Foreign subsidiaries
A group whose subsidiary trades abroad has a practical problem before it has an accounting one: the subsidiary keeps its books in a currency the parent does not report in. Its assets, its liabilities, its revenue and its costs are all measured in a currency of their own. They cannot simply be added across.
This chapter deals with the two steps that follow. First the subsidiary's own financial statements are made correct in its own functional currency — which is the work of the IAS 21 chapter. Then those statements are translated into the group's presentation currency and consolidated in the ordinary way. Translation is the second step, and it is the only thing that is new here: every consolidation working you already know still applies, and the goodwill, non-controlling interest and group reserves calculations are unchanged in substance.
Overseas consolidation (IAS 21, groups): five points. The company on screen is called Bill, not Holly. The recording answers only part (b) — part (a) has no video. Two arithmetic slips are self-corrected. It rounds the exchange loss to $23m and reaches group reserves of $111.2m where this chapter prints $110.9m. It is right on the key point: the 130 is in dinars and must be divided by 4.3.
This recording predates IFRS 18 Presentation and Disclosure in Financial Statements, which replaces IAS 1 for accounting periods beginning on or after 1 January 2027. Where the recording’s statement of profit or loss differs from this chapter’s, the chapter governs. The subsidiary’s own statement of profit or loss must be recast into the IFRS 18 categories before it is translated.
1 Functional currency and presentation currency
An entity's functional currency is the currency of the primary economic environment in which it operates — the currency in which it earns and spends. An entity's presentation currency is the currency in which it chooses to present its financial statements. For a single company the two are usually the same. For a group with an overseas subsidiary they are not.
The subsidiary measures everything in its functional currency, including any transactions it entered into in yet another currency; how it does that is the subject of the chapter on IAS 21 The Effects of Changes in Foreign Exchange Rates. Nothing in this chapter starts until that work is finished.
The two steps
Make the subsidiary's own statements correct in its functional currency — settle its own foreign currency transactions, retranslate its monetary items at the closing rate, and take the resulting gains and losses to its profit or loss.
Translate those statements into the group's presentation currency, and consolidate.
Getting the order wrong is a real source of lost marks. A subsidiary's own exchange gains and losses belong in its profit or loss and are translated along with everything else; the exchange difference this chapter is about arises only at step 2, on consolidation, and is a different animal entirely.
2 The translation rules
There are only two of them.
What is being translated | At which rate | Why |
Every asset and every liability in the statement of financial position | Closing rate — the spot rate at the reporting date | The statement of financial position states what the group owns and owes at that date, so it is stated at that date's rate |
Every item of income and expense in the statement of profit or loss and other comprehensive income | Average rate for the period | Income and expenses arise throughout the period. Strictly each transaction is translated at the rate on its own date; the average rate is a practical approximation, permitted where rates have not fluctuated significantly |
Translate everything in the statement of financial position at the closing rate
Do not start dividing the subsidiary's assets into monetary and non-monetary items. That distinction belongs to step 1 — retranslating a company's own foreign currency balances into its own functional currency. At step 2 the whole statement of financial position, monetary and non-monetary alike, goes at the closing rate.
And there is the difficulty. The statement of financial position is translated at one rate, the profit that fed it at another, and the net assets at the start of the year at a third. The three cannot reconcile. The gap is the exchange difference on translating a foreign operation, and section 5 deals with it.
3 IFRS 18 and this chapter
4 The consolidation workings
The rule that governs all four workings is this: anything that belongs to the subsidiary is calculated in the subsidiary's functional currency and then translated at the closing rate. The only working done in the group's presentation currency is group retained earnings, because that is the parent's.
4.1 Net assets of the subsidiary — in the foreign currency
Exactly the working you already know — share capital, retained earnings, fair value adjustments, unrealised profit adjustments, at the reporting date and at acquisition, with the post-acquisition movement as the difference — but every figure in it is in the subsidiary's currency, and it is not translated at all. It is an input to the two workings below, both of which are also done in that currency.
