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Net investment in a foreign operation
Extract from FRS102: Section 30.12 -30.13
30.12 An entity may have a monetary item that is receivable from or payable to a foreign operation. An item for which settlement is neither planned nor likely to occur in the foreseeable future is, in substance, a part of the entity’s net investment in that foreign operation, and is accounted for in accordance with paragraph 30.13. Such monetary items may include long-term receivables or loans. They do not include trade receivables or trade payables
30.13 Exchange differences arising on a monetary item that forms part of a reporting entity’s net investment in a foreign operation shall be recognised in profit or loss in the separate financial statements of the reporting entity or the individual financial statements of the foreign operation, as appropriate. In the financial statements that include the foreign operation and the reporting entity (e.g. consolidated financial statements when the foreign operation is a subsidiary), such exchange differences shall be recognised in other comprehensive income and accumulated in equity. They shall not be recognised in profit or loss on disposal of the net investment.
OmniPro comment
The net investment in a foreign operation is defined in Appendix I of FRS 102 as ‘the amount of the reporting entity’s interest in the net assets of that operation’. In effect this includes monetary items that are payable or receivable from or to a foreign operation for which settlement is neither planned nor likely to occur in the foreseeable future (often referred to as ‘permanent as equity’ loan).
In order for the treatment to occur, there must be some supporting documentation i.e. board minutes to substantiate that the loan will not require settlement in the foreseeable future. In effect this loan is akin to a capital contribution by the company paying the loan. So if for example the loan conditions said it was repayable in 30 years time this would not meet the condition to be treated as permanent as equity as the settlement is planned in the future. If further conditions are then added to the loan to say that this loan no longer matures in 20 years time and is not repayable in the foreseeable future, it is likely this treatment will be obtained.
If the loan only becomes repayable on sale of the foreign operation this would meet the condition.
As these type of loans are monetary assets, the assets/liabilities must be retranslated at each period end using the year end spot rate.
The way in which a net investment should be treated in the individual financial statements of the entity that takes the foreign exchange risk is the same as any other monetary asset:
- The foreign exchange loss/gain as a result of retranslating the asset to the year end rate is posted to the profit and loss account as an unrealised foreign exchange loss/gain.
However in the consolidated financial statements the foreign exchange gain/loss is posted to other comprehensive income. Therefore this is only applicable where consolidated accounts are prepared.
Where it becomes evident that a loan previously repayable is not likely to repayable in the foreseeable future, the exchange gain on the loan that is posted in the consolidated accounts to OCI is the exchange rate on the date the loan conditions changed to the year end.
Example 10: Net investment in a foreign operation
Parent A loaned CU100,000 to Sub A on 1 February (Sub A has a functional currency in FC) which is neither planned nor likely to occur in the foreseeable future, so the entity is regarded as a net investment in a foreign operation. The foreign exchange rate at the date of receipt by Sub A was FC1=CU1.20. The spot rate at 31 December is FC1=CU1.15 and the year end for both companies is 31 December. Assume the average rate in the year was FC1=CU1.17. The journals to be posted for FX are:
Sub A
|
|
FC |
FC |
|
Dr Bank |
83,333 |
|
|
Cr Amounts Due to Parent A (CU100,000/1.2) |
|
83,333 |
Being journal to reflect receipt of loan at transaction date
At year end
|
|
FC |
FC |
|
Dr FX Loss P&L |
3,623 |
|
|
Cr Amounts Due to Parent A ((CU100,000/1.15)=FC86,956-FC83,333) |
|
3,623 |
Being journal to reflect unrealised FX loss due to retranslation to year end rate
Parent A
No FX effect as it was issued in CU.
Consolidated accounts
|
|
CU |
CU |
|
Dr Unrealised FX in OCI |
4,239 |
|
|
Cr FX in Profit and Loss (FC3,623*1.17) |
|
4,239 |
Being journal to reclassify the FX loss from P&L to OCI assuming average rate for the year was used in the consolidation. This would then be recognised in a separate component in equity.
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