ACC4023W Foreign Operations Worked Example

GROUPS PART 1:
FOREIGN OPERATIONS
WORKED EXAMPLE
The purpose of this worked example is to illustrate the steps to follow for the
consolidation of a foreign subsidiary.

You should allow enough time to work through the principles and processes illustrated
in this example. At the end of the example are some further ‘what if?’ scenarios relating
the subsequent sale of the foreign subsidiary.

While doing this example, it is important that you test and evaluate your understanding
of consolidations and group accounting that you have studied in FRII and FRIII. This
example builds on that knowledge, and then illustrates the application of IAS 21.

You should refer to the following IFRSs when working though this example:

• IAS 21, The Effects of Changes in Foreign Exchange Rates

• IAS 1, Presentation of Financial Statements
• IAS 27, Separate Financial Statements
• IAS 28, Investments in Associates and Joint Ventures
• IFRS 3, Business Combinations
• IFRS 10, Consolidated Financial Statements

You should also refer to the additional study notes on Groups and Foreign Operations
that explains the principles relating to the consolidation of foreign subsidiaries, and the
subsequent disposal.

1
ACC4023W Foreign Operations Worked Example

Scenario:

A Ltd is a South African parent company with a Rand functional currency. A Ltd
acquired 80% of the 5 000 shares of B Inc. on 1 January x1, when B Inc. was
incorporated. B Inc. is a foreign subsidiary with a FC functional currency.

The tax rate in South Africa is 28%, with an effective capital gains tax rate of 22.4%.
The tax rate in the country that B Inc. is domiciled for tax purposes (or pays tax in) is
30%. There is no capital gains tax in that country.

A Ltd measures its investments in subsidiaries on the cost basis in its separate
accounts. No dividends were declared in x1. All companies have a 31 December year-
end.

Trial balances as at 31 December x2 of:

A Ltd (company) B Inc.

R FC
Dr Cr Dr Cr
Stated capital 100 000 10 000
Retained earnings as at 31 1 000 000 50 000
December x1
Dividend declared and paid on 1 80 000 1 000
December x2
Revenue 250 000 20 000
Cost of sales 60 000 4 000
Operating expenses 40 000 2 000
Dividend income 3 800
Income tax (P/L) 42 000 4 000
Investment in B 16 000
Property, plant and equipment 623 800 64 000
Current assets 562 000 15 000
Current liabilities 70 000 10 000
1 423 800 1 423 800 90 000 90 000

The following spot rates apply:

1FC = R
1 January x1 2,00
31 December x1 & 1 January x2 3,00
1 December x2 4,75
31 December x2 5,00
Average: x1 financial year 2,50
Average: x2 financial year 4,20

2
ACC4023W Foreign Operations Worked Example

Required:

Prepare consolidated financial statements for A Ltd for the year ended 31 December
20x2. Show all your workings.

Approach:

Follow the steps illustrated below to guide you in the process and take note of the
annotated comments.

Then, continue with the ‘what if?’ scenarios that follow.

3
ACC4023W Foreign Operations Worked Example

SUGGESTED SOLUTION WITH WORKINGS

STEP 1: Starting point: The separate accounts of the parent.

The starting point for the preparation of the group accounts is 100% of the parent’s
trial balance and 100% of the subsidiary’s trial balance.

Think about: what entries did A Ltd record in its separate accounts?

Prepare the journal entry(ies) processed in the separate accounts of A Ltd for x1 and
x2.

A LTD Dr. (Rands) Cr. (Rands)

20x1
Investment in B 16 000
Bank 16 000
10 000 x 2 x 80%
Acquisition at cost, recorded at spot rate. Not
restated for foreign exchange movements as non-
monetary
20x2
Bank 3 800
Dividend income 3 800
1 000 x 4,75 x 80%
Recorded at spot rate on 1 Dec x2

Note the respective rates used for each of these transactions. This is a revision of
basic foreign currency transactions. (See IAS 21: 20 – 23).