4.2 Goodwill — in the foreign currency, then translated
Goodwill on the acquisition of an overseas subsidiary is an overseas asset. What it represents — the subsidiary's reputation, its customer base, its assembled workforce — is located where the subsidiary is. It is therefore calculated in the subsidiary's functional currency, from a consideration figure and a net assets figure both stated in that currency, and then translated into the presentation currency at the closing rate, like every other asset.
That has a consequence students often miss: because goodwill is retranslated at each reporting date, the goodwill figure in the consolidated statement of financial position changes from year to year even when goodwill is not impaired. The movement is part of the exchange difference in section 5.
Where the consideration is given in the parent's currency, translate it into the subsidiary's currency at the rate on the date of acquisition before putting it into the goodwill working.
4.3 Non-controlling interests — in the foreign currency, then translated
The non-controlling shareholders own shares in the overseas subsidiary. Their interest is therefore an interest in a foreign-currency entity, and the working is done in that currency: non-controlling interests at acquisition, plus their share of the post-acquisition movement in net assets, both in the subsidiary's currency — then translated at the closing rate.
4.4 Group retained earnings — in the presentation currency
This one is different, because most of it belongs to the parent. Build it in the group's presentation currency:
Group retained earnings | $ |
100% of the parent's retained earnings | X |
Add: the group's share of the subsidiary's post-acquisition retained earnings, translated at the closing rate | X |
Add / less: the exchange gain or loss on the parent's investment in the subsidiary | X/(X) |
Less: impairment of goodwill to date, and any other usual adjustments | (X) |
X |
The third line is the one that needs explaining. The parent recorded its investment in the subsidiary at the rate ruling on the date of acquisition. On consolidation that investment is cancelled against the subsidiary's net assets at acquisition and the goodwill — but those have been retranslated at the closing rate, and the investment has not. The difference is an exchange loss (where the foreign currency has weakened) or gain, and it is the parent's share of the exchange differences on translation. Section 5 shows how the two routes tie together.
5 The exchange difference on translating a foreign operation
Where it goes. The exchange difference arising on translating a foreign operation is recognised in other comprehensive income, not in profit or loss, and is accumulated in a separate component of equity — a translation reserve. It is not part of the group's trading result, and it is one of the items of other comprehensive income that is not reclassified to profit or loss unless and until the foreign operation is disposed of.
Where it comes from. Three places, and the standard working takes them one at a time:
Exchange difference on translation | $ | |
Opening net assets of the subsidiary | ||
at the opening rate | X | |
at the closing rate | X | |
X/(X) | ||
Profit for the year | ||
at the average rate | X | |
at the closing rate | X | |
X/(X) | ||
Goodwill | ||
at the opening rate | X | |
at the closing rate | X | |
X/(X) | ||
Exchange gain / (loss) on translation | X/(X) |
Read each pair as "what it was worth at the old rate, against what it is worth now". Where the foreign currency has weakened — more of it to the dollar at the year end than at the start — every pair produces a loss.
In the first year of ownership the "opening rate" is the rate at the acquisition date, and the opening net assets are the net assets at acquisition.
The cross-check worth doing
The first two lines of the working are just the movement in the subsidiary's net assets, taken the long way round. You can get the same figure in one line:
closing net assets at the closing rate, less opening net assets at the opening rate, less profit for the year at the average rate = the exchange difference on the net assets.
Add the goodwill difference and you have the total. It is worth doing, because it catches the two errors that matter — using the wrong rate on the profit, and forgetting the goodwill — and because rounding differences in a translated answer are unavoidable and this tells you which of two nearly-equal figures to trust.
How it is attributed. The exchange difference on the subsidiary's net assets belongs to both sets of owners and is split in the ownership ratio. The exchange difference on goodwill belongs only to the owners of the parent where the non-controlling interests are measured at the proportionate share of net assets, because on that policy no goodwill has been attributed to them. Where the non-controlling interests are measured at fair value they carry their share of the goodwill difference too.
