in the case of goodwill, historically different views have been held as set out in the
following example.
Example 15.16: Translation of goodwill
A UK company acquires all of the share capital of an Australian company on 30 June 2019 at a cost of A$3m.
The fair value of the net assets of the Australian company at that date was A$2.1m. In the consolidated financial
statements at 31 December 2019 the goodwill is recognised as an asset in accordance with IFRS 3. The relevant
exchange rates at 30 June 2019 and 31 December 2019 are £1=A$2.61 and £1=A$2.43 respectively. At what
amount should the goodwill on consolidation be included in the statement of financial position?
(i)
(ii)
A$
£
£
Goodwill 900,000
344,828
370,370
(i) This method regards goodwill as being an asset of the parent and therefore translated at the historical
rate. Supporters of this view believe that, in economic terms, the goodwill is an asset of the parent
because it is part of the acquisition price paid by the parent, particularly in situations where the parent
acquires a multinational operation comprising businesses with many different functional currencies.
[IAS 21.BC30].
(ii) This method regards goodwill as being part of the parent’s net investment in the acquired entity and
therefore translated at the closing rate. Supporters of this view believe that goodwill should be treated
no differently from other assets of the acquired entity, in particular intangible assets, because a
significant part of the goodwill is likely to comprise intangible assets that do not qualify for separate
recognition; the goodwill arises only because of the investment in the foreign entity and has no existence
apart from that entity; and the cash flows that support the continued recognition of the goodwill are
generated in the entity’s functional currency. [IAS 21.BC31].
The IASB was persuaded by the arguments set out in (ii) above. [IAS 21.BC32]. Accordingly,
IAS 21 requires that any goodwill arising on the acquisition of a foreign operation and
any fair value adjustments to the carrying amounts of assets and liabilities arising on the
acquisition of that foreign operation should be treated as assets and liabilities of the
foreign operation. Thus they are expressed in the functional currency of the foreign
operation and are translated at the closing rate in accordance with the requirements
discussed at 6.1 above. [IAS 21.47].
Clearly, if an entity acquires a single foreign entity this will be a straightforward exercise.
Where, however, the acquisition is of a multinational operation comprising a number of
businesses with different functional currencies this will not be the case. The goodwill
needs to be allocated to the level of each functional currency of the acquired operation.
However, the standard gives no guidance on how this should be done.
In our experience, the most commonly applied way of allocating goodwill to different
functional currencies is an economic value approach. This approach effectively
1156 Chapter 15
calculates the goodwill relating to each different functional currency operation by
allocating the cost of the acquisition to the different functional currency operations on
the basis of the relative economic values of those businesses and then deducting the fair
values that have been attributed to the net assets of those businesses as part of the fair
value exercise in accounting for the business combination (see Chapter 9 at 5). We
consider that any other basis for allocating goodwill to different functional currencies
would need to be substantiated.
The level to which goodwill is allocated for the purpose of foreign currency translation
may be different from the level at which the goodwill is tested for impairment under
IAS 36 (see Chapter 20 at 8.1). [IAS 21.BC32]. In many cases the allocation under IAS 21
will be at a lower level. This will apply not only on the acquisition of a multinational
operation but could also apply on the acquisition of a single operation where the
goodwill is allocated to a larger cash generating unit under IAS 36 that is made up of
businesses with different functional currencies.
As a consequence of this different level of allocation one particular difficulty that
entities are likely to face is how to deal with an impairment loss that is recognised in
respect of goodwill under IAS 36. If the impairment loss relates to a larger cash
generating unit made up of businesses with different functional currencies, again some
allocation of this impairment loss will be required to determine the amount of the
remaining carrying amount of goodwill in each of the functional currencies for the
purposes of translation under IAS 21.
6.6
Disposal or partial disposal of a foreign operation
The requirements relating to disposals and partial disposals of foreign operations have
been amended a number of times in recent years and the current requirements are
considered at 6.6.1 and 6.6.2 below. However, these amendments have given rise to a
number of application issues, some of which were considered by the Interpretations
Committee in 2010, although their deliberations were ultimately inconclusive.
6.6.1
Disposals and transactions treated as disposals
6.6.1.A Disposals
of
a foreign operation
Exchange differences resulting from the translation of a foreign operation to a different
presentation currency are to be recognised in other comprehensive income and
accumulated within a separate component of equity (see 6.1 above).
