Accounting for Branches including Foreign Branches

1. Introduction
2. Distinction between Branch Accounts and Departmental Accounts
3. Dependent Branches
4. Methods of charging Goods to Branches
5. Accounting for Dependent Branches
6. Accounting for Independent Branches
7. Adjustment and Reconciliation of Branch and Head Office Accounts
8. Incorporation of Branch Balance in Head Office Books
9. Incomplete Information in Branch Books
10. Foreign Branches
11. Accounting for Foreign Branches
12. Techniques for Foreign Currency Translation
13. Change in Classification

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1. INTRODUCTION

A branch can be described as any establishment carrying on either the same or substantially the same activity as that carried on by head office of the company. It must also be noted that the concept of a branch means existence of a head office; for there can be no branch without a head office - the principal place of business. Branch offices are of a great utility in the sense that they allow business to be expanded closer to the clients and hence they facilitate face to face interaction with customers.

 

From the accounting point of view, branches may be classified as follows:

• Inland Branches which can be further classified as:

1. Independent Branches which maintain independent accounting records
2. Dependent Branches for which whole accounting records are kept at Head Office

• Foreign Branches

Branch: Establishment at location different from Head Office to carry either same or substantially same activity as carried on by Head Office

Department: Division of a large organization dealing with a various kind of activity at the same location.

Let’s take an example of a CA Firm working in the field of Auditing, Taxation and Finance having office at Mumbai, Chennai and Delhi practicing such fields. The CA firm has various branches in different cities, i.e., Mumbai, Chennai and Delhi, also it has various department of Auditing, Taxation and Finance at one particular branch (location).

 

Basis of distinction	Branch Accounts	Departmental Accounts
Maintenance of accounts	Branch accounts may be maintained either at branch or at head office.	Departmental accounts are maintained at one place only.
Apportionment of common expenses	As expenses in respect of each branch can be identified, so the apportionment problem never arises.	Common expenses are distributed among the departments concerned on some equitable basis considered suitable in the case.
Reconciliation	Reconciliation of head office and branch accounts is necessary in case of Branches maintaining independent accounting records at the end of the accounting year.	Such problem never arises.
Conversion of foreign currency figures	At the time of finalization of accounts, conversion of figures of foreign branch is necessary.	Such arises. problem never

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3. DEPENDENT BRANCHES

When the business policies and the administration of a branch are wholly controlled by the head office and its accounts also are maintained by it, the branch is described as Dependent branch. Branch accounts, in such a case, are maintained at the head office out of reports and returns received from the branch. Some of the significant types of branches that are operated in this manner are described below:

1. A branch set up merely for booking orders that are executed by the head office. Such a branch only transmits orders to the head office;
2. A branch established at a commercial center for the sale of goods supplied by the head office, and under its direction all collections are made by the H.O.; and
3. A branch for the retail sale of goods, supplied by the head office.

Accounting in the case of first two types is simple. Only a record of expenses incurred at the branch has to be maintained.

But however, a retail branch is essentially a sale agency that principally sells goods supplied by the head office for cash and, if so authorized, also on credit to approved customers. Generally, cash collected is deposited into a local bank to the credit of the head office and the head office issues cheques or transfers funds thereon for meeting the expenses of the branch. In addition, the Branch Manager is provided with a ‘float’ for petty expenses which is replenished from time to time on an imprest basis. If, however, the branch also sells certain lines of goods, directly purchased by it, the branch retains a part of the sale proceeds to pay for the goods so purchased.

 

Goods may be invoiced to branches

1. at cost; or
2. at selling price; or
3. in case of retail branches, at wholesale price.

Selling price method is adopted where the goods would be sold at a fixed price by the branch. It is suitable for dealers in tea, petrol, ghee, etc. In this way, greater control can be exercised over the working of a branch in as much as that the branch balance in the head office books would always be composed of the value of unsold stock at the branch and remittances or goods in transit.

 

Dependent branch does not maintain a complete record of its transactions. The Head office may maintain accounts of dependent branches in any of the following methods:

 

If goods are invoiced to the branch at cost, the trading results of branch can be ascertained by following any of the three methods: (i) Debtors Method, (ii)Stock and Debtors method, (iii) Trading and Profit and Loss Account (Final Accounts) Method.

