Translation reserve

How does the translation reserve build up?

A foreign subsidiary keeps its books in its own currency. To add it to the group, its statements are translated into the group’s presentation currency. Income and expenses are translated at the average rate for each month, and assets and liabilities at the closing rate on the last day¹.

The two rates differ, so the translated statements do not balance on their own. The gap is the exchange difference. It is recognised in other comprehensive income and collected in a separate component of equity², which is the translation reserve. It rises when the subsidiary’s net assets are worth more in the group’s currency than before, and falls when they are worth less.

A worked month

Palmridge Hospitality LLC keeps its books in dirhams and is translated into pounds sterling. Its net assets at the start of September were AED 12,000,000. The closing rate moved from 0.2010 to 0.2040 during the month, and the profit earned in the month was translated at the average rate of 0.2025.

Opening net assets AED 12,000,000, rate moved from 0.2010 to 0.2040	36,000
September profit AED 1,905,000, translated at the average 0.2025, held at the closing 0.2040	2,858
Added to the translation reserve	38,858

Example group used across Finconsol guides. Figures rounded to the pound.

The opening net assets gained 0.0030 a dirham (0.2040 less 0.2010), which is 36,000. The profit was put into the income statement at 0.2025 but sits in net assets at 0.2040, so it adds 0.0015 a dirham, which is 2,858 (1,905,000 times 0.0015 is 2,857.50, rounded). The month adds 38,858 to the reserve. The example assumes no dividends or new capital during the month.

What happens when the subsidiary is sold?

When the group sells the subsidiary, the balance in the translation reserve for that subsidiary is moved from equity to profit or loss, as part of the gain or loss on the sale³. Until then the amount stays in equity, even if the exchange rate swings back. A part-sale that leaves the group in control moves a share of the reserve to the non-controlling interest instead of to profit or loss.

Related: Closing rateClosing rateThe spot exchange rate on the last day of the reporting period, used to translate a foreign subsidiary's assets and liabilities.Open the glossary entry, Average rateAverage rateThe exchange rate for a period, usually the month, used to translate a foreign subsidiary's income and expenses into the group's presentation currency.Open the glossary entry, Functional currencyFunctional currencyThe currency of the main economic environment in which a company operates. It is usually the currency the company records its transactions in.Open the glossary entry, Presentation currencyPresentation currencyThe currency in which the group's financial statements are presented.Open the glossary entry, Net investment in a foreign operationNet investment in a foreign operationThe parent's interest in the net assets of a foreign subsidiary, including long-term loans that will not be repaid in the foreseeable future.Open the glossary entry.