Foreign Exchange(An Audit Approach)

General Understanding on -

Foreign exchange is concerned with the settlement of international INDEBTEDNESS, the methods of effecting the settlements and the instruments used in this connection, and the variation in the rates of exchange at which settlement of international indebtedness is made.

Fundamentals of Foreign Exchange:

Every country has its own currency – distinctive unit of account; i.e BDT, USD, Rupee etc.

The conversion of one currency into another is made by the banks; and

These exchanges are effected by means of credit instruments i.e. Demand Draft, Mail Transfer etc.

 

Accounts maintained in banks -Nostro Account :

Nostro is a Latin word meaning “Ours”. A nostro account is referred to as a “Foreign currency account”. In the nostro account, the bank will show the foreign currency accounts of each transaction. When the bank makes purchase of foreign currency, the nostro account will be credited by foreign bank. When it makes a sale it will result in a debit in the nostro account. Applicable IAS 21: Foreign currency.

Vostro Account :The word “Vostro” means Yours. A vostro account is also called a “Local currency account”. Foreign banks maintain current accounts in domestic currency with local banks and such accounts are called vostro accounts.

DOCUMENTS USED IN FOREIGN TRADE COMMERCIAL INVOICES:

A commercial invoice is the SELLER’S BILL for the merchandise. It is drawn up by the seller on his business head and contains full details of the transaction. Including the full name and address of the consignee, quality, quantity, unit price and total price of the goods, reference of the L/C no etc.

CERTIFICATE OF ORIGIN: A certificate of origin IS A STATEMENT EVIDENCING THE ORIGIN OF THE GOODS and it is required in compliance with exchange control regulations in the IMPORTING country.

PACKING LIST: The EXPORTER must prepare a packing list showing, item by item, THE CONTENTS OF THE CONTAINERS OR CASES to enable the importer of the goods to check the shipment. It should give description of the goods, net weight and gross weight measurement etc.

QUALITY OR INSPECTION CERTIFICATE: This is a certificate declaring that the goods have been examined and found to be in accordance with the contract of sale BY A RECOGNIZED INDEPENDENT INSPECTION BODY.

BLACK LISTED CERTIFICATE: DUE TO STRAINED POLITICAL RELATIONS or any other reasons some countries DO NOT ALLOW TRANSACTIONS WITH SOME PARTICULAR COUNTRIES. These countries and the exporters are black listed.

MARINE INSURANCE: Marine insurance is a contract between the insurer and the insured whereby the former in consideration of the payment of premium from the latter, AGREES TO INDEMNIFY THE LATTER AGAINST LOSS incurred in respect of goods exposed to “Perils of the Sea” or to the particular peril insured against.

BILL OF LADING: The bill of lading is one of the most important documents in foreign trade. It is a DOCUMENT SIGNED BY THE MASTER OF THE SHIP OR SHIPPING COMPANY or its agents ACKNOWLEDGING RECEIPT OF SPECIFIED GOODS ON BOARD THE VESSEL FOR CARRIAGE which are deliverable to the consignee named in the bill.

BILL OF EXCHANGE: The bill of exchange is the most important and most widely used instrument in the international trade by which seller can obtain payment from the buyer for the invoiced value of goods. It is an UNCONDITIONAL ORDER IN WRITING ADDRESSED BY ONE PERSON TO ANOTHER, signed by the person giving it, requiring the person to whom it is addressed TO PAY ON DEMAND OR AT A FIXED OR DETERMINABLE FUTURE TIME A CERTAIN SUM OF MONEY.

BILL OF ENTRY: The IMPORTER of the goods is required to submit a “Bill of Entry” for home consumption or warehousing in the prescribed form at any time AFTER THE DELIVERY OF THE IMPORT MANIFEST. The bill of entry must contain the nature and value of all the goods mentioned in the bill of lading received by the importer from the seller.

MECHANISM OF LETTER OF CREDIT:

SCRUTINIZATION OF DOCUMENTS BY NEGOTIATING BANK :

Negotiating bank scrutinizes the documents carefully with letter of credit in the following manners:

1. The credit is in force and the last date of shipment and the negotiation has not expired.

2. Normally, the L/C gives details of the documents required. The banker must examine each and every document and see that all the documents refer solely to the specific shipment and the description of the goods shipped as given in the documents agrees with that provided in the L/C.

3. The invoice must be examined to see that it corresponds with the details of all other documents submitted under the bill, that it details the quantity and quality of goods described in L/C. The price stated in invoice should be the same as stipulated in the L/C.