For finding out the trading results of branch, it is assumed that the branch is an entity separate from the head office. On this basis, a Branch Account is stated in the head office books to which the price of goods or services provided or expenses paid out are debited and correspondingly, the value of benefits and cash received from the branch are credited.

Debtors method This method of accounting is suitable for small sized branches. Under this method, separate branch account is maintained for each branch to compute profit or loss made by each branch. Various accounting adjustments to respective branch account are as follows:

• The opening balance of stock, debtors (if any), petty cash (if any), are debited to the Branch Account; the cost of goods sent to branch as well as any direct purchases made by branch (for which Head Office makes the payment), expenses of the branch paid by the head office, e.g., salaries, rent, insurance, etc., are also debited to it.
• Conversely, amounts remitted by the branch and the cost of goods returned by the branch are credited.
• At the end of the year, the value of unsold stock, the total of customers’ balances outstanding and that of petty cash are brought into the branch account on the credit side.
• Accordingly, the branch account will reveal profit or loss; Debit ‘balance’ will be the loss suffered by the working of the branch and vice versa.

If the branch is allowed to make small purchases of goods locally as well as to incur expenses out of its cash receipts, it will be necessary for the branch to supply to the head office a copy of the Cash Account, showing details of cash collections and disbursements. To illustrate the various entries which are made in the Branch Account, the proforma of a Branch Account is shown below:

 

To Balance b/d   Cash   Stock   Debtors   Petty Cash   Fixed Assets  Prepaid Expenses To Goods sent to Branch To Bank A/c   Salaries   Rent Sundry Expenses To Profit & Loss A/c—Profit (if credit side is larger)	By Bank A/c (Cash remitted) By Return to H.O. By Balance c/d   Cash   Stock   Debtors   Petty Cash   Fixed Assets   Prepaid Expenses   By Profit and Loss A/c—Loss  (if debit side is larger)

1. Having credited the Branch Account by the actual cash received from debtors, it would be incorrect to debit the Branch Account, in respect of discount or allowances to debtors.
2. The accuracy of the trading results as disclosed by the Branch Account, so maintained, if considered necessary, can be proved by preparing a Memorandum Branch Trading and Profit & Loss Account, in the usual way, from the balances of various items of income and expenses contained in the Branch Account.

Whenever, goods sent to branch are invoiced at selling price, certain considerations need to be kept in mind such as:

1. It would be obvious that, if Branch Account is debited with the sales price of goods and subsequent to the debit being raised there is a change in the sale price, the amount of debit either has to be increased or reduced on a consideration of the quantity of unsold stock that was there at the branch at the time the change took place. Such an adjustment will be necessary as often as the change in sale price occurs.
2. Moreover, the amount of anticipatory or unrealized profit, included in the value of unsold stock with the branch at the close of the year will have to be eliminated before the accounts of the branch are incorporated with that of the head office. This will be done by creating a reserve.

It may also be necessary to adjust the value of closing stock on account of the physical losses of stock due to either pilferage or wastages which may have occurred during the year. This adjustment is made by debiting the cost of such goods to Goods Lost Account and the amount of loading (included in the lost goods), to the Branch Adjustment Account.

The three different methods that are usually adopted for maintaining accounts on this basis are described below:

Under this method, when goods are invoiced at selling price, one additional account i.e. ‘Branch Adjustment account’ is also prepared in addition to all the accounts which are maintained on cost basis. (Refer para 5.1)

• When goods are invoiced at selling price, the following points should be kept in mind under this method:

Transaction	Accounts debited	Accounts credited
Sale price of the goods sent from H.O. to the Branch	Branch  Stock  A/c  (at selling price)	Goods sent to Branches A/c with cost of the goods sent. Branch Adjustment A/c(with the loading i.e., Difference between the selling and cost price).
Return of goods By the Branch to H.O.	Goods sent to Branch A/c  (with  the cost of goods returned).  BranchAdjustment A/c (with the loading)	Branch Stock A/c
Cash sales at the Branch	Cash/Bank A/c	Branch Stock A/c
Credit Sales at the Branch	Branch Debtors A/c	Branch Stock A/c
Goods returned to Branch by customers	Branch Stock A/c	Branch Debtors A/c (at selling price)
Goods lost in Transit or stolen	Goods Lost in Transit A/c or Goods Stolen A/c (with cost of the goods) BranchAdjustment A/c (with the loading)	Branch Stock A/c

