Chapter 5: Disposal or partial disposal of a foreign operation

The cumulative amount of exchange differences recognised in other comprehensive income is carried forward as a separate component of equity until there is a disposal of the foreign operation. On the foreign operation’s disposal, such exchange differences are recognised in profit or loss (that is, reclassified) when the gain or loss on disposal is recognised. Disposal might occur either through sale, liquidation, repayment of share capital or a quasi-equity loan, or abandonment of all (or a part) of the entity.

A partial disposal is a reduction in an entity’s ‘ownership interest’ in a foreign operation, other than loss of control, significant influence or joint control.

Summary of disposals, partial disposals and effect on cumulative translation adjustment Event Disposal or partial disposal Effect on cumulative translation adjustment (CTA) Subsidiary to Subsidiary (change in non-controlling interest (NCI)) Partial disposal Proportionate share of CTA reattributed to NCI Subsidiary to Joint Venture (JV) or Associate (loss of control) Disposal All CTA reclassified to profit or loss Subsidiary to Investment (loss of control) Disposal All CTA reclassified to profit or loss Associate to Associate (reduction in ownership percentage) Partial disposal Proportionate share of CTA reclassified to profit or loss Associate or JV to Investment Disposal All CTA reclassified to profit or loss Impairment of carrying amount of foreign operation Neither None Cessation of hedge accounting for net investment Neither None Conversion of ‘net investment’ loan to equity instrument Neither None Repayment of quasi-equity loan Accounting policy choice – disposal or not a disposal Depends on policy choice Dividend Depends on substance and policy choice. If the dividend payment is, in substance, a return of capital or liquidation, there is an accounting policy choice – disposal or non- disposal. If it is not, in substance, a return of capital or liquidation, it is not a disposal/partial disposal. Depends on substance and policy choice.

Does a parent entity need to track cumulative exchange differences individually for each of its foreign operations? Yes. However, the tracking of cumulative exchange differences can be onerous. For a parent entity with more than one foreign operation, it could be tempting to aggregate these exchange differences related to all the net investments in one currency together, with the reclassification of these exchange differences on the disposal (or partial disposal) of some of those foreign operations being calculated proportionately, based on the whole investments’ portfolio. IAS 21 requires reclassification whenever there is a disposal, or partial disposal, of a foreign operation, so the cumulative translation adjustment (CTA) needs to be tracked on each individual net investment. There is no requirement to separately track the CTA on a loan that forms part of the net investment in the foreign operation, because such CTA is included within the total CTA for the foreign operation.

Reclassification of cumulative exchange differences due to a group restructuring In a group restructuring, a foreign operation is transferred from one intermediate holding entity to another. The group continues to hold a 100% interest in that foreign operation. No third parties are involved with the group restructuring. Are the cumulative exchange differences reclassified in the group’s consolidated financial statements? No. The key question is whether the restructuring results in an economic change that, from the group’s perspective, constitutes a partial or full disposal. The foreign operation continues to be part of the consolidated group and so, from the group’s perspective, the restructuring is not a disposal event. Accordingly, no cumulative translation adjustment (CTA) is reclassified in the group’s financial statements. However, if the intermediate holding entity that disposes of the foreign operation prepares consolidated financial statements under IFRS, the CTA deferred in equity (if any) that arises at that intermediate reporting level is reclassified to profit or loss. Are the cumulative exchange differences reclassified in an intermediate holding entity’s consolidated financial statement? If the intermediate holding entity that disposes of the foreign operation prepares consolidated financial statements under IFRS and it recognises the gain or loss on the disposal of the foreign operation in profit or loss, the CTA deferred in equity (if any) that arises at that intermediate reporting level is also reclassified to profit or loss. However, if the disposal by the intermediate holding entity is a non-reciprocal group restructuring transaction outside the scope of IFRS 10 and IFRIC 17 (a demerger), the intermediate holding entity might account for the gain or loss on disposal in equity. In such a case, the intermediate holding entity has an accounting policy choice to recognise the CTA previously deferred in equity either in profit or loss (by applying IAS 21), or in equity (by applying consistent principles to those applied to recognise the gain or loss on disposal in equity. The chosen accounting policy should be applied consistently and disclosed.

