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Accounting for Foreign Exchange Gains & Losses

By Carter McBride, eHow Contributor Print this article Share

A U.S. company performing transactions in the euro may have foreign exchange gains or losses.

Companies must follow the generally accepted accounting principles when accounting for foreign currency exchange gains and losses. The most common type of foreign currency exchange gains and losses occur when a company completes transactions in a foreign currency.

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What Are the Treatments for Foreign Exchange Gains & Losses?

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1. Converting Foreign Currencies


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Each time a company has a transaction in another currency, the accountant must convert the currency to the company's currency using the foreign currency exchange rate. This rate is found online at sources such as X Rates and Yahoo! Finance.

Record the Initial Transaction


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When accounting for foreign currency exchanges, the accounting must first record the initial sale. For example, a United States company buys 200 euros worth of widgets. At

the time, 200 euros equals $250. The accountant would debit "Purchases" by $250 and "Accounts Payable" by $250.
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Recording a Gain When Completing Transaction


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If the foreign currency exchange rate changes favorably, record a gain. In the example, if 200 euros now equals $200, then debit "Accounts Payable" by $250, then credit "Cash" by $200 and "Foreign Exchange Gain" by $50.

Recording a Loss When Completing a Transaction


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If the foreign currency exchange rate changes unfavorably, record a loss. In the example, if 200 euros now equals $300, then debit "Accounts Payable" by $250, "Foreign Exchange Loss" by $50, then credit "Cash" by $300.

Time To Revalue Currency


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The accountant must report gains or loses on the transaction at both the end of an accounting period and when the company finishes the transaction. For example, the company enters a transaction on Sept. 1, 2009 and pays for the transaction on Jan. 31, 2009. The company must revalue the transaction on both Jan. 1 and Jan. 31.

Read more: http://www.ehow.com/facts_6728729_accounting-foreign-exchange-gainslosses.html#ixzz2YdmplKUf

What is Journal Entry For Foreign Currency Transactions


Foreign currency transactions are denominated in a currency other than the companys functional currency. Foreign currency transactions may result in receivables or payables fixed in the amount of foreign currency to be received or paid. A foreign currency transaction requires settlement in a currency other than the functional currency! A change in exchange rates between the functional currency and the currency in which a transaction is denominated increases or decreases the expected amount of functional currency cash flows upon settlement of the transaction. This change in expected functional currency cash flows is a foreign currency transaction gain or loss that typically is included in arriving at earnings in the income statement for the period in which the exchange rate is changed. An example of a transaction gain or loss is when an Italian subsidiary has a receivable denominated in lira from a British customer. Similarly, a transaction gain or loss (measured from the transaction date or the most recent intervening balance sheet date, whichever is later) realized upon settlement of a foreign currency transaction usually should be included in determining net income for the period in which the transaction is settled. Example:

An exchange gain or loss occurs when the exchange rate changes between the purchase date and sale date. Merchandise is bought for 100,000 pounds. The exchange rate is 4 pounds to 1 dollar. The journal entry is:
[Debit]. Purchases = 25,000 [Credit]. Accounts payable = 25,000 (Note: 100,000/4 = $25,000)

When the merchandise is paid for, the exchange rate is 5 to 1. The journal entry is:
[Debit]. Accounts payable = 25,000 [Credit]. Cash = 20,000 [Credit]. Foreign exchange gain = 5,000 (Note: 100,000/5 = $20,000)

The $20,000 using an exchange rate of 5 to 1 can buy 100,000 pounds. The transaction gain is the difference between the cash required of $20,000 and the initial liability of $25,000. Note that a foreign transaction gain or loss has to be determined at each balance sheet date on all recorded foreign transactions that have not been settled. Another example: A U.S. company sells goods to a customer in England on 11/15/X7 for 10,000 pounds.The exchange rate is 1 pound is $0.75. Thus, the transaction is worth $7,500 (10,000 pounds 0.75). Payment is due two months later. The entry on 11/15/X7 is:
[Debit]. Accounts receivableEngland = 7,500 [Credit]. Sales = 7,500

Accounts receivable and sales are measured in U.S. dollars at the transaction date employing the spot rate. Even though the accounts receivable is measured and reported in U.S. dollars, the receivable is fixed in pounds. Thus, a transaction gain or loss can occur if the exchange rate changes between the transaction date (11/15/X7) and the settlement date (1/15/X8). Since the financial statements are prepared between the transaction date and settlement date, receivables that are denominated in a currency other than the functional currency (U.S. dollar) have to be restated to reflect the spot rate on the balance sheet date. On December 31, 20X7, the exchange rate is 1 pound equals $0.80. Hence, the 10,000 pounds are now valued at $8,000 (10,000 $.80). Therefore, the accounts receivable denominated in pounds should be upwardly adjusted by $500.The required journal entry on 12/31/X7 is:
[Debit]. Accounts receivableEngland = 500 [Credit]. Foreign exchange gain = 500