The balance in the Branch Stock Account at the close of the year normally should be equal to the unsold stock at the Branch valued at sale price. But quite often the value of stock actually held at the branch is either more or less than the balance of the Branch Stock Account. In that event, as discussed earlier, it will be necessary that the balance in the Branch Stock Account is increased or reduced by debit or credit to Goods Lost Account (at cost price of goods) and Branch Adjustment Account (with the loading). The Stock Account at selling price, thus reveals loss of stock (or surplus) and serves as a check on the branch in this respect.

The discrepancy in the amount of balance in the Branch Stock Account and the value of stock actually in hand, valued at sale price, may be the result of one or more of the under-mentioned factors:

• An error in applying the percentage of loading.
• Goods having been sold either below or above the established selling price.
• A Commission to adjust returns or allowances.
• Physical loss of stock due to natural causes or pilferage.
• Errors in Stock-taking.

For example, the balance brought down in the Branch Stock Account is ` 100 in excess of the value of stock actually held by the branch when the goods were invoiced by the head office to the branch at 25% above cost and the discrepancy is either due to pilferage or loss by fire, the actual loss to the firm would be ` 80, since 20% of the invoice (same as 25% above cost) price would represent the element of profit. The adjusting entry in such a case would be:

Particulars	Dr. Amount	Cr. Amount
Goods Lost A/c         Dr.	80
Branch Adjustment A/c          Dr.	20
To Branch Stock A/c		100

If on the other hand, a part of the sale proceeds has been misappropriated, then in that case Loss by Theft A/c would be debited, rest of the entry being same.

Rebates and allowances allowed to customers debited to P&L A/c & credited to debtors A/c.

In the Goods Sent to Branch Account, the cost of the goods sent out to a branch for sale is credited by debiting Branch Stock Account. Conversely, the cost of goods returned by the branch is debited to this account. As such the balance in the account at the end of the year will be the cost of goods sent to the branch; therefore, it will be transferred either to the Trading Account or to Purchases Account of the head office.

The amount of profit anticipated on sale of goods sent to the branch is credited to the Branch Adjustment Account and conversely, the amount of profit not realized in respect of goods returned by the branch to head office or that in respect to stock remaining unsold with the branch at the close of the year is debited to Branch Adjustment Account. The balance in this account, at the end of year thus will consist of the amount of Gross Profit earned on sale by the branch. On that account, it will be transferred to the Branch Profit and Loss Account.

The balance in the Branch Stock account would be at the sale price; therefore, it would be necessary to eliminate the element of profit included in such closing stock. This is done by creating a reserve against unrealized profit, by debiting the Branch Adjustment Account and crediting Stock Reserve Account with an amount equal to the difference in the cost and selling price of unsold stock. Sometimes instead of opening a separate account in respect of the reserve, the amount of the difference is credited to Branch Stock Account. In that case, the credited balance of such a reserve is also carried forward separately, along with the debit balance in the Branch Stock Account; the difference between the two would be the value of stock at cost. In either case, the credit balance will be deducted out of the value of closing stock for the purpose of disclosure in the balance sheet, so that the stock is shown at cost.

An Alternative method: Where the gross profit of each branch is not required to be ascertained separately, although the selling price is uniform, the amount of goods sent to the branch is recorded only in two accounts namely - Branch Stock Account and Goods Sent to Branch A/c.

In this method, at the end of the year the Branch Stock Account is closed by transfer of the balance representing the value of closing stock, at sale price, to the Goods Sent to Branch Account. This has the effect of altogether eliminating from the books the value of stock at the branch. The balance of Goods sent to Branch Account is afterwards transferred to the Trading Account representing the net sale price of goods sold at the branch. In that case, the value of closing stock at the branch at cost will be subsequently introduced in the Trading Account together with that of closing stock at the head office.

