The financial statements of foreign subsidiaries must be translated into the group’s presentation currency (which is often, but not always, the parent’s functional currency). The relevant requirements are included in IAS 21 ‘The Effects of Changes in Foreign Exchange Rates’.
Translation of financial statements Consolidation of foreign operations
The translation of foreign operations (subsidiary, associate, joint arrangement or branch op a reporting entity) with a different functional currency is done using the current rate method, which requires:
- Assets and liabilities for each balance sheet presented (i.e. including comparatives) to be translated at the closing rate at the date of that balance sheet;
- Income and expenses for each income statement (i.e. including comparatives) to be translated at exchange rates at the dates of the transactions; and
- All resulting exchange differences to be recognized as a separate component of other comprehensive income (OCI) and classified as a separate translation reserve in equity.
Recalculating income and expenses at the exchange rates at the dates of the transactions has been simplified into using the average exchange rate for the period concerned. Gains and losses (in the statement of other comprehensive income) and cash flows (in the statement of cash flows) are similarly to income and expenses translated at the exchange rates at the dates of the transactions which also means using the average exchange rate for the period concerned. Consolidation of foreign operations
A foreign operation that is integral to the reporting entity (i.e. it carries on business as if it is an extension of the reporting entity’s own operations), will -by definition- have the same functional currency as the reporting entity since it operates in the same primary economic environment as the reporting entity. Such a integrated foreign operation will account its financial statements in the same currency as the reporting entity and translate transactions in foreign currency as per translation of foreign currency transactions.
Disposal of a foreign operation Consolidation of foreign operations
On the disposal of an entity’s entire interest in a foreign operation, the cumulative amount of the exchange differences previously recognized in accumulated OCI relating to that foreign operation are recognized in profit or loss when the gain or loss on disposal is recognized. When realised in the derecognition the result is reclassified from other comprehensive income to profit or loss and the translation reserve is reclassified from the translation reserve to retained earnings. In addition, the following partial disposals are accounted for as disposals:
- When the partial disposal involves the loss of control of a subsidiary that includes a foreign operation, regardless of whether the entity retains a non-controlling interest in the former subsidiary; and Consolidation of foreign operations
- When the retained interest after the partial disposal of an interest in a joint arrangement or an associate that includes a foreign operation is a financial asset that includes a foreign operation.
On disposal of a subsidiary that includes a foreign operation, the cumulative amount of the exchange differences relating to that foreign operation that have been attributed to the non-controlling interests is derecognized, but is not reclassified to profit or loss.
Partial example worksheets consolidation Consolidation of foreign operations
Here is an example from a real life consolidation, the FX translation on the opening balance is recalculated (as the difference at opening exchange rates and closing exchange rates) and the roll forward of equity in the subsidiaries A, B and C shows, including the FX translation for the income statement at average rates for the year (approximating translation of income and expense at transaction date rates) to year end rates.
And here is a consolidation working sheet translating a part of the balance sheet of two subsidiaries from USD to EUR and from CNY to EUR at the year-end rate of exchange.