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HMRC internal manual

Corporate Finance Manual

Accounting for corporate finance: foreign exchange: foreign operations: overview

Foreign operations: overview

CFM26020 explained that a company will be exposed to currency fluctuations if it invests in an entity that keeps its accounts in a foreign currency. If a company has an investment in an overseas subsidiary (or an associated company or joint venture), it will need to include the results of that entity in its consolidated financial statements. Similarly, if a company carries on operations through a branch, and that branch accounts in a foreign currency, the company will need to translate the results of the branch when it prepares its own accounts. This section focuses on this second scenario.

In cases where the foreign operation operates autonomously from the rest of the company and, as a result, has a different functional currency (or local currency if applying SSAP 20 under Old UK GAAP) then the results of the foreign operation must initially be calculated by reference to that currency before being retranslated into the presentation currency of the accounts in which it assets, liabilities and results are to be included. This method was referred to as the closing rate or net investment method in SSAP 20 under Old UK GAAP. Whilst FRS 23 under Old UK GAAP, IFRS and New UK GAAP do not refer directly to this method their requirements are very similar in this situation.

Where, on the other hand, a foreign operation merely acts as an extension of its parent without significant autonomy it was possible if applying SSAP 20 under Old UK GAAP for the foreign operation to have a different local currency to its parent. However on consolidation the assets, liabilities and results of the foreign operation would be translated into the local currency of the parent company as though they were the parent company’s own. In SSAP 20 under Old UK GAAP this was referred to as the temporal method. This method does not arise when applying FRS 23 under Old UK GAAP, IFRS or New UK GAAP as the foreign operation would have the same functional currency as its parent. The net effect however is the same.

This section of the guidance explains what these two methods are, and when each should be used.