Enterprises will be entering into forward exchange contract or similar financial instruments not for speculation or trading. but to establish how much of reporting currency is required for settling a foreign currency obligation on the date of transaction. for how much reporting currency will be available. that is will be received when foreign currency transaction is settled on the date of transaction.this forward exchange contract basically establishes how much reporting currency is required for setting a foreign currency transaction or how much reporting currency will be available when we settle a foreign currency transaction .
eg.1st March you are exporting goods worth 1 million dollar and payment is expected on 30th April - you will be getting this $1M but on 1st March when you have exported. when you have raised invoice the exchange rate was rupees Rs.62/$ so 1 million into Indian Rupees 62 you are expecting 62 million indian rupees. but the dollar remains same which is 1 million dollar. 1 million dollar X 62 which is the rate on the date of transaction but the question is on 30th April. what will be the exchange rate?. will it be the same Rs.62/$ so that you will get the same 62 million or will it be better than that say is it going to become 63 and are you going to get 63 million or on the negative side will it go down 61 so you get only 61 million?.
You don't want to put yourself into risk if you are getting. if u r getting 63M well and good but if you are going to get only 61 million then you are at loss. in order to avoid this. what you should do go and book a forward contract and Bank says they are ready to meet this transaction @ 62.5/$ now this spot rate is 62 bank is offering you 62.5 but it is possible on the date of settlement of transaction. exchange rate may be 63 in which case there is an opportunity loss for you. but thats not certain because on the same day it is also possible exchange rate can also become 61. now by going for this forward contract you are establishing how much reporting currency will be available on the date of settlement of transaction and in this case if you notice you recorded 62 million but what you are going to receive a 62.5 million or 62.5 million or 62 million you have a gain of 0.5 million right?
Now this gain can be income and if it is on the negative side it can be expense. But the point is it should be amortized over the life of the contract and in this case if you notice we are starting this on 1st March and ending on 30th April. in between you have 31st March which is your balance sheet date. we have to amortize say from 1st March to 31st March thats one month and 31st March to 30th April 1 month so totally 2 months. we have a gain of. 5 million which can be split into two 0.25 million And 25 million and this should be recognised in statement of profit and loss.