4
ACC4023W Foreign Operations Worked Example

STEP 2: Starting point: The trial balance of the subsidiary.

The starting point for the preparation of the group accounts is 100% of the parent’s
trial balance and 100% of the subsidiary’s trial balance. We have a Rand-denominated
trial balance of the parent and a FC-denominated trial balance of the subsidiary.

How do we do this? We need to get all the amounts into Rands (as the parent’s
functional currency is most often the presentation currency of the group).

Translate (i.e. convert) the trial balance of B Inc. as at 31 December 20x2 into Rands.

B Inc. Exchange B inc.

FC rate Rands
Dr. Cr. Dr. Cr.
Stated capital 10 000 2 20 000
Retained earnings as at 31 50 000 2,50 125 000
December x1
Dividend declared and paid on 1 1 000 4,75 4 750
December x2
Revenue 20 000 4,20 84 000
Cost of sales 4 000 4,20 16 800
Operating expenses 2 000 4,20 8 400
Dividend income
Income tax (P/L) 4 000 4,20 16 800
Investment in B
Property, plant and equipment 64 000 5 320 000
Current assets 15 000 5 75 000
Current liabilities 10 000 5 50 000
90 000 90 000 441 750 279 000
Bal figure – exchange diff 162 750
441 750 441 750

Refer to IAS 21:38 to 40.

Now that all the amounts (the parent and the subsidiary) are in RANDS, we can follow
consolidation procedures. See steps below.

5
ACC4023W Foreign Operations Worked Example

STEP 3: The analysis of equity

Why prepare an analysis of equity? It helps with determining the amounts that will be
presented in equity in the group accounts as it analyses the equity of the subsidiary
into pre- and post-acquisition and current and prior periods.

100% Exchange 100% 80% 20%

FC rate Total PEH NCI
Rands Rands Rands
At acquisition
Stated capital 10 000 2 20 000 16 000 4 000
Profit for x1 50 000 2,5 125 000 100 000 25 000
(?) Exchange diff x1 35 000 28 000 7 000
Equity at 31.12.x1 60 000 3 180 000 144 000 36 000
Profit for x2 10 000 4,20 42 000 33 600 8 400
Dividends paid (1 000) 4,75 (4 750) (3 800) (950)
(?) Exchange diff x2 127 750 102 200 25 550
Equity at 31.12.x2 69 000 5 345 000 276 000 69 000

The analysis of equity helps to:

Allocate the equity of the subsidiary between the different periods (at acquisition,
since acquisition and current period).

Identify the exchange rate differences in each of these periods. Note that the
Exchange difference in TB (step 2 above) of R162 750 is split between x1 (R35 000)
and x2 (R127 750). [Tip: good way to check your answer!]

Allocate the appropriate portion of the subsidiary’s equity between Parent Equity
Holders (PEH) and non-controlling interest (NCI).

6
 ACC4023W Foreign Operations Worked Example

STEP 4 End point: Prepare the Group financial statements.

Present the group statement of profit or loss and other comprehensive income of A
Ltd for the x2 financial year. Ignore notes and comparatives.

A Ltd
Group Statement of Profit or Loss and Other Comprehensive income
For the year ended 31 December x2
Workings Rands
Revenue (250 000+84 000) 334 000
Dividend income (3 800 – 3800 (AOE, see -
also g- PFJEs)
Cost of sales (60 000+16 800) (76 800)
Operating expenses (40 000+8 400) (48 400)
Income tax (42 000+16 800) (58 800)
Profit for the period 150 000
Other comprehensive income
Amounts that will not be reclassified to profit
or loss
Income tax effect -
Amounts that will be reclassified to profit or
loss
Foreign currency gains AOE/PFJE5 127 750
Income tax effect -
Other comprehensive income for the 127 750
period
Total comprehensive income for the 277 750
period
Profit or loss attributed to:
Equity holders of A (150 000 - 8 400) 141 600
Non-controlling interest AOE/PFJE3 8 400
Total comprehensive income attributed to:
Equity holders of A 277 750 – 33 950 243 800
Non-controlling interest 8 400 (P/L) + 25 550 33 950
(OCI) (PFJE7)

This is revision of IAS 1. Also read IAS 21:43.

