What to consider: accounting for international expansion
31st Jan 2020
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With BREXIT imminent, many UK businesses will be considering setting up subsidiaries in EU countries as an alternative to cross-border trading. Having a local entity can certainly help when it comes to tax, reporting and compliance issues, but it can introduce a new level of complexity to your accounting. Tony Connolly, FCA, Founder and CEO of Cloud financial management software AccountsIQ, talks in our article for ICAEW, about the challenges international businesses face and highlights how today’s accounting systems can address these.
Tony Connolly FCA, Founder & CEO, AccountsIQ
Cross-border trading can be complex and, as cross-border trading increases, businesses often set up entities overseas to localise compliance and show customers their commitment to that market. Even if your business hasn’t previously done this, with the onset of Brexit, it could be easier to trade in the EU via a legal entity in a member country. While operating through a local entity can make trading easier, establishing multiple entities involves more complex accounting processes, including handling multiple currencies (FX), dealing with inter-company transactions and having to consolidate and report results in multiple currencies.
Managing multiple currency transactions
If you already handle multiple currency transactions, you’ll appreciate the complexities of processing realised and unrealised gains and losses on FX transactions and outstanding FX balances. Consolidating FX subsidiaries brings a new level of complexity around reporting results in base currency, involving FX Revaluation Reserves to recognise gain or loss in net asset value resulting from holding those net assets in foreign currency. Spreadsheets are not ideal for converting different elements at different rates and posting the monthly difference to Revaluation Reserves can be tricky. To calculate this you would need to:
Value Profit & Loss accounts at period average rate (ie: as revenues and costs build)
Value Assets & Liabilities at period end rate (ie: as if you had to realise them at that point)
Value Equity investments at the rate when the investment was made.
Doing this once a year for audit purposes is reasonably straightforward but, if you are reporting monthly results, managing constant FX fluctuations outside the system can prove difficult as losses in one month can be compensated by gains in subsequent months and vice versa.
What about Inter-Company Transactions and Balances?
With multiple entities you will undoubtedly end up with inter-company transactions from inter-company trading, recharges of centrally paid costs or charging management fees for shared services. With entities in different base currencies, there are FX risks in any outstanding balances that need to be accounted for and you need to decide whether the parent or subsidiary takes the risk – i.e. if the currency fluctuates, which is at risk?
Managing Inter-Company transactions using GL journals makes calculating unrealised gains and losses on month end outstanding balances difficult. This is best done via Inter-company AP and AR accounts. Usually the charging entity initiates transactions and the entity being charged takes the FX risk, so the balances need to be managed in the charging entity currency. Unrealised gains/losses need to be recognised in the subsidiary before consolidation so that Inter-company balances eliminate on consolidation into group base currency.