Under this method, the principal accounts that will be maintained are:

• The Branch Account;
• The Goods Sent to Branch Account; and
• The Stock Reserve Account.

Entries in these accounts will be made in the following manner:

Transaction	Account Debited	Account Credited
Goods sent to Branch at selling price	Branch A/c	Goods Sent to Branch A/c
'Loading' being the difference between selling price and cost of goods	Goods Sent to Branch A/c	Branch A/c
Returns to H.O. at selling price	Goods Sent to Branch A/c	Branch A/c
‘Loading’ in respect of goods returned to H.O.	Branch A/c	Goods Sent to Branch A/c
‘Loading’ included in the opening stock to reduce it	Stock Reserve A/c	Branch A/c
Closing stock at selling price	Branch Stock A/c	Branch A/c
‘Loading’ included in closing stock to reduce it to cost	Branch A/c	Stock Reserve A/c

It will be observed that entries in the Branch Account in respect of goods sent to a branch or returned by it, as well as those for the opening and closing stock, will be at selling price. In consequence, the Branch Account is maintained at selling price.

Hence, the Branch Account will not correctly show the trading profit of the Branch unless these amounts are adjusted to cost. Such an adjustment is effected by making contra entries in ‘Goods Sent to Branch A/c’ and ‘Stock Reserve Account’. In respect of closing stock at branch for the purpose of disclosure in the Balance Sheet, the credit balance in the ‘Stock Reserve Account’ at the end of the year will be deducted from the value of the closing stock, so as to reduce it to its cost; it will be carried forward as a separate balance to the following year, for being transferred to the credit of the Branch Account.

All items of memorandum Branch Trading and Profit and Loss Account are to be converted into cost price if the goods are invoiced to branch at selling price. Other points will remain same as already discussed in Para 5.1 for this method if goods are invoiced at cost.

Under this method, the Head Office (particularly, the manufacturing concern) supplies goods to its retail branches at wholesale price which is cost plus wholesale profit.

Profit of branch = Sale proceeds at shop - wholesale price of the goods sold.

For this purpose, it is assumed that Manufacturer would always be able to sell the goods on wholesale terms thereby Manufacturer profit = Wholesale price - Cost.

Many concerns, therefore, invoice goods to such shops at wholesale price and determine profit or loss on sale of goods on this basis.

Branch Stock Account or the Trading Account is debited with:

1. the value of opening stock at the Branch; and
2. price of goods sent during the year at wholesale price.

It is credited by:

1. sales effected at the shop; and
2. closing stock of goods valued at wholesale price.

The value of goods lost due to accident, theft etc. also is credited to the Branch Stock Account or Trading Account calculated at the wholesale price. At this stage, the Branch Stock or Trading Account will reveal the amount of gross profit (or loss). It is transferred to the Branch Profit and Loss Account. On further being debited with the expenses incurred at the shop and the wholesale price of goods lost, the Branch Profit and Loss Account will disclose the net profit (or loss) at the shop.

Since the closing stock at the branch has to be valued at wholesale price, it would be necessary to create a stock reserve equal to the difference between its wholesale price and its cost (to the head office) by debiting the amount in the Head Office Profit and Loss Account. This Stock Reserve is carried forward to the next year and then transferred to the credit of the (Head Office) Profit and Loss Account.

When the size of the business is big, it is desirable that the branch maintains complete records of its transactions. These branches are called independent branches and each independent branch maintains comprehensive account books for recording their transactions; therefore, a separate trial balance of each branch can be prepared. The head office maintains one ledger account for each such branch, wherein all transactions between the head office and the branches are recorded.

Salient features of accounting system of an independent branch are as follows:

1. Branch maintains its entire books of account under double entry system.
2. Branch opens in its books a Head Office account to record all transactions that take place between Head Office and branch. The Head Office maintains a Branch account to record these transactions.
3. Branch prepares its Trial Balance, Trading and profit and loss Account at the end of the accounting period and sends copies of these statements to Head Office for incorporation.
4. After receiving the final statements from branch, Head Office reconciles between the two – Branch account in Head Office books and Head Office account in Branch books.
5. Head office passes necessary journal entries to incorporate branch trial balance in its books.

