Internal Audit

Audit Procedure for Foreign Exchange Gains & Losses: Insights

A Foreign exchange gain & loss occurs when a company buys or sells goods and services in a foreign currency, and that currency fluctuates from country to country. It can develop distinctions in the value of monetary assets and liabilities, which need to be recognized periodically. The distinction in the value of the foreign currency when it is converted into the local currency of the seller is called the exchange rate. If the value of the particular currency rate increases after the conversions, then the seller will make the gains, and if the decreases, then it will become a loss for the seller in the market; this is how the foreign exchange will affect the gains and losses.

How Foreign Exchange Affects Businesses?

Businesses that conduct business internationally are continuously affected by the foreign currency exchange rate. This applies to businesses that get international money repayments from consumers outside the company’s residence nation or those that send out repayments to vendors in a foreign currency. Since exchange rates are dynamic, it is feasible that the exchange rate will certainly vary from the moment the deal takes place to when it is paid and converted to the local currency. This is how businesses dealing in foreign markets are affected by the foreign currency exchange rate and face gains and losses.

Audit Procedure for Foreign Exchange Gains & Losses: Realized and Unrealized Transactions

Realized and Unrealized Foreign Exchange Gains or Losses from currency-related transactions differ depending on the transaction’s status at the end of the period of accounting. Unrealized gains and losses are the amount that the vendor anticipates gaining or losses while completing the transactions. The vendor computes the gains and losses that would certainly have been incurred if the individuals had paid the invoices at the end of the accounting period. When financial statements are prepared for a particular duration, the transactions are recorded as an unrealized gain or loss in the balance sheet of the company. Realized gains and losses are specified as the gains or losses on the transactions that have been completed, which implies that the individuals have already settled the amount before the end of the accounting period. In the case of realized gains or losses, the currency exchange rate gain or loss is recorded in the books of the income. However, the audit procedure for foreign exchange gains & losses helps in the evaluation of the realized and unrealized gains and losses to show financial accuracy in the business.

Legal Framework for Conducting the Audit Procedure for Foreign Exchange Gains & Losses

The following key legal framework conducting the audit procedure for foreign exchange gains & losses are stated below:

Directorate General of Foreign Trade (DGFT)

The DGFT is responsible for preparing and implementing India’s foreign trade policy. However, the audit procedure for foreign exchange gains & losses is performed by the auditor to review the compliance with DGFT regulations considering foreign exchange transactions, especially about the import and export procedures and verify the foreign exchange transaction adherence to DGFT guidelines.  

Reserve Bank of India (RBI)

The RBI regulated the foreign exchange transactions under the Foreign Exchange Management Act. However, the audit procedure for foreign exchange gains & losses is performed by the auditor to ensure compliance with the guidelines issued by the RBI related to foreign exchange transactions and review the documents related to foreign exchange transactions, such as certificates related to foreign remittance and bank realizations to confirm the compliance with RBI.

International Chamber of Commerce (ICC)

The ICC provides guidelines and rules for international trade so the audit procedure for foreign exchange gains & losses is performed by the auditor to help in assessing the validity and accuracy of foreign exchange transactions.

Foreign Exchange Vendors Association of India (FEDAI)

The FEDAI is an association for banks to deal in foreign exchange in India and promote ethical conduct in the global markets. The auditor refers to the FEDAI guidelines to evaluate the execution and recording of foreign exchange by banks.

Export Credit Guarantee Corporation (ECGC)

The audit procedure for foreign exchange gains & losses is performed to review the impact of ECGC policies on foreign exchange transactions and concerns related to credit risk management and mitigate the strategies.

Ministry of Commerce

The Ministry of Commerce has control over the trade policies and regulations related to foreign exchange, so the audit procedure for foreign exchange gains & losses is performed to assess compliance with the trade-related regulations that affect the transactions of foreign exchange.

Foreign Exchange Management Act 1999 (FEMA)

It is a crucial act that puts down the underlying policies controlling all international or foreign transactions. The Auditor must check the compliance with FEMA provisions when auditing the foreign exchange gains and losses. The auditor also verifies the foreign exchange transactions and reporting requirements.

