Intercompany Balances: How to Decide Translation vs Remeasurement and Your Functional Currency

How to Handle Foreign Currency Intercompany Balances

Your US-based startup has just opened its first international entity in the UK. The initial wire transfer to fund the new office was simple, but now you face a recurring challenge: how to handle foreign currency intercompany balances. This isn't just an accounting detail; it's a foundational issue that can create a mess in QuickBooks and spreadsheets if managed incorrectly. Getting it wrong leads directly to misstated financial reports, jeopardizing your audit readiness and rattling investor confidence during a funding round or due diligence process. Understanding the difference between translation vs remeasurement is the first step toward building a scalable, multi-entity finance operation.

The Single Most Important Question: What Is Your Functional Currency?

Before you can correctly account for a single transaction, you must determine the UK subsidiary’s functional currency. This is not necessarily the local currency (GBP). The functional currency is the primary currency of the economic environment in which an entity operates. This decision dictates the entire accounting method for handling foreign exchange effects and is the most critical distinction in multi-entity consolidation. For a clear explanation of functional versus presentation currency, see our Functional vs Presentation Currency: Startup Guide.

So, how do you decide? It's about operational reality, not just the entity’s legal address.

When the Functional Currency is Likely GBP

Your UK subsidiary’s functional currency is likely GBP if it operates as a relatively self-sufficient business. Key indicators include:

• It generates its own revenue, primarily from UK customers in GBP.
• It incurs the majority of its operating expenses (such as payroll, rent, and local vendors) in GBP.
• It is financed independently or maintains its own cash reserves without constant infusions from the US parent.
• It operates with a high degree of management and operational autonomy.

When the Functional Currency is Likely USD

Your UK subsidiary’s functional currency is likely USD if it functions more as an extension of the parent company. This is common in early-stage startups. Key indicators include:

• It acts primarily as a sales, support, or R&D arm for the US parent.
• It is entirely dependent on the US parent for funding to cover its expenses.
• Its cash flows are immediately and directly linked to the parent company’s operations and funding decisions.
• It essentially acts as a remote department of the US entity, with key decisions made by US management.

The Functional Currency Memo: Your Audit Defense

This isn't a casual choice. The formal documentation of the functional currency decision is a requirement under US GAAP, specifically ASC 830. This means you must prepare a written memo that explains the reasoning behind your conclusion. This document analyzes the relevant factors and becomes a key piece of evidence for your auditors, demonstrating that you have thoughtfully applied the rules rather than defaulting to an incorrect method. At this stage, those running finance usually face pressure to close the books quickly, but this is a decision worth pausing for. A well-reasoned memo is your audit defense and prevents painful rework down the line.

Path A: GBP Functional Currency (The Translation Method)

If you've determined your UK subsidiary operates with genuine autonomy and its functional currency is GBP, you will use the Translation method for consolidation. This approach is designed to convert the financial statements of a self-sustaining foreign entity into the parent company’s reporting currency (USD) in a way that preserves the UK entity's standalone financial story.

The mechanics are straightforward. Under the Translation method, different exchange rates are used for different parts of the financial statements.

• Balance Sheet Items: All assets and liabilities are translated using the exchange rate on the balance sheet date, often called the current or spot rate.
• Income Statement Items: All revenues and expenses are translated using the weighted-average exchange rate over the reporting period.

Under IFRS, IAS 21 governs foreign currency translation and follows similar principles. For the differences between current-rate and temporal approaches, review our Current Rate vs Temporal Method guide.

This difference in rates will inevitably create an imbalance when you consolidate. This is not an error. The balancing amount from the Translation method, the Cumulative Translation Adjustment (CTA), is recorded in Equity under Other Comprehensive Income (OCI) and does not affect the P&L. This protects your P&L from currency volatility, giving investors a clearer view of the UK sub's core operational performance.

Consider a UK e-commerce subsidiary: Its balance sheet shows £100,000 in assets. The current spot rate at the end of the quarter is 1.25 USD/GBP, so these assets translate to $125,000. Its income statement shows £20,000 in net income. The average rate for the quarter was 1.22 USD/GBP, translating the income to $24,400. The mathematical difference required to make the consolidated balance sheet balance is parked in the CTA account within equity.

Path B: USD Functional Currency (The Remeasurement Method)

When the UK entity is simply an extension of the US parent and its functional currency is determined to be USD, the Remeasurement method is required. This often applies to early-stage Deeptech or Biotech startups with a small UK-based R&D team funded entirely from the US. The goal here is not to translate a foreign business's results but to remeasure its transactions as if they had occurred in USD from the start.

This method is more complex because it uses different rates for different types of accounts based on their nature.

• Monetary Items: Assets and liabilities with fixed currency values (e.g., cash, accounts receivable, debt) are remeasured using the current exchange rate from the balance sheet date.
• Non-Monetary Items: Assets and liabilities with values that do not have a fixed currency amount (e.g., prepaid rent, equipment, inventory) are remeasured using the historical exchange rate from the date of the original transaction.

For more on classifying monetary and non-monetary items under IFRS, see the detailed guidance in our Currency Translation for UK Startups: IAS 21 Guide.

Any imbalance that arises from this process is not parked in equity. Instead, the balancing amount from the Remeasurement method is a foreign exchange gain or loss that is recorded directly on the P&L. This introduces volatility but reflects the real economic exposure the parent company has to currency fluctuations.

