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4 Example: Different functional currency from the reporting entity

4 Example: Different functional currency from the reporting entity

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Solution

From the above it can be seen that Stone Co will record its initial investment at $12,000 which is the

starting cost of its shares. The statement of financial position of Brick Inc at 31 December 20X7 is

summarised below.

€'000

96



Non-monetary asset

Share capital

Loan



24

72

96



This may be translated as follows.



$'000



Non-monetary asset

(€3 = $1)



32



Share capital and reserves (retained earnings) (balancing figure)

Loan (€3 = $1)



8

24

32



Exchange gain/(loss) for 20X7



(4)



The exchange gain and loss are the differences between the value of the original investment ($12,000) and

the total of share capital and reserves (retained earnings) as disclosed by the above statements of financial

position.

On liquidation, Stone Co will receive $8,000 (€24,000 converted at €3 = $1). No gain or loss will arise in

20X8.



3.5 Some practical points

The following points apply.

(a)



For consolidation purposes calculations are simpler if a subsidiary's share capital is translated at

the historical rate (the rate when the investing company acquired its interest) and post-acquisition

reserves are found as a balancing figure.



(b)



IAS 21 requires that the accumulated exchange differences should be shown as a separate

component of equity but for exam purposes these can be merged with retained earnings.



You must be able to calculate exchange differences.

FAST FORWARD



Practising examination questions is the best way of learning this topic.



3.6 Summary of method

A summary of the translation method is given below, which shows the main steps to follow in the

consolidation process.



Exam focus

point



You should learn this summary.

Translation



Step 1

Translate the closing statement of financial position

(assets/equity) and use this for preparing the

consolidated statement of financial position in the

normal way.



Use the closing rate at the year end for all items

(see note to step 4).



Part C Group financial statements  16: Foreign currency transactions and entities



463



Translation



Step 2

Translate the statement of profit or loss and other

comprehensive income.

(In all cases, dividends should be translated at the rate

ruling when the dividend was paid.)



Use the average rate for the year for all items

(but see comment on dividends). The figures

obtained can then be used in preparing the

consolidated statement of profit or loss and other

comprehensive income but the statement of

profit or loss and other comprehensive income

cannot be completed until the exchange

difference has been calculated.



Step 3

Translate the shareholders' funds (net assets) at the

beginning of the year.



Use the closing rate at the beginning of the year

(the opening rate for the current year).



Step 4

Calculate the total exchange difference for the year as

follows.

$

Closing net assets at closing rate

(Step 1)



X



Less opening net assets at opening rate

(Step 3)



X

X



Less retained profit as translated

(Step 2 less any dividends)

Exchange differences



X

X



It may be necessary to adjust for any profits or losses

taken direct to reserves during the year.



This stage will be unnecessary if you are only

required to prepare the statement of financial

position. If you are asked to state the total

exchange differences or are asked to prepare a

statement of profit or loss and other

comprehensive income, where the exchange

difference will be shown.

For exam purposes you can translate the closing

shareholders' funds as follows.

(a)



Share capital + pre-acquisition reserves at

historical rate.

(b) Post-acquisition reserves as a balancing

figure.



Question



Consolidated financial statements



The abridged statements of financial position and statement of profit or loss and other comprehensive

incomes of Darius Co and its foreign subsidiary, Xerxes Inc, appear below.

DRAFT STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X9



Assets

Non-current assets

Plant at cost

Less depreciation

Investment in Xerxes

100 €1 shares

Current assets

Inventories

Receivables



464



16: Foreign currency transactions and entities  Part C Group financial statements



Darius Co

$



Xerxes Inc





600

(250)

350



500

(200)

300



25

375





300



225

150

375

750



200

100

300

600



Equity and liabilities

Equity

Ordinary $1/€1 shares

Retained earnings

Long-term loans

Current liabilities



Darius Co

$



Xerxes Inc





300

300

600

50

100

750



100

280

380

110

110

600



STATEMENTS OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

FOR THE YEAR ENDED 31 DECEMBER 20X9

Darius Co

$

Profit before tax

Tax

Profit after tax, retained



Xerxes Inc





200

100

100



160

80

80



The following further information is given.

(a)



Darius Co has had its interest in Xerxes Inc since the incorporation of the company. Neither

company paid dividends during the year to 31 December 20X9 and neither company had any other

comprehensive income in their separate financial statements.



(b)



Depreciation is 8% per annum on cost.



(c)



There have been no loan repayments or movements in non-current assets during the year. The

opening inventory of Xerxes Inc was €120. Assume that inventory turnover times are very short.



(d)



Exchange rates:



€ 4 to $1 when Xerxes Inc was incorporated

€ 2.5 to $1 when Xerxes Inc acquired its non-current assets

€ 2 to $1 on 31 December 20X8

€ 1.6 to $1 average rate of exchange year ending 31 December 20X9

€ 1 to $1 on 31 December 20X9.



Required

Prepare the summarised consolidated financial statements of Darius Co.