Requirements of Audit Procedure for Foreign Exchanges Gains & Losses

The audit procedure for foreign exchange gains & losses is required to deal with the below given following concerns:

• Misclassification of foreign transactions.
• Inaccurate recording of foreign exchange gains and losses.
• Inadequate documents of foreign exchange transactions.
• Insufficient internal controls over the accounting of foreign exchange transactions in the business.
• Failing to adhere to IFRS or GAAP accounting standards.
• Absence of understanding of rates of foreign exchange and their impact on financial statements.
• Incorrect calculation of foreign exchange gains and losses.
• Poor disclosure of foreign exchange transactions.
• Misstatement or misrepresentation of foreign exchange gains or losses in the financial statements.

Relevancy of Audit Assertions While Performing Audit Procedures for Foreign Exchange Gains & Losses

The following audit assertions are relevant when performing audit procedures for foreign exchange gains and losses:

Valuation

The foreign exchange gains and losses have been recorded at the correct currency exchange rate and properly reflect the effect on the financial statements.

Classification

The audit procedure for foreign exchange gains & losses helps in the transactions that have been properly identified as hedging or non-hedging transactions.

Accuracy

The audit procedure for foreign exchange gains &losses is performed to check that the transactions have been properly and correctly reflect the financial positions of the company.

Efficiency or Completeness

All foreign exchange gains and losses have been recorded and disclosed in the financial statements.

Presence or Existence

The audit procedure for foreign exchange gains & losses reviews that the foreign exchange transactions should exist and be recorded correctly in the financial statements.

Rights and Obligations

The company can have the rights to the foreign exchange gains and losses and the obligations to pay or get the amounts.

Cut-off

The foreign exchange gains and losses have been recorded in the correct period.

Disclosure

All pertinent disclosure requirements regarding foreign exchange gains and losses have been met.

Uniformity or Consistency

The accounting treatments of foreign exchange gains and losses are uniform with previous periods.

Steps involved in Testing while Performing Audit Procedures for Foreign Exchange Gains & Losses

Testing is a crucial component of the audit procedure for foreign exchange gains & losses, which involves examining the procedure and controls bordering the recording, valuation and reporting of foreign exchange transactions. The goal of this examination is to get an understanding of the business procedures and controls to identify any potential risks and control the weaknesses in the businesses. The following steps involved in performing testing while conducting audit procedures for foreign exchange gains & losses are given below:

Evaluation of the Accounting Policies and Procedures

The auditor examines the entity’s accounting policies and procedures associated with foreign exchange gains and losses to ensure that they are suitable and also consistent with GAAP.

Identification of the Transactions of Foreign Exchange

The auditor must determine the essential foreign exchange transactions that are most likely to cause gains or losses. This might consist of transactions including foreign currency and other financial instruments or derivatives.

Understanding of the Process

The auditor must recognize the procedure through which the entity records and reports foreign exchange gains and losses. This might consist of comprehending exactly how currency exchange rates are figured out just how foreign exchange gains and losses are identified and exactly how they are included in the financial statements.

Examination of the Controls

The auditor must examine the controls in place to ensure that foreign exchange gains and losses are accurately recorded and reported. This might consist of checking the accuracy of currency exchange rate computations, checking the efficiency, completeness, and accuracy of the accounting records, and testing the accuracy of the financial statements.

Substantive Audit Procedures for Foreign Exchange Gains & Losses

The substantive audit procedure is a crucial aspect of auditing foreign exchange gains and losses. They are created to provide evidence about the completeness, accuracy and credibility of the financial information being audited. The objective of a substantive audit procedure is to identify possible misstatements or mistakes in the financial information. Below are substantive audit procedures that can be performed when performing audit procedures for foreign exchange gains & losses:

Evaluation of Transactions Processing

This procedure includes reviewing the transactions processed in the foreign exchange accounts to ensure that all transactions have been recorded accurately.

Evaluation of Currency Exchange Rate Information

This treatment entails examining the currency exchange rate information utilized to convert foreign currency amounts into functional currency.

Evaluation of Currency Exchange Rate Fluctuations

This procedure examines the currency exchange rate changes over the duration being audited to identify any kind of substantial modifications that might have affected the financial information.

Evaluation of Journal Entries

This procedure includes evaluating the journal entries that have been recorded in the Foreign exchange accounts to ensure that they are accurate and complete.

