The pitfalls of accounting for an organizational unit abroad
Probably every one of us has encountered the term organisational unit, or from the year 2014 (in connection with recodification of civil and commercial law) the term spin-off enterprise (or simply branch). With the term organisational unit being used increasingly more in practice, we will take the liberty of using the term in this article.
Much information could be written about an organisational unit, but the aim of this article is to outline the possible pitfalls in the accounting/ account keeping of an organisational unit and to familiarise readers with things to be careful about and things to handle if they encounter this issue, especially in terms of Czech regulations.
The article only focuses on the form of account keeping on the part of the founder of an organisational unit with registered office in the Czech Republic or an organisational unit established on the territory of the Czech Republic by a foreign founder.
Basic information …. what is it actually
Organisational unit – it is one of the options for how an accounting entity may enterprise nearly in any country around the world, without having to establish for example a subsidiary in the given country. It happens very often that an accounting entity with registered office abroad would like to provide its products/services in the Czech Republic, and a very frequently used option is the establishment of a branch/organisational unit in the Czech Republic. The situation may also be reversed, when a Czech company establishes an organisational unit abroad.
It needs to be said at the beginning that an accounting entity, if it has an organisational unit abroad, continues to act a one subject, only divided into individual parts. In other words there is one legal entity, which keeps accounting as a whole. At the same time, an organisational unit is obliged to abide by the rules of the country of its location, i.e. keep accounting in compliance with the regulations of the country where it has been established.
If intending to establish an organisational unit abroad, then, an accounting entity should find out all relevant information about tax, accounting and legal regulations, in order to be able to assess all information and be aware of its obligations.
It also needs to be mentioned that an organisational unit does not have legal subjectivity and is therefore no separate entity (business corporation) and it therefore has no registered capital established on the territory of the Czech Republic, for example. When founding an organisational unit, it is thus not necessary to deposit any registered investment that other accounting entities are obliged to establish.
From the perspective of the Czech accounting act, an organisational unit is an accounting entity, which is obliged to keep accounting, compile a financial statement and a related corporate income tax declaration. If the organisational unit is also a payer of other taxes – i.e. the value added tax, road tax etc., it is obliged to proceed in compliance with the individual legal regulations and submit the related tax declarations.
Account keeping…..or what are the options
An organisational unit established in the Czech Republic keeps its accounting in compliance with regulations applicable in our country, i.e. it keeps its accounting in the same way as any other form of an accounting entity established on our territory.
The founder on the contrary (as mentioned above), who has a registered office on our territory while also having an organisational unit abroad, keeps accounting for all of its units as well as itself as a whole.
Founders of an organisational unit most frequently keep their accounts and at the same time the accounts of the organisational unit in the two following ways:
- The accounts of the organisational unit are kept in parallel, that is the organisational unit keeps its accounts separately in the country of its establishment and at the same time its founder keeps accounts in his system (for example as a separate centre)
The point is that the organisational unit keeps account separately (on its own behalf). The founder keeps accounts both for his business activity and for the activity of the organisational unit. In the accounting of the founder, the centre is specified within costs, revenues, assets and liabilities, that is all accounts of the chart of accounts, in which all accounting cases belonging to the organisational unit are entered. In other words, it is entered to the same accounts as the founder enters his own transactions, but everything is distinguished by establishing a centre, which divides the given accounting. Accounts are thus kept in one accounting database according to the rules of the founder as well as the organisational unit. Nearly every accounting SW enables establishing centres, and subsequently generating accounting documents for the given centre for their further use – for controlling, for a financial statement etc.
It needs to be said in this connection that the main pitfall here is a correct setup of the given SW including all related outputs, that is setting up the individual processes so that they would generate accurate documents for further use. The main disadvantage may be so-called double work (everything is actually booked twice – once on the part of the organisational unit, and once on the part of the founder) and at the same time all booked/unbooked transactions need to be monitored due to registering different accounting rules in the given countries (for example the issue of revaluation of some asset entries to fair value).
- The accounting of the organisational unit is kept separately and transfer to the accounting of the founder is only performed by means of downloading aggregated entries, turnovers or balances
This is the most frequently used type of account keeping of an organisational unit at the founder. The main reason and actually also the main advantage is that the accounting (entering of primary documents) of the organisational unit is kept only once. It is then “turned over” to the accounts of the founder by means of a data bridge or by downloading directly the given accounting data of the organisational unit. The download (transfer) of accounting data itself is performed on the basis, which the founder needs for his further outputs (controlling etc.). Most frequently we encounter monthly downloads of accounting, which should be the basic period for turning data over. We suppose that a suitable procedure (in order to maintain all details necessary for further use) is to download data by the individual entries booked in the monitored period (for example in case of downloading data for July 2019, it will be performed for the period of 1 July 2019 to 31 July 2019).