When an entity loses control of a subsidiary that is or includes a foreign operation, this is a disposal that triggers reclassification of the entire amount of cumulative translation adjustment (CTA) that has been recorded in equity attributable to that subsidiary, even if the entity retains an interest in that former subsidiary.

How does an entity account for cumulative translation adjustment when there has been a partial disposal? Fully owned subsidiary A parent sells 80% of its 100% interest in the subsidiary, and retains a 20% interest that is classified as being in an associate. The entire amount of cumulative translation adjustment (CTA) in relation to that subsidiary is reclassified to profit or loss (even though the entity retains an interest in that former subsidiary). Partially owned subsidiary Where the subsidiary is partially owned (that is, where a non-controlling interest exists) and the parent has sold its partial interest, the amount of the CTA that has been allocated to the non-controlling interest is derecognised, but it is not transferred to profit or loss. De-recognition of the non-controlling interest (that includes the non-controlling interest’s share of CTA) will form part of the journal entry to recognise the gain or loss on disposal of the subsidiary.

The principle of full reclassification also applies to the loss of joint control or significant influence over a jointly controlled entity or an associate. All CTA that has been accumulated in equity in relation to that jointly controlled entity or associate is reclassified to profit or loss when joint control or significant influence is lost.

On a partial disposal that does not involve loss of control of a subsidiary that includes a foreign operation, the entity re-attributes the proportionate share of the CTA to the non-controlling interests in that foreign operation. Where a subsidiary that is a foreign operation repays a quasi-equity loan or repays/returns share capital, but there is no change in the parent’s proportionate percentage shareholding, there is an accounting policy choice regarding whether the CTA should be reclassified, depending on how ‘ownership interest’ in IAS 21 is interpreted.

Is a repayment of a quasi-equity loan or share capital, without a change in the parent’s proportionate percentage shareholding, a partial disposal for the purposes of IAS 21? Scenario 1 Where a subsidiary that is a foreign operation repays a quasi-equity loan or repays/returns share capital, but there is no change in the parent’s proportionate percentage shareholding, there is an accounting policy choice regarding whether the cumulative translation adjustment (CTA) should be reclassified, depending on how ‘ownership interest’ in IAS 21 is interpreted. Option 1 – No disposal of interest in subsidiary Since the parent continues to own the same percentage of the subsidiary, and continues to control the foreign operation, there has been no change in its proportionate ‘ownership interest’, and hence no disposal or partial disposal. Under this view, ‘ownership interest’ refers only to the proportionate interest. The CTA should not, therefore, be reclassified. Option 2 – Disposal of interest in subsidiary The transaction is a partial disposal, because there has been a reduction in the parent’s absolute ownership interest. Under this view, in addition to a proportionate change in ownership being a partial disposal, ‘ownership interest’ can also be interpreted as a change in the absolute interest held in a net investment. A pro rata share of the CTA should be reclassified. The above options would equally apply to a return of capital/repayment of share capital in similar circumstances. Entities should make an accounting policy choice between these two methods and apply this policy consistently. Scenario 2 Where a foreign operation pays a dividend to its parent, and the substance of the dividend payment is that of a partial return of capital or partial liquidation, the parent similarly has an accounting policy choice whether to treat such an event as a partial disposal.

Partial disposal of a subsidiary while control is retained A parent owns 100% of a subsidiary. The subsidiary is a foreign operation. The parent sells 30% of its shareholding, retaining a 70% shareholding and control. How much, if any, cumulative translation adjustment (CTA) should be reattributed to the non-controlling interest? The reduction in the parent’s ownership interest is a partial disposal under IAS 21. Because 30% of the subsidiary has been disposed of, 30% of the CTA should be re-attributed to the new non-controlling interest. This transfer is accounted for in the statement of changes in equity and is not presented in the performance statements. None of the CTA is reclassified to the income statement.

On the partial disposal of an interest in a jointly controlled entity or an associate, where joint control or significant influence is not lost, a proportionate amount of CTA is reclassified to profit or loss.