The Head Office Account in branch books and Branch Account in head office books is maintained respectively.

Transactions	Head Office Books	Branch Books
Dispatch of goods to branch by H.O.	Branch A/c   To Good sent to Branch A/c	Goods received from H.O. A/c   To Head Office A/c
When goods are returned by the Branch to H.O.	Goods sent to Branch A/c   To Branch A/c	Head Office A/c   To Goods received from H.O. A/c
Branch Expenses are paid by the Branch	No Entry	Expenses A/c   To Bank or Cash A/c
Branch Expenses paid by H.O.	Branch A/c   To Bank or Cash A/c	Expenses A/c   To Head Office A/c
Sales effected by the branch	No Entry	Cash or Debtors A/c   To Sale A/c
Outside purchases made by the branch	No Entry	Purchases A/c   To Bank or Creditors A/c
Collection from Debtors of the Branch recd. by H.O.	Cash or Bank A/c   To Branch A/c	Head office A/c   To Sundry Debtors A/c
Payment by H.O. for purchase made by Branch	Branch A/c   To Bank A/c	Purchases or Sundry Creditors A/c   To Head Office A/c
Purchase of Asset by Branch	No Entry	Sundry Assets   To Bank or Liability
Asset purchased by the Branch but Asset A/c retained at H.O books	Branch Asset A/c   To Branch A/c	Head office   To Bank or Liability A/c
Depreciation (on above)	Branch A/c   To Branch Asset A/c	Depreciation A/c   To Head Office A/c
Remittance of funds by H.O. to Branch	Branch A/c   To Bank A/c	Bank A/c   To Head Office A/c
Remittance of funds by Branch to H.O.	Bank A/c   To Branch A/c	Head Office A/c   To Bank A/c
Transfer of goods from one Branch to another branch	Branch A/c (Recipient) A/c   To Supplying Branch A/c	Supplying Branch H.O. A/c  To Goods sent to H.O. A/c Recepient Branch Goods Received from H.O. A/c   To Head Office A/c

Students may find a few further practical situations and it is hoped that they can pass entries on the basis of accounting principles explained above.

The final result of these adjustments will be that so far as the Head Office is concerned, the branch will be looked upon either as a debtor or creditor, as a debtor if the amount of its assets is in excess of its liabilities and as a creditor if the position is reverse.

A debit balance in the Branch Account should always be equal to the net assets at the branch. The important thing to remember, when independent sets of accounts are maintained, is that the branch and head office books are connected with each other only through the medium of the Branch and the Head Office Account which are converse of each other. Also, when the accounts of branch and head office are consolidated, both the Branch and Head Office Accounts will be eliminated.

If the branch and the head office accounts, converse of each other, do not tally, these must be reconciled before the preparation of the final accounts of the concern as a whole.

 

 

For example, if Head Office has sent goods worth ` 50,000 but the branch has received till the closing date goods only ` 40,000, then the branch should treat ` 10,000 as goods in transit and should pass the following entry :

	Dr. Amount	Cr. Amount
Goods in transit A/c	10,000
To Head Office A/c		10,000

However, there will be no entry in Head office books being the point where the event has been recorded in full, hence no further entries in Head office books.

Following are the possible reasons for the disagreement between Branch A/c in Head office books and Head office A/c in Branch books on the closing date:

• Goods dispatched by the Head Office not received by the branch. These goods may be in transit or loss in transit.
• Goods returned by the branch to Head Office may have been received by the H.O. Again, these goods may be in transit or lost in transit.
• Amount remitted by Head Office to branch or vice versa remaining in transit on the closing date.
• Receipt of income or payment or expenses relating to the Branch transacted directly by the head office or vice versa, hence not recorded at the respective ends wherein they are normally to be recorded.

Important Points to be noted:

1. the balance of Head Office A/c in Branch books and Branch A/c in Head Office books have tallied.
2. Adjustment are made only at the point:
   Where the recording has been omitted, and
   Other than the point where action has already been effected.