The income statement for the year-ended 12/31/X7 shows an exchange gain of $500.Note that sales is not affected by the exchange gain since sales relates to operational activity. On 1/15/X8, the spot rate is 1 pound = $0.78. The journal entry is:

[Debit]. Cash = 7,800 [Debit]. Foreign exchange loss = 200 [Credit]. Accounts receivableEngland = 8,000

The 20X8 income statement shows an exchange loss of $200. Which Transaction Gain Or Loss Should Not Be Reported In The Income Statement? Gains and losses on the following foreign currency transactions ARE NOT included in earnings but rather are reported as translation adjustments: 1. Foreign currency transactions designated as economic hedges of a net investment in a foreign entity, beginning as of the designation date. 2. Inter-company foreign currency transactions of a long-term investment nature (settlement is not planned or expected in the foreseeable future),when the entities to the transaction are consolidated, combined, or accounted for by the equity method in the reporting companys financial statements 3. A gain or loss on a forward contract or other foreign currency transaction that is intended to hedge an identifiable foreign currency commitment (e.g., an agreement to buy or sell machinery) should be deferred and included in the measurement of the related foreign currency transaction. Losses should not be deferred if deferral is expected to result in recognizing losses in later periods. A foreign currency transaction is deemed a hedge of an identifiable foreign currency commitment if both of these conditions are met: 1. The foreign currency transaction is designated as a hedge of a foreign currency commitment. 2. The foreign currency commitment is firm. Related topic: What Is A Forward Exchange Contract, And How Is It Accounted For? Foreign Currency Translation How To Determine The Functional Currency? Accounting And Reporting For Foreign Currency

Journal Entry For Inventory Transactions


The major objectives of accounting for inventories are the matching of appropriate costs against revenues in order to arrive at the proper determination of periodic income, and the accurate representation of inventories on hand as assets of the reporting entity as of the date of the statement of financial position.

Under any system of accounting, financial statements should be fully articulated (i.e., the statement of financial position and income statement are linked together mechanically). And, to achieve the goal, accounts would need to record every single eventrelated to inventory, in this casealong the inventory cycle: raw material received, raw material moved to the line of production, finished goods moved to the finished good warehouse, obsolescence, stolen, and finished goods sold out or moved to other warehouses. So here we go with journal entries

Raw Material Inventory


1. Receiving the raw material When any raw material is received means the raw material inventory is increased too. So, after counting and matching the quantity with the purchase order, you would record Receipt of Goods entries, as follows:
[Debit]. InventoryRaw Materials = xxx [Credit]. Accounts Payable = xxx

(Note: xxx is amount of actual quantity received. You can replace the accounts payable with cash if it is a cash transaction). 2. Moving raw materials to the line of production When any raw materials going out of the warehouseusually to the line of production, means the raw material is decreased. On the other hand, it shifted the raw materials to a new form of inventory which will be located in the line of production, called WIPWork In Process Inventory. So for this event, you would make the following record:
[Debit]. WIPWork In Process Inventory = xxx [Credit]. InventoryRaw Materials = xxx

3. Adjusting raw material inventory Some materials maybe damaged/obsolete, some maybe loss (stolen) time-by-time. Such risks are inevitable. Referring to the conservatism principle, you would need to make a reserve for such risks. Reserving in this case means you are charging cost in advance. So to prepare it, you would need to make reserve account, or you may want to create some for more details report and easier way to drill down in the future. Here are journal entries you would need to make: For obsolete raw materials: [Debit]. Cost of Goods Sold = xxx [Credit]. Obsolescence Raw Material Reserve = xxx For stolen raw materials: [Debit]. Cost of Goods Sold = xxx [Credit]. Stolen Raw Material Reserve = xxx OR; create a single reserve: [Debit]. Cost of Goods Sold = xxx [Credit]. Raw Material Reserve = xxx So, when actual obsolescence or loss (because of it is stolen) is occurred, you would make an adjustment entry as follows:
[Debit]. Raw Material Reserve = xxx [Credit]. Raw Material Inventory = xxx