Partial disposal of an associate An investor owns 40% of the share capital of an entity. It has significant influence over the entity, and it accounts for the investment as an associate using equity accounting. The associate is a foreign operation. The investor sells half of its total shareholding, retaining a 20% investment. It continues to have significant influence and to account for the investment as an associate. How much, if any, cumulative translation adjustment (CTA) is reclassified to profit or loss? The reduction in the investor’s ownership interest is a partial disposal under IAS 21. Because half of the investment in the associate has been disposed of, 50% of the CTA relating to the foreign associate is reclassified to profit or loss.

An impairment of the carrying amount of a foreign operation does not constitute a partial disposal. CTA is not reclassified to profit or loss at the time of the impairment. Where the impairment arises as a result of a planned sale or liquidation (For example, where the foreign subsidiary is treated as a disposal group in accordance with IFRS 5), the impairment is also not treated as a partial disposal.

Therefore, any CTA attributable to that impairment is not reclassified to profit or loss. Reclassification will occur when the foreign operation is sold.

The cessation of hedge accounting of a net investment because the hedge no longer meets the criteria for the hedge accounting in IAS 39 or IFRS 9 is not a disposal. Therefore, the effective portion of the hedge, and the related CTA previously recognised in other comprehensive income, remain in other comprehensive income until the disposal, or partial disposal, of the foreign operation.

The conversion of a ‘net investment’ loan to an equity instrument (as defined in IAS 32) does not result in reclassification. The reason for this is that the conversion of the loan is the swapping of the legal form of an investment from a debt instrument to an equity instrument, so no disposal has occurred. No further exchange differences will arise on the equity investment in the parent’s separate financial statements, as the investment is now a non-monetary item.

(However, exchange differences would continue to arise on the net assets of the foreign operation.)

The re-denomination of a ‘net investment’ loan into a different currency also does not constitute a disposal or partial disposal of the foreign operation. It does not change the parent’s net investment in the foreign operation; there is no cash movement and so, in substance, there has been no disposal. Therefore, no gains or losses are reclassified from equity to profit or loss.

Hedging a net investment

Management might decide to hedge against the effects of changes in exchange rates in the entity’s net investment in a foreign operation. This could be done by taking out a foreign currency borrowing or a forward contract to hedge the net investment.

Hedging a net investment in a foreign operation can only be carried out at the consolidation level, because the net assets of the foreign operation are reported in the reporting entity’s consolidated financial statements. The requirements for hedging documentation and for criteria set out in IAS 39 or in IFRS 9 must be met.

Any exchange differences on the hedging instrument recognised in other comprehensive income are reclassified to profit or loss on disposal of the foreign operation, along with related CTA. IFRIC 16 gives further detailed guidance on hedges of net investments.

Hedging a net investment in a foreign operation – example Company S, a Swedish entity with the Swedish krona as its functional currency, has a subsidiary with the US dollar as its functional currency. Company S has a third-party long-term debt agreement in the amount of US$4,000,000. Company S designates US$2,000,000 of the debt at the beginning of the year as a hedge of its net investment in the foreign subsidiary. The part of the debt qualifying as a hedging instrument is outside the scope of IAS 21 and is instead accounted for under IFRS 9 (or, for entities that have not yet adopted IFRS 9, IAS 39). The portion of the debt instrument that is not designated in the hedging relationship is, however, still within the scope of IAS 21.

Note: IAS 21 does not address the presentation of cash flows arising from transactions in a foreign currency in a statement of cash flows, nor the translation of cash flows of a foreign operation; these issues are addressed in IAS 7.

Foreign operations in hyper-inflationary economies

Where an entity’s functional currency is the currency of a hyper-inflationary economy, the entity restates its financial statements in accordance with IAS 29, ‘Financial reporting in hyper-inflationary economies’.

The restated financial statements are then translated into a different presentation currency by applying the closing rate at the date of the most recent statement of financial position to all amounts (that is, to assets, liabilities, equity items, income and expenses).

