Subsidiary with significant autonomy
Every entity should have its functional or home currency – ie, the currency of the economic environment in which it mainly generates and expends cash. In order to determine the functional currency, you first need to consider the following set of primary factors:
If you can’t make a definitive conclusion based on these, you’ll need to consider the following secondary factors:
These factors will normally need to be considered when the primary factors don’t point to a single currency – eg when the “sales” factor shows euros to be the functional currency while the “cost” factor indicates dollars.
In essence, there are two steps to dealing with a foreign currency transaction:
On the initial recognition, the amount of foreign currency involved has to be converted to the entity’s functional currency by applying the spot exchange rate between the currencies at the transaction date.
The subsequent measurement step is more complicated because monetary items and non-monetary items require different accounting treatments.
Monetary items are defined by IAS21 as “money held, and assets and liabilities to be received or paid, in a fixed or determinable number of units of currency”. Examples include cash, accounts receivable and accounts payable.
Non-monetary items are characterized by the “absence of the right to receive, or obligation to deliver, a fixed or determinable number of units of currency”.
Foreign subsidiaries can be classfied into two groups. First, those which are dependent on parents and infact act like an extension of parents current operations. Second category is where the foreign subsidiary is independent in its operations and acts with autonomy.
In the first category which is a dependent subsidiary, the consolidation process is rather straightforward. The second category, that is, an autonomous subsidiary the consolidation rules relating the foreign exchange are significantly different.
This blog covers the topic of accounting treatment when consolidating a foreign subsidiary that is autonomous in its activities
In a group context, when an entity determines the functional currency of a foreign operation – eg, an overseas subsidiary – the relationship between the two organizations need to be considered. There are two possible scenarios.
One is that the overseas operation has a significant degree of autonomy – eg, inter-company transactions are infrequent. In this case, the functional currency of the foreign subsidiary is that entity’s local currency.
The other scenario is that the foreign operation is an extension of the parent – eg, inter-company transactions are frequent – and it depends on the parent company for financing. In this case, the subsidiary takes the parent’s functional currency.
The essence of consolidating foreign subsidiaries is that their financial statements are presented in a different currency from that of their parent’s presentation currency. An important first step in the consolidation process is to translate the statements of the foreign operation into the parent’s presentation currency.
The method to use is determined as shown in the diagrams below.
You should learn and remember the basic consolidation techniques such as goodwill calculations under IFRS 3 (revised) and the implication behind non-controlling interests (NCI), together with how the NCI figures should be determined.