7
 ACC4023W Foreign Operations Worked Example

End point: Group financial statements

A Ltd
Group Statement of Changes in Equity
For the year ended 31 December x2
Stated Retained Foreign Total equity Non- Total Equity
Capital Earnings Currency attributed to controlling
Translation equity holders interest
Reserve (FCTR) of A Ltd
Balance at 31 Dec x1 100 000 1 100 000 28 000 1 228 000 36 000 1 264 000
(1) (2) (3)
Total Comprehensive Income:
Profit or loss (4) 141 600 141 600 8 400 150 000
Other Comprehensive Income (5) 102 200 102 200 25 550 127 750
Dividends Paid (6) (80 000) (80 000) (950) (80 950)

Balance at 31 Dec x2 100 000 1 161 600 130 200 1 391 800 69 000 1 460 800

Workings

(1) 1 000 000 + 100 000

(2) 28 000 (AoE) (or 162 750 per Trial Bal – 127 750 PFJE5– 7 000 PFJE6)
(3) AOE, where NCI is analysed
(4) Profit or Loss, allocated between PEH and NCI
(5) OCI allocated between PEH and NCI
(6) Dividends declared and paid to group shareholders, allocated between PEH and NCI

8
 ACC4023W Foreign Operations Worked Example

End point: Group financial statements

Prepare the statement of financial position of A at 31 December 20x2.

Ignore comparatives and notes.

A Ltd
Group Statement of Financial Position
At 31 December x2
Workings Rands
Total Equity:
Stated Capital 100 000
Retained earnings 1 161 600
Foreign Currency Translation Reserve See PFJE 130 200
Equity holders of parent 1 391 800
Non-controlling interest 69 000
Total Equity 1 460 800
Current Liabilities (70 000 + 50 000 B 120 000
TB)
Total Equity and liabilities 1 580 800

Total Assets
Property, plant and equipment (623 800 A + 943 800
320 000 B TB)
Current assets (562 000 A + 637 000
75 000 B TB)
Total Assets 1 580 800

9
 ACC4023W Foreign Operations Worked Example

STEP 5 Prepare pro-forma journal entries.

Account Dr. (Rands) Cr. (Rands)

Stated capital 20 000
Investment in B Inc. 16 000
Non-controlling interest (SFP) 4 000
Acquisition date PFJE
Retained earnings 25 000
Non-controlling interest (SFP) 25 000
Allocation of prior year profits to NCI
Non-controlling interest (P/L) 8 400
Non-controlling interest (SFP) 8 400
Allocation of current year profits to NCI
Dividend income 3 800
Non-controlling interest (SFP) 950
Dividends paid (Retained earnings) 4 750
Elimination of inter-company dividend
Foreign currency translation Reserve (FCTR) (1) 127 750
Foreign currency gains (OCI) 127 750
Splitting the FCTR balance to show current year
movement in OCI
FCTR (2) 7 000
Non-controlling interest (SFP) 7 000
Allocation of prior year foreign exchange gains to
NCI
Non-controlling interest (OCI) (1) 25 550
Non-controlling interest (SFP)
Allocation of current year exchange difference to 25 550
NCI

Allocation of FCTR:
Starting point PFJE End-point
FCTR in B Inc’s trial Allocate the FCTR to FCTR in statement of
balance, ‘generated’ by (1) Prior period – changes in equity:
virtue of the translation of allocate to NCI.
the foreign operation’s (2) In current period, Opening balance:
amounts to the presentation allocate to OCI, then R162 750 – 7 000
currency to NCI – 127 750 = R28 000
FCTR R162 750 CR DR FCTR R7 000
Comprising of: CR NCI (2) R7 000 In SPLOCI:
X1: R35 000 R127 750 (OCI), less
X2: R127 750 DR FCTR R127 750 R25 550 attributable to NCI
(see AoE) CR OCI (1) R127 750 = R102 200

DR NCI (OCI) (1) R25 550 Closing balance:

CR NCI (SFP) R25 550 R28 000 + R102 200
= R130 200
(80% of R162 750)

Note that closing PFJEs are not presented.