Evaluation of Supporting Documents

This procedure includes assessing the supporting documents for foreign exchange transactions.

Review of Contracts and Agreements

This procedure involves examining agreements and contracts that might influence foreign exchange gains and losses to ensure that it is accurate and complete.

Evaluation of Disclosure

The procedures include examining the disclosures about foreign exchange gains and losses to make sure that they are precise and complete.

Evaluation of Internal Controls

This procedure involves examining the internal controls connected to the foreign exchange accounts to ensure that they are effective and adequate.

Checklist for Audit Procedure for Foreign Exchange Gains & Losses

Below is the checklist for the audit procedure for foreign exchange gains & losses:

• Customer’s Business Environment
• Recognize the customer’s international operations.
• Evaluate the volume and complexity of foreign currency transactions.
• Determine risks of material misstatement associated with foreign exchange.
• Take into consideration exposure to currency fluctuations and control efficiency.
• Assess control over transaction initiations, permission, recording and reporting.
• Choose a sample of foreign exchange for testing.
• Confirm accuracy, efficiency and supporting documentation.
• Evaluation of the used exchange rates for foreign transactions.
• Analyze the presentation of gains and losses.
• Ensure compliance with accounting standards requirements.
• Verify the documentation supporting the audit procedure for the foreign exchange gains and losses.
• Identifies the issues with management.
• Keep thorough documents of audit procedures and findings.
• Formulate audit findings and results.
• Communicate deficiencies or weaknesses in controls to the business.

Pros for Performing Audit Procedure for Foreign Exchange Gains & Losses

Here are some benefits of performing the audit procedure for foreign exchange gains & losses:

Assurance of Accuracy

Audit procedures for foreign exchange gains & losses are accurately recorded and reported in the financial statements, giving investors or stakeholders reliable information concerning the company’s financial performance.

Compliance Verification

Auditors ensure compliance with accounting standards and regulatory requirements governing the treatment of foreign exchange transactions, decreasing the risk of non-compliance penalties and legal issues.

Risk Identification & Mitigation

The audit procedures for foreign exchange gains & losses help in identifying the potential risks with foreign exchange exposure are identified and evaluated. This makes it possible for the management to execute risk management strategies to mitigate currency-related risks.

Enhancing the Control Environment

The audit procedure for foreign exchange gains & losses entails reviewing internal controls about transactions of currency. These assists enhance the control environment, decreasing the chance of mistakes, scams and misstatements in financial reporting.

Increasing Investor’s Confidence

A thorough audit procedure for foreign exchange gains and losses improves investor’s confidence in the company’s financial statements. Investors can rely upon audited financial information when making financial investment choices, which results in increased trust and credibility.

Detection of Irregularities

Auditors are trained to determine abnormalities or irregularities in financial data consisting of those associated with foreign exchange transactions. Discovery of such abnormalities early can stop possible financial losses and reputational damages to the company.

Management Insights

The audit procedure provides useful understanding to monitor the efficiency of their foreign exchange risk management practices and the effectiveness of their procedures for recording and reporting currency transactions.

Boosted Decision-Making

Accurate and dependable information arising from the audit procedure for foreign exchange gains & losses by allowing monitoring to make informed decisions regarding currency management strategies, investment opportunities and expansion into international markets.

Transparency to Stakeholders

Audited financial statements with foreign exchange gains and losses provide transparency to stakeholders, consisting of investors, creditors and regulatory authorities, fostering trust and goodwill.  

Continuous Improvement

Audit procedure for foreign exchange gains & losses promotes a culture of continual improvements within the company. Management can utilize audit searching and suggestions to refine existing processes, enhance controls, and improve financial management practices.

Conclusion

In conclusion, audit procedure for foreign exchange gains & losses plays an essential role in ensuring transparency and accuracy in the reporting of the foreign financial transactions in the business. A thorough evaluation of foreign currency transactions, analysis of risk, and examination of internal controls, auditors supply guarantees to investors relating to the integrity of financial information. Additionally, the audit procedure helps with the identification of possible risks, boosts control environments and makes the management make informed decisions regarding the management of the strategies related to currency. Promoting compliance with accounting standards, increasing investors’ confidence, driving continuous improvements, and auditing foreign exchange gains and losses contribute to the maintenance of the financial health of the business in the global markets.  

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