CFM8026b – Accounting for foreign exchange: closing rate/net investment example
Closing rate/net investment method: example
A UK company has a US subsidiary which it set up many years ago
when the exchange rate was £1 = $2. It is preparing
consolidated accounts for the year ended 31 December 2004. Exchange
rates are as follows:
31 December 2003: £1 = $1.60
31 December 2004: £1 = $1.20
It translates the profit and loss account of the subsidiary
at the closing rate. The profit and loss account of the subsidiary,
in US dollars and translated into sterling, is
| $ | Rate | £ | |
| Profit on ordinary activities before taxation | 130,000 | 1.2 | 108,333 |
| Taxation | ( 40,000) | 1.2 | 33,333 |
| Profit after taxation | 90,000 | 1.2 | 75,000 |
The opening and closing balance sheets, in US dollars and in sterling, are as follows:
| 31/12/2003 | 31/12/2003 | 31/12/2004 | 31/12/2004 | |||
| $ | Rate | £ | $ | Rate | £ | |
| Fixed assets | 80,000 | 1.6 | 50,000 | 90,000 | 1.2 | 75,000 |
| Current assets | 30,000 | 1.6 | 18,750 | 95,000 | 1.2 | 79,167 |
| Current liabilities | (45,000) | 1.6 | (28,125) | (30,000) | 1.2 | (25,000) |
| Long-term loan | (15,000) | 1.6 | (9,375) | (15,000) | 1.2 | (12,500) |
| Net assets | 50,000 | 1.6 | 31,250 | 140,000 | 1.2 | 116,667 |
| Share capital | 1,000 | 2.0 (note 1) | 500 | 1,000 | 2.0 (note 1) | 500 |
| Retained profits | 49,000 | (note 2) | 30,750 | 139,000 | (note 2) | 116,167 |
| 50,000 | 31,250 | 140,000 | 116,667 |
Note 1: The company's original investment in its subsidiary is
carried at historic cost.
Note 2: Retained profits are the balancing figure.
The sterling figure for retained profits at 31 December 2004
can be analysed as follows:
| £ | |
| Balance b/f | 30,750 |
| Profit for year | 75,000 |
| Exchange gain | 10,417 |
| Total | 116,167 |
The exchange gain of £10,417 arises on retranslation of the opening net assets from the opening to the closing rate:
| $50,000 at £1 = $1.6 | £31,250 |
| $50,000 at £1 = $1.2 | £41,667 |
| Exchange gain | £10,417 |
The gain is taken to reserves. In the consolidated accounts, the
Statement of Total Recognised Gains and Losses (STRGL) will contain
an entry:
Currency translation differences on foreign currency net
investment: £10,417
What will happen if the company translates the profit and
loss account of the subsidiary at an average rate for the year -
say £1 = $1.5?
The sterling equivalent of the $90,000 profit becomes
£60,000. The difference between this amount and the
£75,000 resulting from translation at the closing rate, i.e.
an exchange gain of £15,000, would be taken to reserves. The
analysis of retained profit at 31 December 2004 becomes:
| £ | |
| Balance b/f | 30,750 |
| Profit for year | 60,000 |
| Exchange gain | 25,417 |
| Retained profits | 116,167 |