4. In an insurance policy, the banker must ensure that is properly stamped and that it is made out and endorsed in conformity with the conditions laid down in the L/C

5. The banker must ensure that he receives a complete set of bills of lading. They must be endorsed as stipulated in credit. If they are to be “freight paid”, it must be clearly indicated on them.

6. Reimbursement clause is clear and does not violate Exchange Control Regulations, if any.

DISCREPANCIES IN SHIPPING DOCUMENTSThe discrepancies usually found in shipping documents are listed below, but this is not as EXHAUSTIVE OR EVEN COMPLETE LIST, as the discrepancies vary documents to documents-

OUTSTANDING AMOUNT OF EXPIRED LETTERS OF CREDIT (L/C) WERE NOT ADJUSTED.The Bank has to keep Provision @ 1% against the unadjusted amount It indicates lack of control over L/C management;It may weaken the credit management system of the branches.

IMPORT LC VALUE OF SOME PARTIES EXCEEDED THE IRC LIMITThese instances indicate the weakness of credit management and increase the risk of non-recovery of investment;

IRREGULARITIES FOUND WHILE L/C OPENING LACK OF I.E MEMBER CERTIFICATE OF CHAMBER OF COMMERCE & INDUSTRIES ,TRADE LICENSE & TIN CERTIFICATE ETC. VIOLATION OF FOREIGN EXCHANGE GUIDELINES;

L/CS WERE OPENED WITHOUT OBTAINING SUPPLIERS CREDIT REPORT – IT IS A VIOLATION OF THE BANGLADESH BANK GUIDELINES

OTHER RELATED OBSERVATIONS

Full set of bill of lading was not submitted;

Duplicate copies of EXP form was not submitted to BB

Bill of lading is not properly signed or submitted;

Invoice amount differs from that mentioned in the bill of exchange;

Insurance covers not as per terms of L/C;

Insurance policy is not properly stamped;

Packing list not as per the L/C;

Documents not properly endorsed in favor of the bank; and

No indication of “Freight paid” or “Freight payable at destination.

TYPES OF L/C :

REVOCABLE CREDIT: A revocable credit is one which can be amended or cancelled by the issuing banker at any time without prior notice to seller but before the authorized draft is presented for acceptance or payment.

IRREVOCABLE CREDIT: An “irrevocable” letter of credit contains an absolute undertaking on the part of the issuing bank to accept and pay the bills drawn upon. An irrevocable letter of credit cannot be revoked, amended or modified by the issuing bank without the concurrence of the beneficiary.

SIGHT OR PAYMENT CREDIT: When the credit stipulates that draft (bill of exchange) should be drawn under is on Documents against Payment (DP) terms involving payment to the beneficiary on presentation of documents. It is known as a “sight or payment credit”.

DEFERRED CREDIT: The term deferred means POSTPONE to a FUTURE PERIOD or date. When a credit does not require the payment the beneficiary immediately on presentation of the documents but after a specified period has elapsed, it is known as deferred credit payment.

BACK TO BACK L/C: A back to back credit is essentially a secondary credit opened by a bank on behalf of the beneficiary of the original credit, in favor of a supplier located inside or outside the original beneficiary’s country.

The two credits operate “Back-to-Back”, the one being issued on the security of the other. Thus, a “Back-to-Back” credit transaction involves two separate credits, wherein the beneficiary of the first credit becomes the applicant of the second credit.

PAYMENT AGAINST DOCUMENTS (PAD): When an L/C is established, bank accepts a liability. If shipment is made and shipping documents are submitted by the exporter in terms of L/C, it becomes obligatory for the bank to honor its commitment to pay the import bill.

When an import bill is received under a letter of credit, it is the duty of the opening bank to carefully examine the relative shipping documents. If the documents received are in order, the bank will lodge the shipping documents in their book and the debit entry originated in the books of reimbursement bank as “PAYMENT AGAINST DOCUMENTS (PAD)”.

Thus liability under the letter of credit is converted to bank’s advance. Normally outstanding under “PAD” should not take More Than 21 Days For Adjustment.

LOAN AGAINST IMPORTED MERCHANDISE (LIM):

When the importer request the bank for clearance of goods or fails for retirement of documents on payment, the liabilities under PAD are converted to LIM account and the overdue interest to date of transfer to LIM is charged and incorporated to LIM.

IMPORT TRUST RECEIPT (ITR)/LOAN AGAINST TRUST RECEIPT (LATR):

In the trust letter the importer acknowledges that the goods are held by him in trust for the bank and agrees to make over the sale proceeds to the bank. In the case of insolvency of the importer, the bank can repossess the goods. However, in practice, trust receipt does not secure the position of the bank to a significant extent. The risk are that:a) The importer may re-pledge the goods with another bank;b) The importer may sell the goods without remitting the amount into the bank.

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