CORPORATE REPORTING

ACCOUNTING FOR FOREIGN SUBSIDIARY

IAS 21 deals with the definition of functional currency, accounting for individual transactions in a
foreign currency and translating the financial statements of a foreign operation.
Functional Currency
The functional currency is the currency of the primary economic environment where the entity
operates. In most cases this will be the local currency.
An entity should consider the following when determining its functional currency:
The currency that mainly influences sales prices for goods and services
The currency of the country whose competitive forces and regulations mainly determine the
sales price of goods and services
The currency that mainly influences labour, material and other costs of providing goods and
services.
The currency in which funding from issuing debt and equity is generated
The currency in which from operating activities are usually retained.
The entity maintains its day-to-day financial records in its functional currency.
Presentation Currency
The presentation currency is the currency in which the entity presents its financial statements. This
can be different from the functional currency, particularly if the entity in question is a foreign-owned
subsidiary. It may have to present its financial statements in the currency of its parent, even though
that is different from its own functional currency.
Translation of the financial statements of a foreign operation (foreign subsidiary)
Where a subsidiary entitys functional currency is different from the presentation currency of the
parent, its financial statements must be translated into the parents presentation currency prior to
consolidation.
The method of translating the financial statements of a foreign subsidiary depends on the way in
which it is financed and operates in relation to the holding company.
For this purpose, foreign subsidiaries are classified as either foreign subsidiaries that are integral to
the operations of the holding company or foreign subsidiaries that operate as foreign entities.
1. A foreign subsidiary that is integral to the operations of the holding company:
A foreign subsidiary that is integral to the operations of the holding company carries on its
business as if it was an extension of the holding companys operations. For example such a
foreign subsidiary might only sell goods imported from the holding company and remits the
proceeds to the company.

The accounting treatment can be summarised as follows:

Income statement:
Translate using the actual rates. Average rates for the period may be preferred.
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 Financial position:

Non-monetary items:
(Like inventories, non-current assets and depreciation) are translated using historical
rate of purchase (or revaluation at fair value, or reduction to realisable value)
Monetary items:
(Like cash, bank, accounts receivables and accounts payables) are translated at the
closing rates.
Exchange difference are reported and treated in the income statement.

2. Foreign entities
The following are the indications that a foreign subsidiary is a foreign entity rather than an
operation that is integral to the operations of the holding company:
The activities of the foreign entity are carried out with a significant degree of
autonomy from those of the holding company.
Transactions with the reporting enterprise are not a high proportion of the foreign
operations activities.
The activities of the foreign operations are financed mainly from its own operations or
local borrowings rather than from the reporting enterprise.
Costs of labour, materials and other components of the foreign operations products or
services are primarily local costs rather than costs of products and services obtained
from the country in which the reporting enterprise is located.
The foreign operations market is mainly outside the reporting enterprises country and
cash flows of the reporting enterprise are insulated from the day-to-day activities of
the foreign operations rather than being directly affected from the activities of the
foreign operations.
In translating the financial statement of subsidiary that operates as a foreign entity, for
incorporation in its financial statements, the holding company should use the following
procedures:
Income statement

Income and expenses items of the foreign entity should be translated at exchange rate
at the dates of the transactions (an average rate will usually be used for practical
purposes)
Financial position

The assets, liabilities, share capital and reserves, both monetary and non-monetary of
the foreign entity, should be translated at the closing rate.
The balancing figure that makes up the post-acquisition reserves includes the
exchange difference for the year and prior post-acquisition years. This amount should
be disclosed as a component of other comprehensive income (reserves).
All exchange differences should be classified within equity until the disposal of the
net investment.