If the presentation currency is the currency of a hyper-inflationary economy, comparatives are translated by applying the same methodology; otherwise, the comparative amounts are those that were presented as current year amounts in the relevant prior year financial statements (that is, not adjusted for subsequent changes in the price level or for subsequent changes in exchange rates).

Loss of control of a wholly-owned foreign operation – example A parent, Company P, has held a 100 per cent interest in a subsidiary, Company S, for a number of years. Company S is a foreign operation and, in accordance with IAS 21, exchange differences of CU2.5 million relating to Company S have been recognized in other comprehensive income and accumulated in a separate component of equity. Company P disposes of 51 per cent of its interest in Company S, resulting in loss of control. Its retained interest of 49 per cent ensures that it retains significant influence over Company S. When an entity loses control of a subsidiary that includes a foreign operation, this is accounted for as a full disposal under IAS 21 irrespective of (1) the nature of the event, transaction or change in circumstances leading to the loss of control, and (2) whether the entity retains an interest in the former subsidiary. Consequently, the cumulative exchange differences relating to that operation, previously recognized in other comprehensive income and accumulated in equity, are reclassified from equity to profit or loss when the gain or loss on disposal is recognized. In line with the requirements discussed, in the circumstances described, notwithstanding Company P’s continuing influence over Company S, all of the exchange differences of CU2.5 million are reclassified from equity to profit or loss and are included in the calculation of the profit or loss on disposal of Company S.

Recognition of cumulative exchange differences in profit or loss upon discontinuation of the equity method (no disposal) – example Entity X (functional currency US dollar) is an associate (a foreign operation) of Entity Y (functional and presentation currency Japanese yen). Entity Y accounts for its investment in Entity X using the equity method of accounting, and Entity X’s financial statements are translated into the Japanese yen presentation currency using the methodology illustrated. As a result, Entity Y recognizes exchange differences in other comprehensive income (OCI). During the year ending 31 December 20X1, Entity Y’s representation on the board of directors of Entity X is reduced and Entity Y determines that it no longer has significant influence over Entity X. In accordance with IAS 28, Entity Y is required to discontinue the equity method from the date when Entity X ceases to be an associate (i.e., when it ceases to have significant influence over Entity X) and to measure its retained interest in Entity X, being a financial asset, at fair value, recognizing in profit or loss the difference between the fair value of the retained interest and the carrying amount of the investment at the date the equity method is discontinued. The cumulative exchange differences previously recognized in OCI in respect of its investment in Entity X should be reclassified to profit or loss upon discontinuation of the equity method. IAS 28 requires that when an entity discontinues the use of the equity method, it should account for all amounts previously recognized in OCI in relation to that investment on the same basis as if the investee had directly disposed of the related assets or liability. IAS 28 addresses the appropriate accounting upon discontinuation of the equity method for amounts previously recognized in OCI when an associate or a joint venture has a foreign operation. Although IAS 28 does not specifically mention circumstances in which the associate/joint venture is itself a foreign operation, a consistent approach should be applied. This reflects the fact that, whether the associate/joint venture is itself or has a foreign operation, the economic exposure of the investor to exchange differences is substantively the same.

