to be used in the converted Trial Balance are the actual balances on Branch Current Account in the Head Office Books. Let us see how it is done. Memorandum Sydney Branch Account Date Particulars 01.01.06 To Balance b/d To Goods sent Branch to To Goods sent to Branch
Rs. 5,96,000 17,32,000 1,60,000 24,88,000
Date 30.06.06 29.12.06 31.12.06
Particulars Rs. By Bank By Goods 7,00,000 in-Transit By Cash in- 1,60,000 Transit By Balance 7,92,000 c/d 8,36,000 24,88,000
EXAMPLE OF INCORPORATION OF FOREIGN BRANCH Dubai Branch Of A Foreign Company - Incorporation, Formation & Set Up
Introduction There are many instances where foreign companies wish to set up a presence in Dubai. The foreign company can either open a Representative Office or a Branch Office in Dubai. The difference between the two is quite simple. A Branch can conduct commercial activities ±i.e. invoice customers and clients ± whereas a Representative Office can only conduct marketing activities or provide support and guidance to distributors, and agents in Dubai who have been appointed by the Parent company. The Dubai Branch of a Foreign Company Incorporation Procedure To incorporate a branch of your parent company, you will have to follow a six-step procedure. They are as follows; Step 1: Board Resolution, & Appointment of Manager The Foreign Parent has now decided to open a Branch in Dubai. This decision has to be officially recorded as a Board Resolution by a majority of the board. This resolution should contain the following points; The decision to open a branch in Dubai Naming and Appointing the person who will head the Dubai Branch. In Dubai this person will be called the ³Manager.´ A decision to give this manager power of attorney to discharge his duties as head of the branch. Step 2: Preparation of the necessary Documents The foreign parent then has to prepare the documents required for incorporation of the Dubai Branch. Once these documents are put together, they have to be notarized by the UAE Embassy in that country. You will then have to courier these documents to Fortunum Investments Ltd to complete the incorporation process in Dubai. The required documents to set up a Branch of a Foreign Company in Dubai are as follows; y y y y y y y
Memorandum and Articles of Association of the Foreign Parent Certificate of Incorporation Board Resolution Power of Attorney Audited Financial Statements for the past 2 years Bank Statements for the past year A letter of introduction from the Parent Company¶s bankers
Step 3: Attestation of the Documents in Dubai and Translation into Arabic Once the documents reach Fortunum Investments Ltd. in Dubai, we will have to take these documents to various Government Ministries and Departments for their approval and/or attestation. Once all the necessary stamps have been placed, the documents will have to be translated into Arabic before we can present them for incorporation. Step 4: Initial Approval Obtaining the Initial Approval is the most important part of the incorporation process. The Initial Approval is a document issued by the Dubai Government licensing authorities which approve the following; The Business Activity: Unlike other jurisdictions where you incorporate a company and begin tra ding, Dubai is different in that each and every business activity that you wish to undertake must be approved first by the Dubai Government.
Company Structure: There is only one company structure available for a Dubai Branch ± that of a fully owned subsidiary of the foreign parent. The Dubai Branch will not have any shareholders ± it is legally an extension of the foreign entity. Step 5: Fulfilling the Conditions of the Initial Approval The Initial Approval Document contains a list of conditions that must be fulfilled before the final license is issued. These are usually; Renting an Office: Dubai has very strict zoning laws. You cannot register a company at your home. You cannot even use your friend¶s office ± it is a strict one company per office rule in Dubai. Courts and Notary Procedures: To register a Dubai Branch of a Foreign Company, you have to first appoint a local sponsor to act as your UAE National Service Agent. There is a sta ndard agreement which outlines the service agreement between you and the UAE National Service Agent. This document has to be signed and executed at the Dubai Courts Notary Public Section. Related Ministry or Related D epartment Approval: If you are setting up a straightforward consulting company you will not be required to obtain any further approvals. However, there are many business activities where the Dubai Government has to make sure that you are competent to carry out the intended business ± or there is legislation in place so that a Ministry or Department oversees and approves the licensing procedure. For example, if you wish to set up a financial investment consultancy you will have to obtain Central Bank Approval. Step 6: License Issue Once all the conditions have been fulfilled, the Licensing Authorities take about 1 ± 2 days to check all the documents. A payment voucher will be given to you ± in effect an invoice ± covering the license fees. Once you pay the license fee ± the Final License will be issued.