Answer

Step 1



The statement of financial position of Xerxes Inc at 31 December 20X9, other than share

capital and retained earnings, should be translated at €1 = $1.

SUMMARISED STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER 20X9

$

Non-current assets (NBV)

Current assets

Inventories

Receivables



Non-current liabilities

Current liabilities



300

200

100

300

600

110

110



 Shareholders' funds = 600 – 110 – 110 = $380

Since Darius Co acquired the whole of the issued share capital on incorporation, the

post-acquisition retained earnings including exchange differences will be the value of



Part C Group financial statements  16: Foreign currency transactions and entities



465



shareholders' funds arrived at above, less the original cost to Darius Co of $25.

Post-acquisition retained earnings = $380 – $25 = $355.

SUMMARISED CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER

20X9

$

Assets

Non-current assets (NBV)

Current assets

Inventories

Receivables



$(350 + 300)



650



$(225 + 200)

$(150 + 100)



425

250

675

1,325



Equity and liabilities

Equity

Ordinary $1 shares (Darius only)

Retained earnings

$(300 + 355)

Non-current liabilities: loans

Current liabilities



$(50 + 110)

$(100 + 110)



300

655

955

160

210

1,325



Note. It is quite unnecessary to know the amount of the exchange differences when

preparing the consolidated statement of financial position.



Step 2



The statement of profit or loss and other comprehensive income should be translated at

average rate (€1.6 = $1).

XERXES INC

SUMMARISED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

FOR THE YEAR ENDED 31 DECEMBER 20X9

$

Profit before tax

Tax

Profit after tax



100

50

50



SUMMARISED CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER

COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20X9

Profit before tax

Tax

Profit after tax



$(200 + 100)

$(100 + 50)

$(100 + 50)



$

300

150

150



The statement of profit or loss and other comprehensive income cannot be completed until

the exchange difference has been calculated.



Step 3



The equity interest at the beginning of the year can be found as follows.

Equity value at 31 December 20X9

Retained profit for year

Equity value at 31 December 20X8

Translated at €2 = $1, this gives



466



16: Foreign currency transactions and entities  Part C Group financial statements





380

80

300

$150



Step 4



The exchange difference can now be calculated and the statement of profit or loss and other

comprehensive income completed.

$

Equity interest at 31 December 20X9 (stage 1)

Equity interest at 1 January 20X9 (stage 3)



380

150

230

50

180



Less retained profit (stage 2)

Exchange gain

SUMMARISED CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME FOR THE YEAR ENDED 31 DECEMBER 20X9

$

Profit before tax

$(200 + 100)

300

Tax

$(100 + 50)

150

Profit after tax

$(100 + 50)

150

Other comprehensive income (items that

may be re-classified to profit or loss*)

Exchange difference on translating foreign operations

180

Total comprehensive income

330

*See Chapter 10 for an explanation of this caption.

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (EXTRACT FOR RESERVES)

FOR THE YEAR ENDED 31 DECEMBER 20X9



$



Consolidated reserves at 31 December 20X8

Total comprehensive income

Consolidated reserves at 31 December 20X9



325

330

655



(Note. The post-acquisition reserves of Xerxes Inc at the beginning of the year must have been $150 –

$25 = $125 and the reserves of Darius Co must have been $300 – $100 = $200. The consolidated reserves

must therefore have been $325.)



3.7 Analysis of exchange differences

The exchange differences in the above exercise could be reconciled by splitting them into their component

parts.



Exam focus

point



Such a split is not required by IAS 21, nor is it required in your exam, but it may help your understanding

of the subject.

The exchange difference consists of those exchange gains/losses arising from:





Translating income/expense items at the exchange rates at the date of transactions, whereas

assets/liabilities are translated at the closing rate.







Translating the opening net investment (opening net assets) in the foreign entity at a closing rate

different from the closing rate at which it was previously reported.



This can be demonstrated using the above question.

Using the opening statement of financial position and translating at €2 = $1 and €1 = $1 gives the following.



Non-current assets at NBV

Inventories

Net current monetary liabilities



€2 = $1

$

170

60

(25)

205



€1 = $1

$

340

120

(50)

410



Difference

$

170

60

(25)

205



Part C Group financial statements  16: Foreign currency transactions and entities



467



Equity

Loans



€2 = $1

$



€1 = $1

$



150

55

205



300

110

410



Difference

$

150

55

205



Translating the statement of profit or loss and other comprehensive income using €1.60 = $1 and

€1 = $1 gives the following results.

€1.60 = $1

$

Profit before tax, depreciation and

increase in inventory values

Increase in inventory values

Depreciation

Tax

Profit after tax, retained



75

50

125

(25)

100

(50)

50



The overall position is then:

Gain on non-current assets ($170  $15)

Loss on loan

Gain on inventories ($60 + $30)

Loss on net monetary current assets/

Liabilities (all other differences)

($45  $30  $25)

Net exchange gain: as above



€1 = $1

$



Difference

$



120

80

200

(40)

160

(80)

80



45

30

75

(15)

60

(30)

30



$



$

155

(55)



90



(10)

80

180



3.8 Non-controlling interests

In problems involving non-controlling interest the following points should be noted.

