Following on my previous post [Accounting For Foreign Currency Transactions and Operations]. Through this post we are going to learn about translation of a foreign operation, Disposal Of A Foreign Entity, and Disclosure For Foreign Currency Transaction.
When preparing group accounts, it is normal to deal with entities that utilize different currencies. The financial statements should be translated into the presentation currency.
Any goodwill and fair value adjustments are treated as assets and liabilities of the foreign entity and therefore are retranslated at each balance sheet date at the closing spot rate.
Exchange differences on intra-group items are recognized in profit or loss unless the difference arises on the retranslation of an entity’s net investment in a foreign operation when it is classified as equity.
Dividends paid in a foreign currency by a subsidiary to its parent company may lead to exchange differences in the parent’s financial statements and will not be eliminated on consolidation but recognized in profit or loss.
Case Example: An entity has a foreign subsidiary whose functional currency is the euro. The functional currency of the entity is the dollar. On January 1, 20X6, when the exchange rate was $1= €1.5 the entity loans the subsidiary $3 million. At December 31, 20X6, the loan has not been repaid and is regarded as part of the net investment in the foreign subsidiary, as settlement of the loan is not planned or likely to occur in the foreseeable future. The exchange rate at December 31, 20X6, is $1 = €2, and the average rate for the year was $1 = €1.75.
How this loan would be treated in the entity’s and group financial statements?
There is no exchange difference in the entity’s financial statements, as the loan has been made in dollars. In the foreign subsidiary’s financial statements, the loan is translated into its own functional currency (euro) at the rate of $1= €1.5, or €4.5 million as of January 1, 20X5. At year-end, the closing rate will be used to translate this loan. This will result in the loan being restated at €6 million ($3 million × 2), giving an exchange loss of €1.5 million, which will be shown in the subsidiary’s income statement.
In the group financial statements, this exchange loss will be translated at the average rate, as it is in the subsidiary’s income statement, giving a loss of ($1.5/1.75 million), or $857,000. This will be recognized in equity.
There will be a further exchange difference (gain) arising between the amount included in the subsidiary’s income statement at the average rate and at the closing rate: that is, $857,000 minus $750,000 (1.5 million euros/2), or $107,000.
Thus the overall exchange difference is $750,000. This will be recognized in equity. An alternative way of calculating this exchange loss follows. The loan at January 1, 20X6, is €4.5 million. On retranslation, this becomes $2.25 million at December 31, 20X6 (€4.5/2).The original loan was $3 million, so there is an exchange loss of ($3 – 2.25) million, or $0.75 million.
Disposal Of A Foreign Entity
When a foreign operation is disposed of, the cumulative amount of the exchange differences in equity relating to that foreign operation shall be recognized in profit or loss when the gain or loss on disposal is recognized.
Case Example: An entity has a 100% owned foreign subsidiary, which it carries at its original cost of $2 million. It sells the subsidiary on March 31, 20X7, for €5 million. As of March 31, 20X7, the balance on the exchange reserve was $300,000 credit. The functional currency of the entity is the dollar, and the exchange rate on March 31, 20X7, is $1 = €2. The net asset value of the subsidiary at the date of disposal was $2.4 million.
What is the treatment of the disposal of the foreign subsidiary?
The subsidiary is sold for €5 million /2 or $2.5 million. In the parent entity’s accounts, a gain of $0.5 million will be shown. ($2.5 – $2 million).
In the group financial statements, the cumulative exchange gain will have to be shown in profit or loss together with the gain on disposal. The gain on disposal is $(2.5 – 2.4) million, or $100,000, which is the difference between the sale proceeds and the net asset value of the subsidiary. To this is added the cumulative exchange gain of $300,000 to give a total gain of $400,000, which will be included in the group income statement.
Disclosure For Foreign Currency Transaction
An entity should disclose:
- The amount of exchange differences recognized in profit or loss but not differences arising on financial instruments measured at fair value through profit or loss in accordance with IAS 39
- Net exchange differences classified in a separate component of equity and a reconciliation of the amount of such exchange differences at the beginning and end of the period.
- When the presentation currency is different from the functional currency, disclosure of that fact together with the functional currency is required, and is the reason for using a different presentation currency
- Any change in the functional currency of either the reporting entity or significant foreign operation and the reasons for the change
When an entity presents its financial statements in a currency that is different from its functional currency, it may describe those financial statements as complying with International Financial Reporting Standards (IFRS) only if they comply with all the requirements of each applicable Standard and Interpretation.
If an entity displays its financial statements or other financial information in a currency that is different from either its functional or presentation currency or if the requirements just listed ARE NOT MET, then it should:
- Clearly identify the information as supplementary information to distinguish it from the information that complies with IFRS.
- Disclose the currency in which the supplementary information is displayed.
- Disclose the entity’s functional currency and the method of translation used to determine the supplementary information.