Consolidation procedures
In principle, the same workings and adjustments required in any consolidation question will be
required. You should prepare a group structure, and workings for net assets; goodwill, noncontrolling interest and retained earnings will typically be required. However, IAS 21 requires that
goodwill is calculated using the functional currency of the subsidiary and then subject to annual
retranslation at the closing rate at each reporting date.
It follows that the cost of investment and NCI should be calculated using the same closing rate.
Where goodwill is calculated on a full or fair value basis, it should be calculated using a two-stage
approach. This will determine the respective group and NCI share of goodwill. This ratio will then be
used to allocate exchange gains or losses arising on retranslation of goodwill each year between the
group and NCI.
Non-controlling interest
Income statement
The non-controlling interest in the income statement is the share of the subsidiarys profit
after tax for the year as translated for consolidation purposes.
Financial position
The non-controlling interest in the financial position is computed by references to either fair
value at acquisition plus share of post acquisition retained earnings or net assets of the
subsidiary, in either case translated at the closing rate at the reporting date.
Shortcomings of IAS 21
There are a number of issues on which IAS 21 is either silent or fails to give adequate guidance.
1. Under IAS 21 transactions should be recorded at the rate ruling at the date of the transaction
occurs (i.e. the date when the transaction qualifies for recognition in the accounts), but in
some cases this date is difficult to establish. For example, it could be the order date, the date
of the invoice or the date on which the goods were received.
2. IAS 21 states that average rate can be used if these do not fluctuate significantly, but what
period should be used to calculate average rate? Should the average rate be adjusted to take
account of material transactions?
3. IAS 21 provides only limited guidance where there are two or more exchange rates for a
particular currency or where an exchange rate is suspended. It has been suggested that
companies should use whichever rate seems appropriate given the nature of the transaction
and have regard to prudence if necessary.
4. IAS 21 makes a distinction between the transaction of monetary and non-monetary items, but
in practice some items (such as progress payments paid against non-current assets or
inventories, and debt securities held as investments) may have characteristics of both.
5. Retranslating the opening reserves at the closing rate gives a difference that goes direct to
reserves under the closing rate method. The reasoning behind this is that these exchange
differences do not result from the operations of the group. To include them in profit or loss
would be to distort the results of the groups trading operations. However, some
commentators consider that all such gains and losses are part of a groups profit and should
be recorded in profit or loss.
Calculation of exchange differences
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In order to calculate the foreign exchange differences arising on the net investment in a foreign
operation, these three elements should be considered:
Opening net assets of subsidiary
Profit for the year of subsidiary
Goodwill whether calculated on a fair value or proportionate basis.
Parent
Opening net assets of subsidiary
(Equity brought forward)

@ closing rate
@ opening rate
Gain/loss

Profit of the subsidiary for the year @ closing rate

@ average rate
Gain/loss

Opening goodwill Parents share

Opening goodwill NCIs share

(Full goodwill method only)

X
(X)
X * Parent %
NCI %
X
(X)
X * Parent %
NCI %

@ closing rate
@ opening rate
Gain/loss

X
(X)
X * 100%

@ closing rate
@ opening rate
Gain/loss

X
X
X * 100%

Gain/loss for the year

NCI

X
X

X
X

X
X

Disposal of foreign subsidiary

On the disposal of foreign entity the cumulative amount of the exchange differences which have been
deferred and which relate to that foreign entity should be included as part of the gain or loss on
disposal and recognised in profit or loss.
Equity accounting
The principles to be used in translating a subsidiarys financial statements also apply to the
translation of an associates.
Once the results are translated, the carrying amount of the associate (cost (at the closing rate) plus the
share of post-acquisition retained earnings) can be calculated together with the groups share of the
profits for the period and included in the group financial statements.

Question 1
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Parent ltd is an entity that owns 80% of the ordinary shares of its foreign subsidiary, Overseas ltd,
that has the shilling as its functional currency. The subsidiary was acquired at the start of the current
accounting period on 1 January, 2007 when its reported reserves were 6,000 shillings.
At that date the fair value of the net assets of the subsidiary was 20,000 shillings. This included a fair
value adjustment in respect of land of 4,000 shillings that the subsidiary has not incorporated into its
accounting records and still owns.
Parent ltd wishes the presentation currency of the group accounts to be Ghana cedis. Goodwill is to
be accounted for on a fair value basis, which is unimpaired at the reporting date. At the date of
acquisition, the non-controlling interest in Overseas had a fair value of 5,000 shillings.
Statement of financial position
Investment (21,000 shillings)
Assets
Equity and liabilities
Equity capital
Retained earnings
Liabilities

Parent
GHS
3,818
9,500
13,318

Overseas
shillings
40,000
40,000

5,000
6,000
2,318
13,318

10,000
8,200
21,800
40,000

Statement of comprehensive income

Parent
Overseas
GHS
shillings
Revenue
8,000
5,200
Cost
(2,500)
(2,600)
Profit before tax
5,500
2,600
Tax
(2,000)
(400)
Profit for the year
3,500
2,200
Neither entity recognised any other comprehensive income in their individual accounts in the period.
Relevant exchange rates (shillings to Ghana cedi) are
Date
Exchange rate (shillings)
1 January 2007
5.5
31 December, 2007
5.0
Weighted average for the year
5.2
Required:
Prepare the consolidated statement of financial position at 31 December, 2007, together with a
consolidated income statement for the year ended 31 December 2007.