10
 ACC4023W Foreign Operations Worked Example

‘What if?’ scenarios

Sale of shares

Let’s assume that on 31 December x2, A Ltd sold shares that it owned in B Inc:

a) A Ltd sells all of the shares in B for $100 000 to the 20% shareholder.

What happens to the foreign currency gains or losses recognised in the group
accounts of A Ltd for x2 relating specifically to the sale of the shares?

The cumulative amount of the exchange differences relating to the foreign operation
sold, is reclassified from equity to profit or loss.

What is the cumulative foreign exchange difference relating to the subsidiary that is
sold?

R162 750 – see translation difference in TB (Step 2 above).

What is the currency gain or loss that has been accumulated in the separate reserve
in equity?

The balance of the FCTR = R130 200 (amount “accumulated in separate component
of equity”. (see IAS 21:48)

Thus: What PFJE entry is required for the reclassification adjustment?

Dr FCTR 130 200
Cr Cumulative foreign currency gain 130 200
reclassified from equity (OCI)
Dr Foreign currency gain reclassified 130 200
to P/L (OCI)
Cr Foreign currency gain reclassified 130 200
from OCI (P/L)

Something to do: Make sure that you know how this reclassification should be
presented in the Group Statement of Profit or loss and Other Comprehensive Income
(refer to IAS 1: 82A and layout in Step 4 above).

Something to think about: Why are there no adjustments to NCI? (see IAS 21: 48B).

Thus: R130 200 is reclassified from OCI to P/L when the shares in B Inc is sold,
being 100% of the cumulative gains attributable to equity holders of A Ltd.

11
 ACC4023W Foreign Operations Worked Example

b) A Ltd sells 2 000 shares in B Inc for $50 000 to the 20% shareholder.

What happens to the foreign currency gains or losses recognised in the group
accounts of A for x2 relating specifically to the sale of the shares?

The answer is the same as in (a) above.

Why?

B Inc has 5 000 issued shares (refer to scenario). A Ltd sold 2 000 of its original
interest of 4 000 shares, resulting in A Ltd retaining 2 000 shares. This represents a
40% interest being retained.

Assuming that voting rights (and control) are in line with shareholding interest, A Ltd
has lost control of B Inc. Even though A Ltd only sold 50% of its shareholding, the
result is the B Inc is no longer a subsidiary of A Ltd.

See IAS 21: 48A (a) and (b).

c) A sells 1 000 in B for $30 000 to the 20% shareholder.

What happens to the foreign currency gains or losses recognised in the group
accounts of A for x2 relating specifically to the sale of the shares?

A Ltd has sold 1 000 of its 4 000 shares in B Inc, thus retaining 3 000 shares,
representing 60%. Thus, A Ltd retains control of B Inc, and B Inc remains a subsidiary
of A Ltd.

The change in shareholding is an equity transaction between the different

classifications of shareholders. As control is not lost, there is no reclassification.

Thus: R32 550 (i.e. 25% (1 000/4 000)) of the foreign currency reserve is transferred
to retained earnings or another reserve (see IAS 21: 48C).

Some take-away points:

Within group accounting, when translating amounts relating to the foreign operation:
• Exchange differences are presented in OCI, specifically in the section that deals
with reclassifiable amounts.
• The OCI account is closed off to the Foreign Currency Translation Reserve (FCTR)
account for the parent’s share and the NCI for the NCI’s share.
• The FCTR is an accumulation of exchange differences recognised to date.
Remember that ‘reclassifiable’ means that the amounts that were recognised in OCI at a
point in time are subsequently reclassified from OCI to P/L, when some event happens.
So, then you must be asking: if the OCI is reclassifiable, then when does reclassification
happen and what about the FCTR, can it be transferred?

