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A UK company has a US branch which it set up many years ago when the exchange rate was £1 = $2. It is preparing accounts for the year ended 31 December 20X4. Exchange rates are as follows:

31 December 20X3: £1 = $1.60

31 December 20X4: £1 = $1.20

It translates the profit and loss account of the foreign operation at the closing rate. »Ê¹ÚÌåÓýapp profit and loss account of the foreign operation, in US dollars and translated into sterling, is

�	$	Rate	£
Profit on ordinary activities before taxation	130,000	1.2	108,333
Taxation	- 40,000	1.2	33,333
Profit after taxation	90,000	1.2	75,000

»Ê¹ÚÌåÓýapp opening and closing balance sheets, in US dollars and in sterling, are as follows:

�	31/12/X3	�	31/12/X3	31/12/X4	�	31/12/X4
�	$	Rate	£	$	Rate	£
Fixed assets	80,000	1.6	50,000	90,000	1.2	75,000
Current assets	30,000	1.6	18,750	95,000	1.2	79,167
Current liabilities	- 45,000	1.6	- 28,125	- 30,000	1.2	- 25,000
Long-term loan	- 15,000	1.6	- 9,375	- 15,000	1.2	- 12,500
Net assets	50,000	1.6	31,250	140,000	1.2	116,667
Branch capital	1,000	2.0 (note 1)	500	1,000	2.0 (note 1)	500
Retained profits	49,000	(note 2)	30,750	139,000	(note 2)	116,167
�	50,000	�	31,250	140,000	�	116,667

Note 1: »Ê¹ÚÌåÓýapp company’s original investment in its foreign operation is carried at historic cost.

Note 2: Retained profits are the balancing figure.

»Ê¹ÚÌåÓýapp sterling figure for retained profits at 31 December 2004 can be analysed as follows:

�	£
Balance b/f	30,750
Profit for year	75,000
Exchange gain	10,417
Total	116,167

»Ê¹ÚÌåÓýapp exchange gain of £10,417 arises on retranslation of the opening net assets from the opening to the closing rate:

�	£
$50,000 at £1 = $1.6	£31,250
$50,000 at £1 = $1.2	£41,667
Exchange gain	£10,417

»Ê¹ÚÌåÓýapp exchange gain is taken to reserves as an item of other comprehensive income (OCI). In the reporting entity’s accounts, the Statement of Comprehensive Income will contain the following entry (under Old UK GAAP this will be recognised in the Statement of Total Recognised Gains and Losses (STRGL)):

Currency translation differences on foreign currency net investment: £10,417

What will happen if the company translates the profit or loss of the foreign operation at an average rate for the year - say £1 = $1.5? (Note this is the only option for companies adopting FRS 23,IFRS and New UK GAAP).

»Ê¹ÚÌåÓýapp sterling equivalent of the $90,000 profit becomes £60,000. »Ê¹ÚÌåÓýapp difference between this amount and the £75,000 resulting from translation at the closing rate, i.e. an exchange gain of £15,000, would be taken to reserves (OCI). »Ê¹ÚÌåÓýapp analysis of retained profit at 31 December 2004 becomes:

�	£
Balance b/f	30,750
Profit for year	60,000
Exchange gain	25,417
Retained profits	116,167