Question 2
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On 1 July 2011, Saint ltd acquired 60% of Angels ltd, whose functional currency is Dalasi. The
financial statements of both entities as at 30 June 2012 were as follows:

Assets:
Investment in Angels ltd
Loan to Angels ltd
Tangible assets
Inventory
Receivables
Cash at bank
Equity and liabilities
Equity capital (GHS1/D1)
Share premium
Retained earnings (reserves)
Non-current liabilities (loan)
Current liabilities

Saint ltd
GHS
5,000
1,400
10,000
5,000
4,000
1,600
27,000

Angels ltd
D
15,400
4,000
500
560
20,460

10,000
3,000
4,000
5,000
5,000
27,000

1,000
500
12,500
5,460
1,000
20,460

Statement of comprehensive income for the year ended 30th June 2012
Saint ltd
GHS
Revenue
50,000
Cost of sales
(20,000)
Gross profit
30,000
Distribution and administration expenses
(20,000)
Profit before tax
10,000
Tax
(8,000)
Profit after tax
2,000

Angels ltd
D
60,000
(30,000)
30,000
(12,000)
18,000
(6,000)
12,000

The following information is applicable:

1. Saint ltd purchased the shares in Angels ltd for D10,000 on the first day of the accounting
period. At the date of acquisition the retained earnings of Angels ltd were D500 and there was
an upward fair value adjustment of D1,000. The fair value adjustment is attributable to plant
with a remaining five year life as at the date of acquisition. This plant remains held by Angels
and has not been revalued. No shares have been issued since the date of acquisition.
2. Just before the year-end Saint ltd acquired some goods from a third party at a cost of
GHS800, which it sold to Angels ltd for cash at a mark up of 50%. At the reporting date all
the goods remain unsold.
3. On 1 June 2012 Saint ltd lent Angels ltd GHS1,400. The liability is recorded at the historic
rate within the non-current liabilities of Angels ltd.
4. No dividends have been paid. Neither company has recognised any gain or loss in reserves.

5. Goodwill is to be accounted for on a full fair value basis. No goodwill has been impaired. The
fair value of the non-controlling interest at the date of acquisition was D5,000. The
presentational currency of the group is to be the Ghana Cedi.
Exchange rates to GHS1
D
1 July 2011
2.00
Average rate
3.00
1 June 2012
3.90
30 June 2012
4.00
Required:
1. Prepare the group statement of financial position at 30th June 2012
2. Prepare the group income statement for the year ended 30th June 2012
Question 3
Little ltd was incorporated over 20 years ago, operating as an independent entity for 15 years until 1
April, 2010 when it was taken over by Large ltd. Larges directors decided that the local expertise of
Littles management should be utilised as far as possible, and since the takeover they have allowed
the subsidiary to operate independently, maintaining its existing supplier and customer bases. Large
exercises arms length strategic control, but takes no part in day-to-day operational decisions.
The statements of financial position of Large and Little at 31 March 2014 are given below. The
statements of financial position of Little is prepared in francos (F), its functional currency.
Large ltd
Little ltd
GHS000
F000
Non-current assets
Property, plant and equipment
63,000
80,000
Investments
12,000
75,000
80,000
Current assets
Inventories
25,000
30,000
Trade receivables
20,000
28,000
Cash
6,000
5,000
51,000
63,000
126,000
143,000
Equity
Equity capital (50 pesewas/1 Franco)
30,000
40,000
Revaluation reserves
6,000
Retained earninigs
35,000
34,000
65,000
80,000
Non-current liabilities
Long-term borowings
20,000
25,000
Deferred tax
6,000
10,000
26,000
35,000
Current liabilities
Trade payables
25,000
20,000
Tax
7,000
8,000
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Bank overdraft