6 Worked example
Overseas consolidation
Statements of profit or loss for the year ended 31 December 20X5
Holly | Ivy | |
$m | Dinars m | |
Revenue | 247 | 1,664 |
Cost of sales | (181) | (1,288) |
Gross profit | 66 | 376 |
Operating expenses | (29) | (170) |
Operating profit | 37 | 206 |
Profit before financing and income taxes | 37 | 206 |
Finance costs | (8) | (40) |
Profit before tax | 29 | 166 |
Income tax expense | (5) | (36) |
Profit for the year | 24 | 130 |
Neither company holds an investment that produces investing-category income of its own, so in each column profit before financing and income taxes is the same figure as operating profit. Neither company recognised any other comprehensive income of its own.
Statements of financial position at 31 December 20X5
Holly | Ivy | |
$m | Dinars m | |
Non-current assets | 200 | 500 |
Investment in Ivy | 200 | – |
Current assets | 90 | 390 |
Total assets | 490 | 890 |
Share capital | 250 | 350 |
Retained earnings | 110 | 280 |
Non-current liabilities | 80 | 65 |
Current liabilities | 50 | 195 |
Total equity and liabilities | 490 | 890 |
The following information is relevant to the preparation of the consolidated financial statements of Holly.
On 1 January 20X5, Holly acquired 80% of the equity share capital of Ivy for a consideration of Dinars 760 million, when Ivy's retained earnings were Dinars 150 million and the fair value of its net assets was Dinars 600 million. Any difference between the fair value of the net assets and their book value is due to non-depreciable land.
The non-controlling interests are measured at their proportionate share of the subsidiary's net assets.
Ivy paid no dividend during the year, and no goodwill was impaired.
The following exchange rates are relevant.
Dinars to $1 | |
1 January 20X5 | 3.8 |
31 December 20X5 | 4.3 |
Average rate for the year ended 31 December 20X5 | 4.0 |
Required:
Prepare the consolidated statement of profit or loss for the Holly group for the year ended 31 December 20X5, showing the profit attributable to the owners of the parent and to the non-controlling interests.
State the following figures for the consolidated statement of financial position at 31 December 20X5: goodwill; non-controlling interests; group retained earnings; non-current assets; current assets.
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Gain or loss on translation of the overseas subsidiary
Continuing from Example 1, calculate the exchange difference arising on the translation of Ivy for the year ended 31 December 20X5, state where it is presented, and attribute it between the owners of the parent and the non-controlling interests.
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7 Exam technique
Questions on this topic are almost always a request for one figure — goodwill, the non-controlling interests, group reserves, or the exchange difference — from a large amount of information. The order below gets to any of them quickly.
Read off the three rates and label them: acquisition (or opening), average, closing.
Do the net assets working in the foreign currency. Nothing else can be done until it is done.
Goodwill and non-controlling interests, still in the foreign currency, then divide each by the closing rate.
Group retained earnings in dollars: the parent in full, plus the group share of the subsidiary's post-acquisition retained earnings at the closing rate, plus or minus the exchange difference on the investment.
The exchange difference on translation, if it is asked for, from the three-part working — and cross-check it.
Five ways to lose the marks
Translating the workings instead of doing them in the foreign currency. Goodwill and the non-controlling interests are calculated in the subsidiary's currency and translated once, at the end. Translating the inputs first and then combining them gives a different — and wrong — answer.
Using the consideration in the wrong currency. If the parent paid in its own currency, translate it into the subsidiary's currency at the acquisition rate before the goodwill working.
Forgetting the fair value adjustment when translating an asset line. A fair value uplift on the subsidiary's land is part of the subsidiary's net assets and is translated with them at the closing rate.
Putting the exchange difference in profit or loss. It goes to other comprehensive income.
Multiplying where you should divide. With a rate quoted as "Dinars to $1", you divide the Dinar figure by the rate to get dollars. Sanity-check every answer: at 4.3 Dinars to the dollar, Dinars 890 million is about $207 million, not $3.8 billion.
One last reassurance. If the consolidated statement of financial position balances, the exchange difference is almost certainly right, because it is the only figure with nowhere else to go. That is why Answer 1 sets out the whole statement even though the question asked for five figures.
8 Test your knowledge
Foreign subsidiaries
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