The same case could be happened to the WIPWork In Process Inventory. And, the same steps are required to reflect those in the book, except that you need to replace the Raw Material with WIPWork In Process. In any manufacturing process, wastes are inevitable. And, you would need to reflect the loss in the book by making the following journal entry in the current period:
[Debit]. Cost of goods sold = xxx [Credit]. WIPWork In Process Inventory = xxx

Finished Goods Inventory


1. Finished Goods Inventory Received Finished goods inventories could be come from inside the companyline of production (when it is a manufacturing company), or from outside of the companyfinished good purchased (when it is a retail/trading company). Wherever it comes from, finished goods inventory is increased and need to be reflected in the book. So, you would make the following entries: Finished Goods come from line of production:
[Debit]. Finished Goods Inventory = xxx [Credit]. WIPWork In Process Inventory = xxx

Finished Goods come from outside of the company (purchased finished goods):
[Debit]. Finished Goods Inventory = xxx [Credit]. Accounts Payable = xxx

(Note: xxx is amount of actual quantity received. You can replace the accounts payable with cash if it is a cash transaction). 2. Finished Goods Shipped Out There are two possibilities of reason for shipping out the finished goods inventory: sold or moved to other warehouse location. Either it is shipped out to customers (sold) or moved to other warehouse location, it will definitely decrease the finished goods inventory and should be reflected on the book. So, here are journal entries you need to make: Finished good sold:
[Debit]. Accounts Receivable = xxxx [Credit]. Sales = xxx [Credit]. Sales Tax Payable = x (Note: This is to record the sales and sales tax. xxxx is amount of the sales plus sales tax, xxx is amount of the sales only, x is amount of the sales tax)

AND;
[Debit]. Cost of Goods Sold = xxx [Credit]. Finished Goods Inventory = xxx

(Note: This is to record the finished goods decrease. xxx is amount of the cost) 3. Finished Goods Inventory Adjustment Finished goods inventory could become obsolete or stolen, and to anticipate the risk, you would need to reserve it. To do that, you would need to make the following entry:
[Debit]. Cost of Goods Sold = xxx [Credit]. Finished Goods Reserve = xxx

So, when actual obsolescence or loss (because of it is stolen) is occurred, you would make an adjustment entry as follows:
[Debit]. Finished Goods Reserve = xxx [Credit]. Finished Goods Inventory = xxx

As what you do on the raw material inventory, you may want to separate the obsolescence with stolen too for easier control and analyses in the future time.

Physical Count Inventory Adjustment


The accounting for inventories is done under either a periodic or a perpetual system. In a periodic inventory system, the inventory quantity is determined periodically by a physical count. The quantity so determined is then priced in accordance with the cost method used. Cost of goods sold is computed by adding beginning inventory and net purchases (or cost of goods manufactured) and subtracting ending inventory. Alternatively, a perpetual inventory system keeps a running total of the quantity (and possibly the cost) of inventory on hand by recording all sales and purchases as they occur. When inventory is purchased, the inventory account (rather than purchases) is debited. When inventory is sold, the cost of goods sold and reduction of inventory are recorded. Periodic physical counts are necessary, howeverat least to satisfy the tax regulations (tax regulations require that a physical inventory be taken, at least annually). Most likely, you will find variancesactual quantity vs. recorded quantity. And, you would need to make both perfectly matched, means you would need to adjust your recordeither up or down. The following entries assume that there are increases in inventory balances:
[Debit]. Raw materials inventory = xxx [Debit]. Work-in-process inventory = xxx [Debit]. Finished goods inventory = xxx [Credit]. Cost of goods sold = xxx

(Note: If there are decreases in the inventory balances, then the debits and credits are reversed.)

Specific Inventory Adjustment Entries


As I have described it in the preface of this post: first, the COGS and other costs in the Income Statement should be tightly linked with the on hand inventory balance on the Balance Sheet which should represent the real value of the actual asset. However, for some reasons, sometime, you may find values of the inventory youve recorded become higher compare to the market price. To achieve the goal, you would need to make the following adjustment entry:
[Debit]. Loss on Inventory Valuation = xxx [Credit]. Raw Materials Inventory = xxx [Credit]. WIPWork In Process Inventory = xxx [Credit]. Finished Goods Inventory = xxx

What Does and Does Not Effect Working Capital

Working capital has a deceptively simple definition: Current assets minus current liabilities. That is, working capital is the amount of a companys assets that can be converted to cash in the near future, taking into account the payments that have to be made. The result is the amount of funds available for investment to generate new business. Its helpful to get a sense of what does and doesnt have an effect on the amount of working capital available, because that can clarify the concept. The first aspect to notice is that any change involving only current accounts has no net effect on working capital. As an example: paying a $100 bill reduces a bank account and therefore current assets by $100. That also reduces accounts payable by $100, so there is no net effect on working capital.
Obviously, the components of working capital are changing constantly. Satisfying an account payable involves only current accounts, and there is no effect on working capital.