On the disposal of a foreign operation, the exchange differences relating to that foreign
operation that have been recognised in other comprehensive income and accumulated
in the separate component of equity should be recognised in profit or loss when the gain
or loss on disposal is recognised. [IAS 21.48]. This will include exchange differences arising
on an intragroup balance that, in substance, forms part of an entity’s net investment in a
foreign operation (see 6.3 above).
Example 15.17: Disposal of a foreign operation
A German entity has a Swiss subsidiary which was set up on 1 January 2016 with a share capital of CHF200,000
when the exchange rate was €1=CHF1.55. The subsidiary is included in the parent’s separate financial statements
at its original cost of €129,032. The profits of the subsidiary, all of which have been retained by the subsidiary, for
Foreign
exchange
1157
each of the three years ended 31 December 2018 were CHF40,000, CHF50,000 and CHF60,000 respectively, so
that the net assets at 31 December 2018 are CHF350,000. In the consolidated financial statements the results of the
subsidiary have been translated at the respective average rates of €1=CHF1.60, €1=CHF1.68 and €1=CHF1.70 and
the net assets at the respective closing rates of €1=CHF1.71, €1=CHF1.65 and €1=CHF1.66. All exchange
differences have been recognised in other comprehensive income and accumulated in a separate exchange reserve.
The consolidated reserves have therefore included the following amounts in respect of the subsidiary:
Retained
profit
Exch
ange reserve
€
€
1 January 2016
–
–
Movement during 2016
25,000
(13,681)
31 December 2016
25,000
(13,681)
Movement during 2017
29,762
5,645
31 December 2017
54,762
(8,036)
Movement during 2018
35,294
(209)
31 December 2018
90,056
(8,245)
The net assets at 31 December 2018 of CHF350,000 are included in the consolidated financial statements at €210,843.
On 1 January 2019 the subsidiary is sold for CHF400,000 (€240,964), thus resulting in a gain on disposal in
the parent entity’s books of €111,932, i.e. €240,964 less €129,032.
In the consolidated financial statements for 2019, IAS 21 requires the cumulative exchange losses of €8,245
to be recognised in profit or loss for that year. Assuming they were included as part of the gain on disposal
(which was explicitly required by earlier versions of IAS 27)14 this gain would be reduced to €21,876, being
€30,121 (the difference between the proceeds of €240,964 and net asset value of €210,843 at the date of
disposal) together with the cumulative exchange losses of €8,245.
In this example, this gain on disposal of €21,876 represents the parent’s profit of €111,932 less the cumulative
profits already recognised in group profit or loss of €90,056.
The following accounting policies of Pearson reflect these requirements as shown below.
Extract 15.4: Pearson plc (2015)
Notes to the consolidated financial statements [extract]
1 Accounting
policies [extract]
c.
Foreign currency translation [extract]
3. Group companies – The results and financial position of all Group companies that have a functional currency
different from the presentation currency are translated into the presentation currency as follows:
i)
Assets and liabilities are translated at the closing rate at the date of the balance sheet
ii)
Income and expenses are translated at average exchange rates
iii)
All resulting exchange differences are recognised as a separate component of equity.
On consolidation, exchange differences arising from the translation of the net investment in foreign entities, and of
borrowings and other currency instruments designated as hedges of such investments, are taken to shareholders’
equity. The Group treats specific inter-company loan balances, which are not intended to be repaid in the foreseeable
future, as part of its net investment. When a foreign operation is sold, such exchange differences are recognised in
the income statement as part of the gain or loss on sale.
The principal overseas currency for the Group is the US Dollar. The average rate for the year against sterling was
$1.53 (2014: $1.65) and the year end rate was $1.47 (2014: $1.56).
1158 Chapter 15
This treatment is to be adopted not only when an entity sells an interest in a foreign
entity, but also when it disposes of its interest through liquidation, repayment of share
capital, or abandonment of that entity. [IAS 21.49].
The requirement to reclassify the cumulative exchange differences to profit or loss
cannot be avoided, for example, by an entity merely disposing of the net assets and
business of the foreign operation, rather than disposing of its interest in the legal entity
that is the foreign operation. This is because paragraph 49 refers to the disposal of a
foreign operation, and a foreign operation as defined by IAS 21 must have ‘activities’
(see 2.3 above). Following the disposal of the net assets and business, there no longer
are ‘activities’. Furthermore, a foreign operation need not be an incorporated entity but
may be a branch, the disposal of which would necessarily take the form of an asset sale.