3,000
35,000
126,000

28,000
143,000

Notes to the accounts

1. On 1 April 2010, Large purchased 36 million shares in Little for 72 million francos. The
retained earnings of little at that date were 26 million francos. It is group policy to account for
goodwill on a proportionate basis. At 1 April 2013, goodwill had been fully written off as a
result of impairment losses.
2. Little sells goods to Large, charging a mark-up of onethird on production cost. At 31 March
2014, Large held GHS1 million (at cost to large) of goods purchased from Little in its
inventories. The goods were purchased during March 2014 and were recorded by Large using
an exchange rate of GHS1 = 5 francos. (There were minimal fluctuations between the two
currencies during March 2014) On 29 March 2014, Large sent Little a cheque for GHS1
million to clear the intra-group payables. Little received and recorded this cheque on 3 April
2014.
3. The accounting policies of the two entities are the same, except that the direcotrs of Little
have decided to adopt a policy of revaluation of property, whereas Large includes all property
in its statement of financial position at depreciated historical cost. Until 1 April 2013, Little
operated from rented warehouse premises. On that date, the entity purchased a leasehold
building for 25 million francos, taking out a long-term loan to finance the purchase. The
buildings estimated useful life at 1 April 2013 was 25 years, with an estimated residual value
of nil, and the direcotrs decided to adopt a policy of straight line depreciation. The building
was professionally revalued at 30 million francos on 31 March 2014, and the direcotrs have
included the revalued amount in the statement of financial position.
4. The exchange rates are
Date
Exchange rate (Francos to GHS1
1April 2010
6.0
31 march 2013
5.5
31 march 2014
5.0
Average for the year to 31 march 2014
5.2
Average for the dates of acquisition
of closing inventory
5.1
Required
Prepare the consolidated statement of financial position of Large group at 31 March 2014.
Question 4
Peace Limited acquired 2,100,000 ordinary shares in Love Limited, a Zambian Company on 1st
January 2003. The Income surplus balance of Love Limited on that date was KA4,500,000 and the
exchange rate was KA10 to GHC1. The currency of Zambia is Kwacha (KA).
The income statement of Peace limited and Love limited for the year ended 31st December, 2010
were as follows:
Peace ltd
Love ltd
GHS000
KA000
Turnover
27,675
283,500
Cost of sales
18,081
189,000
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Gross profit
Distribution costs
Administrative expenses
Depreciation

9,594
3,870
4,407
573
744
945
1,689
585
1,104
549
555

Investment income from subsidiary

Tax
Profit after tax
Dividend paid
Transfer to income surplus

94,500
22,659
7,560
6,300
57,981
57,981
22,710
35,271
12,600
22,671

The statements of financial position of the two companies as at 31st December, 2010 were as
follows:
Peace ltd
Love ltd
GHS000
KA000
Assets
Property, plant and equipment
5,295
115,500
Investment in Love ltd
915
Inventories
6,735
11,025
Receivables
1,845
5,250
Cash and Bank
468
28,350
15,258
160,125
Equity and liabilities
Trade payables
Long term loan
Ordinary share capital (GHS1.00 each)
Ordinary share capital (KA3.00 each)
Income surplus

6,735
3,690
1,800
3,033
15,258

13,125
26,040
10,500
110,460
160,125

Additional information:
1. The property, plant and equipment of Love ltd were acquired on 1 st January 2003 and are
stated at cost less accumulated depreciation.
2. On 31 December 2009, the inventories held by Love ltd amounted to KA14,280,000 and the
exchange rate at the time they were purchased was KA10 to GHS1.
3. Exchange rates have been as follows:
KA to GHS1
st
1 January 2003
10.00
th
30 June 2009
10.50
th
30 September 2009
10.00
st
31 December 2009
9.50
Average for 2010
8.00
th
30 June 2010
8.00
th
30 September 2010
7.50
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31st December 2010

7.00

4. The inventories of Love ltd as at 31 December 2010 were purchased at the time the exchange
rate was KA7.50 to GHS1.00.
5. In determining appropriate method of currency translation, it has been established that the
trade of Love ltd is more dependent on the economic environment of the investing companys
currency than that of its own reporting currency.
Required:
Prepare the consolidated statement of comprehensive income for the year ended 31 December 2010:
and consolidated statement of financial position as at 31 December 2010 for Peace ltd and its
subsidiary.
Note: work to the nearest Ghana Cedi. (GHS1.00)

Compiled by Cornelius Azumah

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