Inter-branch transactions (i.e. transaction between two branches) are usually adjusted as if they were entered into only with the head office. It is a very convenient method of treating such transaction especially where the number of branches are large.

Often the accounts of fixed assets of a branch are kept in the head office books; in such a case, at the end of the year, the amount of depreciation on the assets is debited to the branch concerned by recording the following entry by head office:

Branch Account Dr.

  To Branch Asset Account

 

The branch will pass the following entry:

Depreciation Account Dr.

  To Head Office Account

Usually the head office devotes considerable time in attending to the affairs of the branch; on that account, it may decide to raise a charge against the branch in respect of the cost of such time. In such a case the amount is debited to the branch (being receivable from branch) and is credited to appropriate expense head such as Salaries Accounts, General Charges Account, Entertainment Account etc (i.e. reducing the expense in head office books). The branch credits the H.O. Account and debits Expenses Account.

The method that will be adopted for incorporating the trading result of the branch with that of the head office would depend on whether it is desired to prepare

1. Standalone P&L & Balance Sheet for each Branch, or
2. Consolidated statement of Branch & H.O.

Amount of P&L is shown by Branch & is transfer to H.O. in Branch books & converse entry is passed in H.O. Books as:

Branch A/c Dr.

  To Profit & Loss A/c

In such a case, not only P&L but also separate Balance Sheet for Branch & H.O. is to be prepared. The Branch Balance Sheet would show the amount advanced by H.O. to it as "Capital." In H.O. Books such amount would be shown as "Advance to Branch"

Individual balances of all the revenue accounts would be separately transferred to the Head Office Account by debit or credit in the branch books and the converse entries would be passed in the head office books. The effect thereof will be similar to the amount of net profit or loss of the branch having been transferred since it would be composed of the balances that have been transferred. In case it is also desired that consolidated balance sheet of the branch and the head office should be prepared, it will also be necessary to transfer the balance of assets and liabilities of the branch to the head office. The adjusting entries that would be passed in this respect in the books of branch are shown below:

(a) Head Office Account Dr.

         To Asset (individual) Account

(b) (Individual) Liability Account Dr.
         To Head Office Account

Converse entries are passed in the head office books.

 

It is obvious that after afore-mentioned entries have been passed, the Branch Account in the Head Office books and Head Office Account in the branch books will be closed and it will be necessary to restart them at the beginning of the next year.

In consequence, at the beginning of the following year, the under-mentioned entry is recorded by the branch:

Asset Account (In Detail) Dr.

   To Liability Accounts (In Detail)

   To H.O. Account (The difference between assets and liabilities)

   

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9. INCOMPLETE INFORMATION IN BRANCH BOOKS

If it is desired that profitability of the branch should be kept secret from the branch staff, the head office would hold back some key information from the branch, e.g., amount of opening stock, cost of goods sent to the branch, etc. The head office, in such a case would maintain a record of goods sent to the branch by passing the entry:

Goods Supplied to the Branch Account Dr.

   To Purchases Account

 

The value of the closing stock will also be adjusted only in head office books.

In such a case, for closing its books at the end of the year, the branch will simply transfer various revenue accounts to the head office without drawing up a Trading and Profit & Loss Account.

On that basis, supplemented by the record of transactions maintained at the head office, it will be possible to construct the Trading and Profit & Loss Account of the branch.

Foreign branches generally maintain independent and complete record of business transacted by them in currency of the country in which they operate. Thus, problems of incorporating balances of foreign branches relate mainly to translation of foreign currency into Indian rupees. This is because exchange rate of Indian rupee is not stable in relation to foreign currencies due to international demand and supply effects on various currencies. The accounting principles which apply to inland branches also apply to a foreign branch after converting the trial balance of the foreign branch in the Indian currency.

For the purpose of accounting, AS 11 (revised 2003) classifies the foreign branches may be classified into two types:

• Integral Foreign Operation;
• Non- Integral Foreign Operation.

Let us discuss these two types of foreign branches in detail.