12
 ACC4023W Foreign Operations Worked Example

IAS 21 deals with this. The main issues are:

• 100% of the cumulative amounts recognised in the FCTR are reclassified through
OCI from profit or loss when control or significant influence is lost.
• Where control is not lost, there is no reclassification – think about why this makes
sense (if the investor has not lost control – no amounts are recognised in P/L, this
is an equity transaction.
• The amounts relating to the % interest lost is transferred when a shareholding in an
associate is reduced based on the investor’s share that is reduced.

Inter-group transactions

(a) In the example above, we have considered one instance of an inter-group transaction,
i.e. case of dividends. Let’s look at another.

Say on 1 January 20x2, A lends $10 000 to B, repayable in full on 31 December 20x4
at an interest rate of 5% p.a. (which is a fair and effective interest rate). All entities
carry the instrument at amortised cost.

Prepare the pro-forma journal entries that may be required to prepare A’s group
accounts for x2.

Account Dr. (Rands) Cr. (Rands)

Interest Income 21 000
Interest Expense 21 000
($10 000 x 5% x 4,20)
Elimination inter-company transaction
Loan payable 50 000
Loan receivable 50 000
($10 000 x 5)
Elimination of inter-company balance
(monetary item so restated to closing rate by
A and B’s translated trial balance at the
reporting date will include the loan in Rands
at the closing rate)

See IAS 21:45.

(b) In the previous example, the $10 000 was repayable by B Inc on 31 December 20x4.
The interest will continue to be settled annually.

What is the IAS 21 consequence if the capital of $10 000 was not repayable?

Choose from the below.

13
 ACC4023W Foreign Operations Worked Example

A. Nothing different to the original example

B. The same pro-forma journal entries + a pro-forma journal entry to
remove all the exchange difference recognised by A Ltd in profit or
loss and recognise the exchange difference in OCI
C. The same pro-forma journal entries + a pro-forma journal entry to
remove all the exchange difference recognised by B Inc in profit or
loss and recognise the exchange difference in OCI
D. The same pro-forma journal entries + a pro-forma journal entry to
remove the exchange difference recognised by A Ltd relating to the
capital amount ($10 000 only) in profit or loss and recognise the
exchange difference in OCI
E. The same pro-forma journal entries + a pro-forma journal entry to
remove the exchange difference recognised by B Inc relating to the
capital amount ($10 000 only) in profit or loss and recognise the
exchange difference in OCI

The correct answer is D.

Think about it:

• What happens in A Ltd’s separate financial statements?

As this loan is repayable in US$, it is classified as a monetary asset

(receivable) in the separate financial statements of A Ltd.
At the reporting date, A Ltd will recognise this loan at R50 000 (after
translating it at the closing exchange rate and recognising an exchange
difference in P/L).

• What is the classification on consolidation?

In the group, this loan is a monetary item “which settlement is neither

planned nor likely to occur in the foreseeable future” (see IAS 21:15).
It is therefore part of the net investment in B Inc.
The correct PFJE will therefore reverse the exchange difference by A Ltd in
P/L and recognise the difference in OCI.
See IAS 21: 15, 32 – 33.

Goodwill and adjustments at the acquisition date

In our original example, A Ltd acquired the shares in B Inc on incorporation of B Inc. The
implications were that A Ltd paid for shares at an amount equal to the stated capital on
incorporation and the only asset that arose in B Inc at that date was bank.

Thus, our example did not include:

• Goodwill (or a bargain purchase gain)

• Any adjustments to the net assets of B Inc at the acquisition date.

14
 ACC4023W Foreign Operations Worked Example

Explain the implications would be if:

1) there was goodwill,
2) fair value adjustments to B’s net assets at acquisition.

