Integral vs Non-Integral Foreign Operations under AS 11

Understand Net Investment in Non-Integral Foreign Operations

Key rules to remember

Classification test

Integral = extension of the reporting enterprise's business. Non-integral = operates substantially in its own local currency.

Paras 17 to 19. Classification depends on how the operation is financed and operates in relation to the reporting enterprise.

Translation of a non-integral operation: assets and liabilities

Assets and liabilities (monetary and non-monetary) × closing rate

Para 24(a). Fixed assets and inventory also use the closing rate, unlike historical-cost translation.

Translation of a non-integral operation: income and expenses

Income and expense items × rate at the date of each transaction

Para 24(b). In practice, an average rate is often used as a approximation when the question says so.

Exchange difference on translation

Exchange difference = Net assets at closing rate (translated) − Opening net investment (at opening rate) − Profit for the year (at transaction rates) ± other equity changes

Balancing figure that arises from the sources in Para 26. It goes to the foreign currency translation reserve, not to profit or loss.

Net investment

Net investment = Reporting enterprise's share in the net assets of the non-integral foreign operation

Para 7.12.

Treatment of exchange difference

Accumulate in foreign currency translation reserve until disposal of the net investment

Para 24(c). On disposal, it is recognised as income or expense (Para 15 refers to Para 31).

Monetary item forming part of net investment

Exchange difference on such an item → foreign currency translation reserve until disposal

Para 15. Applies where the item, in substance, forms part of the net investment.

Minority interest

Translation differences attributable to minority interest are allocated to and reported as part of minority interest

Para 26, for a non-integral operation that is consolidated but not wholly owned.

How to solve Net Investment in Non-Integral Foreign Operations questions

1. 1Read the facts and classify the operation. Does it act as an extension of the parent (sells parent's goods, remits proceeds) or does it operate in its local currency with its own finance? Write the classification and one line of reason.
2. 2List the rates given: opening rate, closing rate, rate on transaction dates or average rate. Note which items each rate applies to.
3. 3For a non-integral operation, translate all assets and liabilities at the closing rate. Show each item in a column.
4. 4Translate income and expense items at transaction-date rates (or the average rate if the question gives it). Find the translated profit.
5. 5Translate the opening net investment at the opening rate, so you have the figure previously reported.
6. 6Find the exchange difference as the balancing figure: closing net assets translated minus opening net investment minus translated profit (and adjust for any other equity change given).
7. 7Transfer the exchange difference to the foreign currency translation reserve. Do not take it to the statement of profit and loss.
8. 8Present the translated balance sheet so that it balances, and state that the reserve stays until disposal of the net investment.

Quickest way: Closing-net-assets balancing method

Common mistakes in Net Investment in Non-Integral Foreign Operations

• Taking the exchange difference on translation of a non-integral operation to the statement of profit and loss.

  Students mix it up with the treatment of exchange differences on foreign currency transactions of the enterprise itself.

  Fix: Remember Para 24(c) and Para 26: these differences are not income or expense for the period. Accumulate them in the foreign currency translation reserve until disposal.

• Translating fixed assets and inventory of a non-integral operation at historical rates.

  Students carry over the historical-cost approach used for non-monetary items elsewhere.

  Fix: Para 24(a) says assets and liabilities, both monetary and non-monetary, are translated at the closing rate.

• Translating all income and expenses at the closing rate.

  Students apply one rate to the whole trial balance for speed.

  Fix: Para 24(b) requires the rates on the dates of the transactions. Use the average rate only when the question gives it or tells you to approximate.

• Classifying the operation by its legal form, such as subsidiary or branch, instead of how it operates.

  Students think a branch is always integral and a subsidiary is always non-integral.

  Fix: Apply the functional test of Paras 17 to 19: does it work as an extension of the parent, or substantially in local currency with its own finance?

• Eliminating the exchange difference on an intra-group monetary item against another intra-group balance on consolidation.

  Students assume all intra-group balances cancel out.

  Fix: Para 29 says such a difference cannot be eliminated because the item commits the group to convert one currency into another. It stays in income or expense, or in the translation reserve if Para 15 applies.

• Ignoring the minority's share of the translation difference in a partly owned subsidiary.

  Students put the whole reserve under the parent's equity.

  Fix: Per Para 26, the share attributable to minority interest is allocated to and reported as part of the minority interest.

Worked examples