Loss of control of a partially-owned foreign operation – exchange differences attributable to non-controlling interests – example A parent, Company P, has held an 80 per cent interest in a subsidiary, Company S, for a number of years. Company S is a foreign operation and, in accordance with IAS 21, exchange differences of CU2.5 million relating to Company S have been recognized in other comprehensive income. 80 per cent of the exchange differences (i.e., CU2 million) have been accumulated in Company P’s foreign currency translation reserve in equity, and the remainder has been attributed to non-controlling interests. At 31 December 20X1, the net assets of Company S are as follows. Total Attributable to Company P (80%) NCI (20%) CU ‘000 CU ‘000 CU ‘000 Net assets 30,000 24,000 6,000 Foreign currency translation reserve 2,500 2,000 500 Other equity 27,500 22,000 5,500 Total equity 30,000 24,000 6,000 On 1 January 20X2, Company P disposes of a 31 per cent interest in Company S, resulting in loss of control. Its retained interest of 49 per cent ensures that it retains significant influence over Company S. As illustrated, notwithstanding this continuing influence, all of the exchange differences of CU2.5 million are required to be derecognised. The proceeds on disposal are CU15 million. The fair value of Company P’s continuing 49 per cent interest in Company S is CU22 million. Assume that there are no other components of equity to be reclassified on disposal. In accordance with IFRS 10, Company P’s profit on disposal of its 31 per cent interest is calculated as follows. CU ‘000 Proceeds on disposal 15,000 Fair value of interest retained 22,000 Net assets disposed of (30,000) NCI derecognised 6,000 Exchange differences reclassified 2,000 Gain on disposal 15,000 In accordance with IAS 21, the exchange differences attributable to Company P (CU2 million) are reclassified to profit or loss from the foreign currency translation reserve in equity and included in the calculation of the profit or loss on disposal of Company S. In accordance with IAS 21, the exchange differences attributable to the non-controlling interests (CU0.5 million) are derecognised, but they are not separately reclassified to profit or loss. Those exchange differences were already reflected as part of the carrying amount of non-controlling interests of CU6 million in the consolidated statement of financial position which, as described in IFRS 10, is included in the calculation of the profit or loss on disposal of Company S.

Reduction in proportionate interest in a subsidiary that includes a foreign operation The transfer, or re-attribution, required in respect of the partial disposal of a subsidiary should be recognized in equity. Therefore, the exchange differences relating to the portion of the investment disposed of are not recognized in profit or loss as a reclassification adjustment at the date of the transaction. Nor are they reclassified to profit or loss at the date of ultimate disposal of the partially-owned subsidiary. This treatment, illustrated below, reflects the general approach adopted under IFRS 10 that changes in a parent’s ownership interest in a subsidiary that do not result in a loss of control are accounted for as equity transactions. For example, a parent, Company P, has held a 100 per cent interest in a subsidiary, Company S, for a number of years. Company S is a foreign operation and, in accordance with IAS 21, exchange differences of CU2.5 million relating to Company S have been recognized in other comprehensive income and accumulated in a separate component of equity. Entity P disposes of 20 per cent of its interest in Company S, but retains control over the subsidiary. This transaction is classified as a partial disposal of Company S because there has been a reduction in Entity P’s ownership interest but no loss of control. When a parent disposes of part of its interest in a subsidiary that includes a foreign operation, but it retains control of that subsidiary, IAS 21 requires that the parent should re-attribute the proportionate share of the cumulative amount of the exchange differences recognized in other comprehensive income to the non-controlling interests in that foreign operation. Consequently, in the circumstances described, at the date of the transaction, 20 per cent of the cumulative exchange differences (i.e., CU0.5 million) are transferred within equity from the foreign currency translation reserve to non-controlling interests. No amounts are reclassified to profit or loss.