Goodwill (IAS 21:47)

a) Goodwill arises as a result of the acquisition of the subsidiary and is recognised in the
group financial statements of the parent as an asset.
b) It is assumed for the purposes of translating from the subsidiary’s functional currency
to the group’s presentation currency that goodwill is an asset that must be translated at
the closing rate at each reporting date.
c) Thus:
• At acquisition the goodwill is recorded in foreign currency and translated into Rands
using the spot rate at that date.
• At each subsequent reporting date, the goodwill balance is translated at the closing
rate.
• Exchange differences are recognised in OCI.
• Exchange differences relating to goodwill are attributed to NCI based on their %
interest in the subsidiary if goodwill is calculated using the full goodwill method (i.e.
NCI is measured at fair value at acquisition).
• Exchange differences relating to goodwill are not attributed to NCI if the goodwill is
calculated on the partial goodwill method (i.e. NCI is measured at its % share of the
net assets of the subsidiary).
d) As goodwill arises at a group level, PFJEs are required to: 1) recognise goodwill (at
acquisition date PFJE); 2) subsequently to restate to the closing rate.
e) Goodwill is not impaired, but tested for impairment, which normally happens at the
reporting date. Thus: impairment loss is translated at the rate on that date.

Bargain purchase gain

a) Bargain purchase gains are recognised as income in the group financial statements in
the year that the subsidiary is acquired (and closed off to group retained earnings).
b) The bargain purchase gain is calculated in the foreign currency and translated into
Rands using the spot exchange rate at the acquisition date.
c) As it is an income item, it is not restated for exchange rate movements.

Fair value adjustments (IAS 21:47)

a) Fair value adjustments arise at acquisition when the assets and liabilities of the
subsidiary are considered under or overvalued. Remember the group recognises the
assets and liabilities at fair value at the acquisition date.
b) As the fair value adjustments relate to a particular asset or liability, the usual
consolidation adjustments and reversals apply as the specific asset is depreciated, etc.
c) As the fair value adjustments relate to a particular asset or liability and the para 15
exemption does not apply in a business combination, there will be deferred tax based
on how the asset is recovered or the liability is settled in the country in which the foreign
operation is domiciled for tax purposes.

15
 ACC4023W Foreign Operations Worked Example

d) As the fair value adjustments relate to a particular asset or liability, there is exchange
differences that arise from translating amounts at the closing rate at each reporting
date. These exchange differences are recognised in OCI and the NCI share in these
exchange differences based on their % interest in the subsidiary.
e) PFJEs will be required for these if the subsidiary has not processed the adjustments in
its own accounts.

Equity method

Assume instead: that A Ltd is the 20%-shareholder instead and thus that B Inc. is an
associate.

Prepare the pro-forma journal entries to apply the equity method when preparing the group
accounts of A Ltd for the x2 financial year.

Account Dr. (Rands) Cr. (Rands)

Investment in associate 25 000
Retained earnings 25 000
Prior year profits
Investment in associate 7 000
FCTR 7 000
Prior year exchange differences
Investment in associate 8 400
Earnings from associate 8 400
Current year profits
Dividend Income 950
Investment in associate 950
Elimination of inter-company dividend
Investment in associate 25 550
Share of OCI of associate 25 550
Current year exchange differences

Some important aspects to think about:

• A 20% equity interest in B Inc, means that B Inc. is an associate (see IAS 28).
• Remember that you should (in your mind) first translate the trial balance of B Inc.
(the foreign operation) to the presentation currency (RANDS). This will result in the
recognition of the CTA in the trial balance of B Inc., amounting to R162 750.
• Thus, the amounts are as per the 20% column on the AoE.
• The PFJEs are the same as what you have always done for associates. The
translation into the Rands is the only new concept.
• Remember the cost of the investment (20% in this case) would already have been
recorded in A Ltd’s separate financial statements when it was acquired.

16