For example, a US Biotech parent funds its UK lab. The UK entity has £50,000 cash (monetary) and a £200,000 piece of lab equipment (non-monetary) purchased when the exchange rate was 1.20. At month-end, the rate is 1.25. The cash is remeasured to $62,500 (£50,000 * 1.25). The equipment, a non-monetary asset, remains on the books at its historical USD value of $240,000 (£200,000 * 1.20). This difference in treatment creates an FX gain or loss that hits the consolidated P&L.

A Quick Guide on How to Handle Foreign Currency Intercompany Balances

Choosing the correct method for your multi-entity consolidation is crucial. Here is a simple guide to help you make the right call based on your UK subsidiary’s operational reality.

Use the Translation Method when:

• Your UK subsidiary is an autonomous business unit.
• Its functional currency has been determined to be GBP.
• You want to insulate your consolidated P&L from FX fluctuations.
• The accounting result is a Cumulative Translation Adjustment (CTA) in the equity section.

Use the Remeasurement Method when:

• Your UK subsidiary is a direct extension of the US parent.
• Its functional currency has been determined to be USD.
• You need to reflect the full economic impact of FX changes on your P&L.
• The accounting result is a foreign exchange gain or loss on the income statement.

The lesson that emerges across cases we see is that the choice is driven by substance over form. Where the business happens is more important than where the entity is legally registered.

Practical Takeaways and Stage-Specific Actions

Knowing the theory is one thing, but implementing it with limited resources is another. The reality for most pre-seed to Series B startups is more pragmatic, focusing on getting the fundamentals right today to avoid costly rework later.

Here are three actions every company with a new UK-US structure should take immediately:

1. Decide and Document Your Functional Currency. This is the most important step. Hold a meeting with your finance lead and advisors, assess the operational factors, make a decision, and write the formal memo outlining your conclusion and rationale as required by ASC 830. Store it securely. For implementation details, see our ASC 830 Currency Translation for US Startups guide.
2. Standardize Your Exchange Rate Source. Lacking a consistent exchange-rate tracking process causes month-end consolidation delays. Choose a single, reliable source for your rates (like OANDA, Bloomberg, or your primary bank) and use it consistently for current, average, and historical rates. Document this policy. Our Monthly Average Rates guide lists reliable sources.
3. Segregate Intercompany Activity. In your Chart of Accounts, create distinct accounts for intercompany transactions. For example, “Intercompany Loan to UK Sub” and “Intercompany Payable to US Parent.” This prevents these critical balances from getting lost in other accounts and makes the consolidation and elimination process infinitely cleaner. If you use QuickBooks, our Setting Up CTA in QuickBooks Multi-Currency guide covers practical setup steps.

Guidance by Funding Stage

Your specific focus will change as your company grows and your international subsidiary finance needs evolve.

• Pre-Seed to Seed: At this stage, your UK entity is almost certainly an extension of the US parent, making the Remeasurement method the likely choice. Your consolidation is probably done in a spreadsheet. The priority is meticulous tracking. Document the functional currency decision early and keep a clear ledger of all intercompany loans, payments, and expenses. Don't let this become a tangled mess to unwind later.
• Series A: You may have a part-time controller and growing UK operations. Now is the time to clean up the Chart of Accounts in both the US QuickBooks and the UK Xero. If the UK team is starting to generate local revenue and hire independently, it's time to formally re-evaluate your functional currency. A common pain point is that month-end P&L swings from remeasurement confuse stakeholders; having a clear FX process and explanation is key. If you handle subscription revenue, see our Currency Translation for SaaS Multi-Currency Revenue guide.
• Series B: With a full-time finance hire, the spreadsheet-based consolidation process becomes a significant operational risk. Incorrect FX treatment can create tax and regulatory compliance gaps. For UK cross-border tax considerations, review official guidance from HMRC on international arrangements. A scenario we repeatedly see is companies at this stage discovering their initial functional currency decision was wrong or undocumented, forcing them to restate prior periods during due diligence. This is the moment to ensure your processes are audit-proof and can withstand scrutiny from investors or potential acquirers.

Ultimately, correctly managing your intercompany balances is about more than just compliance. It is about producing reliable financial statements that give you, your team, and your investors a clear and accurate picture of your company’s performance. Getting this right builds trust and lays a solid foundation for future international growth.

Frequently Asked Questions

Q: Can we change our subsidiary's functional currency?

A: Yes, but only if there is a significant change in the underlying economic facts and circumstances of the subsidiary's operations. This is considered a major accounting change that must be well-documented and justified to auditors. It cannot be changed frequently or to achieve a specific accounting outcome.

Q: What happens to the Cumulative Translation Adjustment (CTA) if we sell the UK subsidiary?

A: When you sell or substantially liquidate the foreign subsidiary, the entire accumulated CTA balance that is sitting in equity is released and recognized on the P&L. This reclassification affects the total gain or loss recognized on the disposal of the investment in that accounting period.

Q: Does our functional currency choice for US GAAP reporting affect our UK taxes?

A: The functional currency decision is primarily for financial reporting under accounting standards like US GAAP. For UK tax purposes, a company's taxable profits are typically calculated in GBP. However, the treatment of intercompany loans and transactions can have transfer pricing implications that are scrutinized by both HMRC and the IRS.