(a)



The figure for non-controlling interest in the statement of financial position will be calculated

using the method seen in earlier chapters and including the appropriate proportion of the translated

share capital and reserves of the subsidiary.



(b)



The non-controlling interest in the reconciliation following the statement of profit or loss and

other comprehensive income will be the appropriate proportion of dollar profits and other

comprehensive income. The non-controlling interest in other comprehensive income will include

their share of exchange differences on translating the subsidiary but will exclude exchange

differences arising on retranslating goodwill (see below) if the group measures non-controlling

interests at acquisition using the proportionate method.



3.9 Goodwill and fair value adjustments

Goodwill and fair value adjustments arising on the acquisition of a foreign operation should be treated as

assets and liabilities of the acquired entity. This means that they should be expressed in the functional

currency of the foreign operation and translated at the closing rate.

Here is a layout for calculating goodwill and the exchange gain or loss. The parent holds 90% of the

shares. NCI is valued as the proportionate share of the fair value of the subsidiary's identifiable net assets.



468



16: Foreign currency transactions and entities  Part C Group financial statements



Goodwill



F'000



Consideration transferred (12,000  6)

Non-controlling interest

66,000  10%

Less

Less share capital

Pre acquisition retained earnings



Rate



$'000



72,000

6,600

78,600

40,000

26,000

(66,000)

12,600



12,600



At 1.4.X1

Foreign exchange gain

At 31.3.X7

*

**



F'000



6*

Balance

5**



2,100

420

2,520



Historic rate

Closing rate



3.10 Example: including goodwill and non-controlling interests

Henley acquired 70% of Saar a foreign company for Units 4,500 on 31 December 20X4 when the retained

reserves of Saar were Units 1,125. No impairment losses had been necessary up to 31 December 20X7.

Neither company paid or declared dividends during the year.

Group policy is to measure non-controlling interests at acquisition at their proportionate share of the fair

value of the identifiable net assets.

Exchange rates

31 December 20X4

31 December 20X6

31 December 20X7

Average exchange rate for year ended 31 December 20X7



Units to $1

4.5

4.3

4

3.8



Required

Prepare the consolidated statement of profit or loss and other comprehensive income, statement of

financial position and statement of changes in equity (attributable to equity holders of the parent only) for

the Henley Group for the year ended 31 December 20X7.

Note. In the exam you would expect the question to show the separate financial statements of the parent

and the subsidiary. These have been included alongside the solution below, to make it easier to illustrate

the methods being used.



Solution

Statement of financial position

In questions asking for a full set of financial statements including a foreign subsidiary, it is always best to

start with the statement of financial position. The starting point, as always, is to draw up the group

structure:

Group structure

Henley

31.12.X4



70%



Pre-acquisition ret'd reserves 1,125 Units

Saar



Part C Group financial statements  16: Foreign currency transactions and entities



469



The following table includes:





The separate statements of financial position of Henley and Saar, each in their own currency (these

would normally be given within the question information)







A column showing the exchange rates chosen to translate Saar’s balances into $







A column showing the translated statement of financial position of Saar







A final column showing the consolidated statement of financial position for the Saar Group

(consolidation workings are shown below the table)



STATEMENTS OF FINANCIAL POSITION AT 31 DECEMBER 20X7



Property, plant and equipment

Goodwill (W1)

Investment in Saar

Current assets



Henley

$

4,500



Saar

Units

4,000



Rate



1,000

2,400

7,900



3,000

7,000



4



Saar

$

1,000



4



Share capital

Pre-acquisition reserves



2,000



2,250

1,125



4.5

4.5



Post-acquisition reserves (W2)



4,400



2,825







6,400



6,200



1,500

7,900



800

7,000



Non-controlling interest

Loans



Consol

$

5,500

534



750

1,750



3,150

9,184



500

250

750

800



2,000



1,550



7,019

465

7,484

1,700

9,184



5,019



200

1,750



4



Workings

1



Goodwill

Consideration transferred



Units

4,500



Rate

4.5



$

1,000



Non-controlling interests (30% × 3,375)



1,012



4.5



225



(3,375)

2,137



2,137



2,137



4.5

4.5



4.3



4



(750)

475

22

497

37

534



Share capital

Retained reserves



Exchange gain 20X5-20X6 b/d

At 31.12.X6

Exchange gain 20X7

At 31.12.X7



Units



2,250

1,125



Note. Goodwill is initially measured in the subsidiary’s currency, then retranslated at each year end

so that we can identify the cumulative exchange differences. In the consolidated statement of

financial position these are taken to reserves (see working 2)

2



Retained reserves carried forward

Henley

Saar (800(W2)  70%)

Goodwill – exchange gain ((W1): (22 + 37) × 70%



470



16: Foreign currency transactions and entities  Part C Group financial statements



$

4,400

560

41

5,001



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