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Business Doctor: Eurozone arm causes accounting headache

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RS writes: I have a parent company in the UK and a subsidiary in France, with the latter funded from the UK business. This generates a foreign-exchange difference in my group accounts when I consolidate the two at the year end. In the past few years this has been a loss, but I’m concerned that currency movements could have a significant impact. What can I do to mitigate this?

Many global businesses are in a similar position as accounting entries to consolidate accounts can give rise to significant profits or losses in group accounts, writes Jon Dawson, partner at Kingston Smith LLP.

The first point is that these are accounting entries that generally arise from transactions between your UK and French companies. Such transactions are translated at the foreign-exchange rate on the day they occur and build up into intercompany loan balances. You have an asset in the UK company and a liability owed by the French subsidiary. In theory, the two balances should be the same but they vary because different exchange rates are used to build up the balances.

At the year end, the balances are consolidated and an adjustment is made to equalise and cancel the intercompany balances in the group accounts. Where there are significant movements in exchange rates, this adjustment can be large. If sterling weakens, the French company will have better results, comparatively, and the amount it shows as owing the UK company will fall. This may generate a profit on consolidation.

If intercompany loans are kept to a minimum, there is less impact on group reporting. You could explore waiving any loans, but consider if this has a tax effect on either company. You should also explore if the waiver is treated as a distribution under French accounting regulations.