Meaning of the term partial disposal – reductions in an entity’s absolute interest with no change in proportionate interest IAS 21 defines a partial disposal of an entity’s interest in a foreign operation as “any reduction in an entity’s ownership interest in a foreign operation, except those reductions in IAS 21 that are accounted for as disposals”. IAS 21 does not provide any further guidance on what is meant by “any reduction in an entity’s ownership interest in a foreign operation”. When there has been a reduction in the percentage equity ownership of a foreign operation, it is clear that the entity’s ownership interest has been reduced and, therefore, a partial disposal has occurred. However, there are other transactions that do not affect an investor’s percentage equity ownership but that could be argued to reduce its ownership interest in the foreign operation; For example: a pro rata repayment of capital by the foreign operation to all investors; repayment of a loan or redemption of non-equity shares that form part of the net investment in the foreign operation; or the payment by the foreign operation of a dividend to all shareholders in proportion to their shareholdings. The question arises as to whether a partial disposal occurs only when there is a reduction in the proportionate (relative) equity ownership interest in a foreign operation or whether a partial disposal can also occur when there is a reduction in the entity’s absolute interest in the foreign operation but no reduction in the proportionate equity ownership interest. This question was considered by the IFRS Interpretations Committee in September 2010. The Committee considered a proposal to amend the wording of IAS 21 to ‘clarify’ that reclassification of exchange differences is appropriate when any absolute reduction in the net investment occurred. This proposal was rejected by the Committee and no consensus emerged. The September 2010 IFRIC Update reported the Committee’s decision as follows. “The Committee considers that different interpretations could lead to diversity in practice in the application of IAS 21 on the reclassification of the FCTR [foreign currency translation reserve] when repayment of investment in a foreign operation occurs. However, the Committee decided neither to add this issue to its agenda nor to recommend the Board to address this issue through Annual Improvements because it did not think that it would be able to reach a consensus on the issue on a timely basis.” The view expressed by the IFRS Interpretations Committee indicates that the Committee regards both interpretations of the requirements of IAS 21 as acceptable. The ‘proportionate’ approach is straightforward and easily understood and might, therefore, be seen as preferable. Under this method, a transaction that does not reduce the investor’s percentage equity ownership of a foreign operation will not result in the reclassification or re-attribution of cumulative exchange differences previously recognized in other comprehensive income. Application of the ‘absolute’ approach, on the other hand, involves many challenges – particularly in the context of partial disposals of subsidiaries. Under this method, reclassification or re-attribution of amounts held in the foreign currency translation reserve may arise in circumstances when the investor’s percentage equity ownership does not change. However, a number of issues arise in applying such an approach that were not addressed by the IFRS Interpretations Committee and that are not explained by IAS 21. These include the following in respect of the mechanics of such an approach: the amount that should be re-attributed from the foreign currency translation reserve to non-controlling interests on a pro rata repayment of capital to all equity holders by a partially-owned subsidiary. It is unclear how in these circumstances exchange differences have been ‘transferred’ from the parent to the non-controlling interests; and the calculation of the ‘proportionate share’ of exchange differences to reclassify or re-attribute on repayment of a loan that forms part of the net investment in a foreign operation (i.e., the exchange differences relating to the repaid loan or a proportionate amount of the total exchange differences recognized on the investment). In addition, there are circumstances in which application of an absolute approach does not appear to result in an outcome that is a relevant or representationally faithful depiction of the ‘partial disposal’ transaction: it does not appear appropriate to re-attribute amounts from the foreign currency translation reserve to non-controlling interests when a subsidiary that includes a foreign operation is wholly owned before and after the partial disposal transaction; and it could be argued that payment of a dividend reduces the absolute interest in an investee. However, IAS 21 expresses an intention that dividends recognized in profit or loss in accordance with IAS 27 cannot be considered a disposal or partial disposal of a net investment in IAS 21. Entities need to make accounting policy choices between the proportionate and absolute reduction approaches and, if applicable, how the absolute reduction approach is applied. An entity’s accounting policies should be disclosed when material.

Write-downs A write-down of the carrying amount of a foreign operation, either because of its own losses or because of an impairment loss recognized by the investor, does not constitute a partial disposal. Accordingly, no part of the foreign exchange gain or loss recognized in other comprehensive income is reclassified to profit or loss at the time of a write-down.

Reduction in proportionate interest in an associate with no loss of significant influence – example An investor, Company I, has held a 40 per cent interest in an associate, Company B, for a number of years. Company B is a foreign operation and, in accordance with IAS 21, exchange differences of CU50,000 relating to Company B have been recognized in other comprehensive income and accumulated in the foreign currency translation reserve. Company, I dispose of a 10 per cent interest in Company B, but retains significant influence over the associate through its remaining 30 per cent shareholding. This transaction is classified as a partial disposal of Company B because there has been a reduction in Entity P’s ownership interest but no loss of significant influence. When an investor disposes of part of its interest in an associate that includes a foreign operation but retains significant influence over that associate, IAS 21 requires that the investor reclassify to profit or loss the proportionate share of the cumulative amount of the exchange differences previously recognized in other comprehensive income. Consequently, in the circumstances described, at the date of the transaction one quarter of the cumulative exchange differences (i.e., CU12,500) are reclassified from equity to profit or loss.