CFM8026 – Accounting for foreign exchange: translating the accounts of a foreign enterprise

Closing rate/net investment method

Where the closing rate/net investment method is used to translate the results of a foreign enterprise:

• the company’s net investment in the foreign enterprise is translated at the closing rate of exchange.

For example, if a company owns 75% of the shares in an overseas subsidiary, its net investment will be 75% of the net assets of the subsidiary. In many cases, that net investment will be represented simply by the appropriate proportion of the subsidiary’s share capital plus retained profits. But in appropriate cases, intra-group loans may be counted as part of the effective equity stake (see CFM8015).

• the profit and loss account of the foreign enterprise is translated at either the closing rate, or at an average rate for the period.

SSAP20 leaves it open for the company to choose between using the closing rate or using an average rate. (In practice, using an average rate has become almost universal). But, whichever the company chooses, it must apply it consistently from one period to another. Using the closing rate maintains the relationships shown in the financial statements of the overseas enterprise but SSAP20 justifies use of an average rate by saying that it better reflects the impact of cash flows throughout the period from the group viewpoint.

• all exchange differences arising on consolidation are accounted for through reserves.

See CFM8026a for an explanation of how exchange differences arise when the closing rate/net investment method is used. There is an example at CFM8026b.

CFM8028 explains in what circumstances the closing rate/net investment method is used.