 

It is a foreign operation, the activities of which are an integral part of those of the reporting enterprise. The business of IFO is carried on as if it were an extension of the reporting enterprise’s operations. For example, sale of goods imported from the reporting enterprise and remittance of proceeds to the reporting enterprise.

It is a foreign operation that is not an Integral Foreign Operation. The business of a NFO is carried on in a substantially independent way by accumulating cash and other monetary items, incurring expenses, generating income and arranging borrowing in its local currency. An NFO may also enter into transactions in foreign currencies, including transactions in the reporting currency. An example of NFO may be production in a foreign currency out of the resources available in such country independent of the reporting enterprise.

The following are the indicators of Non- Integral Foreign Operation-

• Control by reporting enterprises - While the reporting enterprise may control the foreign operation, the activities of foreign operation are carried independently without much dependence on reporting enterprise.
• Transactions with the reporting enterprises are not a high proportion of the foreign operation’s activities.
• Activities of foreign operation are mainly financed by its operations or from local borrowings. In other words, it raises finance independently and is in no way dependent on reporting enterprises.
• Foreign operation sales are mainly in currencies other than reporting currency.
• All the expenses by foreign operations are primarily paid in local currency, not in the reporting currency.
• Day-to-day cash flow of the reporting enterprises is independent of the foreign enterprises cash flows.
• Sales prices of the foreign enterprises are not affected by the day-to-day changes in exchange rate of the reporting currency of the foreign operation.
• There is an active sales market for the foreign operation product.

 

The above are only indicators and not decisive/conclusive factors to classify the foreign operations as non-integral, much will depend on factual information, situations of the particular case and, therefore, judgment is necessary to determine the appropriate classification.

Controversies may arise in deciding the foreign branches of the enterprises into integral or non-integral. However, there may not be any controversy that subsidiary associates and joint ventures are non-integral foreign operation.

In case of branches classified as independent for the purpose of accounting are generally classified as non-integral foreign operations.

Following are the standard recommendations for foreign currency translation:

(1) All transactions of IFO be translated at the rate prevailing on the date of transaction. This will require date wise details of the transaction entered by that operation together with the rates. Weekly or monthly average rate is permitted if there are no significant variations in the rate.

(2) Translation at the balance sheet date-

1. Monetary items at closing rate;
2. Non-monetary items: The cost and depreciation of the tangible fixed assets is translated using the exchange rate at the date of purchase of the asset if asset is carried at cost. If tangible fixed asset is carried at fair value, translation should be done using the rate existed on the date of the valuation.
3. The cost of inventories is translated at the exchange rates that existed when the cost of inventory was incurred and realizable value is translated applying exchange rate when realizable value is determined which is generally closing rate.
4. Exchange difference arising on the translation of the financial statement of integral foreign operation should be charged to profit and loss account.

Accounts of non-integral foreign operation are translated using the following principles:

• Balance sheet items i.e. Assets and Liabilities both monetary and non- monetary – apply closing exchange rate.
• Items of income and expenses – At actual exchange rates on the date of transactions. However, accounting standard allows average rate subject to materiality.
• Resulting exchange rate difference should be accumulated in a “foreign currency translation reserve” until the disposal of “net investment in non- integral foreign operation”.

Items	Integral Foreign Operations	Non Integral Foreign Operations
Monetary Items (Cash, Bank Balance, Debtor, Creditor, Loans, Bills receivable, Bills Payable)	Closing rate	Closing rate
Non-Monetary Items (Fixed Assets)	Rate on date of purchase	Closing Rate
Inventory	Generally, closing rate (but if rate on the date of purchase of inventory is available, then that rate)	Closing Rate
Profit and Loss items (revenue items)	Average rate (but if rate on the date of transaction is available, then that rate)	Average rate (but if rate on the date of transaction is available, then that rate)
Exchange Difference	Charge to P&L account.	Accumulated in Foreign Currency Translation reserve.

When there is a change in classification, accounting treatment is as under-

1. Translation procedure applicable to non-integral shall be followed from the date of change.
2. Exchange difference arising on the translation of non-monetary assets at the date of re-classification is accumulated in foreign currency translation reserve.