The legal form of the entity should make no difference to the accounting treatment of
exchange differences, including the reclassification of cumulative exchange differences
from equity to profit or loss. It also follows that reclassification of exchange differences
could potentially be required on the disposal of a branch or similar operation within a
legal entity if it represents a separate foreign operation (see 4.4 above).
Where it is a subsidiary that is disposed of, the related exchange differences that have
been attributed to the non-controlling interests should be derecognised and therefore
included in the calculation of the gain or loss on disposal, but should not be reclassified
to profit or loss. [IAS 21.48B]. This is illustrated in the following example.
Example 15.18: Disposal of a partially owned foreign subsidiary
Entity P, which is incorporated in France and has the euro as its functional currency, owns 80% of Entity S
which has US dollars as its functional currency. In P’s consolidated financial statements, the following
amounts have been recognised in relation to its investment in S:
• net assets of €1,000 and associated non-controlling interests of €200;
• foreign exchange gains of €100 were recognised in other comprehensive income, of which €20 was
attributable to non-controlling interests and is therefore included in the €200 non-controlling interests;
• €80 of foreign exchange gains have therefore been accumulated in a separate component of equity
relating to P’s 80% share in S.
P sells its 80% interest in S for €1,300 and records the following amounts:
Dr Cash
1,300
Dr NCI
200
Dr OCI
80
Cr Net assets
1,000
Cr Profit on disposal
580
It can be seen that €80 of the foreign currency gains previously recognised in OCI, i.e. the amount attributed
to P, is reclassified to profit or loss (profit on disposal) and reported as a loss in OCI. However, the €20 of
such gains attributed to the non-controlling interests is not reclassified in this way and is simply derecognised
along with the rest of the NCI balance.
6.6.1.B
Transactions treated as disposals
In addition to the disposal of an entity’s entire interest in a foreign operation, the
following partial disposals are accounted for as disposals: [IAS 21.48A]
Foreign
exchange
1159
(a) when the partial disposal involves the loss of control of a subsidiary that includes
a foreign operation, regardless of whether the entity retains a non-controlling
interest in its former subsidiary after the partial disposal; and
(b) when the retained interest after the partial disposal of an interest in a joint
arrangement or a partial disposal of an interest in an associate that includes a
foreign operation is a financial asset that includes a foreign operation.
Therefore all exchange differences accumulated in the separate component of equity
relating to that foreign operation are reclassified on its disposal even if the disposal results
from a sale of only part of the entity’s interest in the operation, for example if a parent
sold 60% of its shares in a wholly owned subsidiary which as a result became an associate.
The treatment of exchange differences relating to an investment in an associate or joint
venture that becomes a subsidiary in a business combination is not clearly specified in
IAS 21. However, in these circumstances, IAS 28 clearly requires the reclassification of
equity accounted exchange differences of the associate or joint venture that were
recognised in other comprehensive income (see Chapter 9 at 9 and Chapter 11 at 7.12.1)
and, in our view, the same treatment should apply to the exchange differences arising
on the associate or joint venture itself.
6.6.2 Partial
disposals
6.6.2.A
What constitutes a partial disposal?
A partial disposal of an entity’s interest in a foreign operation is any reduction in its
ownership interest, except for those that are accounted for as disposals (see 6.6.1 above).
[IAS 21.48D].
A write-down of the carrying amount of a foreign operation, either because of its own
losses or because of an impairment recognised by the investor, does not constitute a
partial disposal, therefore no deferred exchange difference should be reclassified from
equity to profit or loss at the time of the write-down. [IAS 21.49]. Similarly, it is implicit in
the requirement of IFRS 5 – Non-current Assets Held for Sale and Discontinued
Operations – for separate disclosure of cumulative gains and losses recognised in equity
relating to a disposal group (see Chapter 4 at 2.2.4) that the classification of a foreign
operation as held for sale under IFRS 5 does not give rise to a reclassification of foreign
exchange differences to profit or loss at that time.
Also, a dividend made by a foreign operation that is accounted for as revenue by its
parent, investor or venturer in its separate financial statements (see Chapter 8 at 2.4.1)
should not be treated as a disposal or partial disposal of a net investment. [IAS 21.BC35].
The term ‘ownership interest’ is not defined within IFRS, although it is used in a number
of standards,15 normally to indicate an investor’s proportionate interest in an entity. This
might seem to indicate that a partial disposal arises only when an investor reduces its
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 229