A founder with registered office on the territory of CR and his organisational unit abroad nearly always have a different functional currency and it is therefore also necessary to arrange exchange rate setup for the given data transfer. In other words, it is necessary to set up rules for establishing the conversion rate, by which the given data will be transferred to the founder. In practice the most frequent way is transfer of data by means of a fixed exchange rate set up by an internal guideline of the founder.
Whether the founder chooses one or the other option within account keeping, it is necessary to obtain all supporting documents, because various pitfalls may arise when accounting for an organisational unit on the founder's side. i.e. if the founder (accounting entity) does not have the due and detailed documentation on the procedure of capturing the oganisational unit in his accounting – that is how accounts are kept, how they are transferred, procedures within internal invoicing etc. Thus it may happen that every month the procedure differs – for example a different exchange rate for conversion is used, different analytical accounts etc. And insufficiently recorded internal procedures may then lead to incorrect account keeping or even distortion of accounting documents, and thus a failure to fulfil one of the basic accounting principles, which is to keep accounts in true and fair presentation. It is therefore always recommended that the accounting entity should have detailed compiled documentation for reporting and taking over information from an organisational unit into its accounting. The most common way is writing up an internal guideline that describes the individual accounting cases, which may occur in an organisational unit and their capturing in the accounting of the organisational unit as well as subsequent transfer to the accounting of the founder.
We wrote above that the accounting of an organisational unit is most frequently downloaded (the second option of account keeping – downloading aggregated data) into the accounting of the founder on the basis of the individual entries and at the same time that a fixed exchange rate is most frequently used for the transfer. We would like to mention in this context, however, that in practice one can also encounter other options, both in terms of downloading of the given data and in terms of the used exchange rate for currency conversion.
Data are also downloaded based on turnovers (not the individual entries) for the monitored period. At the same time, the professional public often debates the accuracy of using an exchange rate within the downloading of turnovers, entries and balances of the organisational unit themselves into the accounts of the founder. During the conversion itself, the nature of the transferred balance/ turnover should always be considered. In practice we encounter the following views regarding the data downloads and selection of an exchange rate for conversion:
- Entries in the accounts of fixed tangible/intangible assets, including related depreciation reserves, provisioning, costs of sale of a given asset etc. should be converted using a rate as of the date of inclusion of the given asset, or more specifically the moment of realisation of the accounting case. But you may see a pitfall here already, because the date of realisation of the accounting case may also be the date of purchase of the given asset, not its inclusion.
- Balances, turnovers or entries in accounts of assets and liabilities (for example receivables, payables, monetary units etc.) should be converted using a rate valid as of the date, when the given balances are downloaded, i.e. the last day of the downloaded period.
- Balances, turnovers or entries in asset and liability accounts not mentioned in the previous two points should be converted using a rate valid as of the moment of realisation of the accounting case.
- Balances, turnovers or entries in outturn accounts, which are not part of the above-mentioned points, should be converted using an average rate for the monitored period. Here, too, we get into a discussion, though, because within the options of using an exchange rate, the accounting act permits either the use of an exchange rate as of the realisation of a chargeable event or a fixed rate, which is set up by the accounting entity according to the Czech National Bank and its declaration.
In case of transfer of the accounting of an organisational unit into the accounting of the founder by using the method of downloading turnovers, entries and balances, exchange rate differences may arise. The question, which everyone is asking now, is, if these exchange rate differences should directly influence the costs and revenues of the given accounting period, or if these exchange rate differences should be part of the founder's own equity. This topic is also a much discussed one and in practice, most accounting entities leave these exchange differences as a part of the profit and loss account (costs and revenues). The question is, of course, if these arising exchange differences should not rather influence own equity instead, and not the profit and loss in the current accounting period.
What to say to conclude….
The topic of account keeping of an organisational unit especially from the perspective of the founder is a very broad one and much more information could be written about it, including a comparison of the different views held among the professional public and the established practice.
We suppose that the most important thing the founder should keep in his mind in case of founding an organisational unit abroad is to find out all local regulations that he will need to comply with and to have all supporting documents prepared within the accounting records of an organisational unit abroad, meaning that not only the established rules within accounting and transfer of balances, but also the relating controlling and the total outputs within one entity should be clear.
Petra Čechová & Ludmila Malimánková