Similarly, when a customer sends a check for $200 to pay an invoice, you reduce accounts receivable by $200 and increase a bank account (even if only eventually via undeposited funds, another current asset) by $200. No change to total current assets, so no change to working capital.
Its easy. Am I right? Well, those are changes to the current accounts. How about change to noncurrent accounts? Read on

Changes To Non-current Accounts


If you have an algebraic turn of mind, you might consider the following sequence, beginning with the fundamental accounting equation:
Assets = Liabilities + Equity

Now, using these abbreviations:

CA = Current Assets NCA = Noncurrent Assets [including both fixed and other assets] CL = Current Liabilities NCL = Noncurrent Liabilities, including long-term and other liabilities We can get to an algebraic definition of working capital:
CA + NCA = CL + NCL + Equity CA CL + NCA = NCL + Equity Working Capital + NCA = NCL + Equity Working Capital = NCL + Equity NCA

A change in the balance of a noncurrent account often, but not always, changes the amount of working capital. So, as distinct from changes involving only current accounts, a change to a noncurrent account (a noncurrent asset, a noncurrent liability, or an equity account) can change the amount of working capital. If Lie Dharma Construction takes out a three-year loan for $15,000 and deposits the funds in a bank account for example, working capital increases by $15,000. The liability account that records the loan is a long-term liability, not a current liability. So current liabilities remain unchanged and both current assets and working capital increase by $15,000.
Of course, a companys primary source of working capital in the long run is net income, the excess of revenues over expenses, and thats the principal financialreason for being in business at all. From an accounting perspective, how do current assets such as inventory and accounts receivable get to be noncurrent, so that they affect working capital? Read on

Let say you starts a new company called Lie Dharma Floors, a sole proprietorship, at the end of April and provides it with startup funds by depositing $25,000 in its bank account. At tyour point, the company has no liabilities, current or otherwise, and a current asset (and owners equity) of $25,000. The companys working capital is therefore $25,000 at the outset. You then records the following transactions: A deposit of another $15,000 from your personal funds into the companys checking account, and also recorded as paid-in equity. The purchase of $28,000 in inventory for resale. The sale of $21,000 worth of inventory for $33,000. The receipt of $15,000 in payments from customers for their $33,000 worth of purchases. Those payments post first into Undeposited Funds, and then post into the companys checking account. The total of the customers outstanding balances, $18,000, remains in accounts payable. The receipt of bills for the $28,000 worth of inventory from your vendors and the payment of $18,000, leaving $10,000 in accounts payable. You pay $8,500 in various operating expenses such as travel and communications. You also purchase a small, two-room office in a shopette for $22,000, paying for it with $15,000 in cash and $7,000 from a six-month bank loan. The withdrawal of $1,000 for your personal use, as an owners draw. Upon finishing your P&L and Balance Sheet you would find the net income of $3,500 during May acts as a source of working capital.

On the balance sheet, the net income appears in Equity, a noncurrent account. $22,000 of current assets have been converted to fixed assets by the purchase of the office space. Current assets of $37,500 less current liabilities of $17,000 result in working capital of $20,500. Lie Dharma Floors started out with $25,000 in working capital. It has earned $3,500 in net income. But its cash account has fallen to $12,500 and its working capital is down from $25,000 to $20,500.
How does this come about?

Looking into the matter helps you get a clearer understanding of how the company does business. Each transaction listed later has an effect on the amount of working capital available, subsequent to your initial $25,000 investment. You also see that none of the transactions involves solely current accounts. Other activities the company undertakes, such as purchasing inventory, are not listed because they involve only current accounts and therefore have no net effect on working capital. Your second investment increases working capital by $15,000 to $40,000. Product sales bring in $12,000 in gross profit, increasing working capital to $52,000. The company pays $8,500 in operating expenses, decreasing working capital to $43,500. A check for $15,000 is written as a partial payment for the office space. Working capital is now $28,500. Accounts payable is increased by $7,000 as a result of the short-term loan to pay the remaining balance owed on the office space. Working capital is $21,500. You withdraws $1,000 for your personal use, decreasing both your equity and working capital by $1,000, leaving working capital at $20,500. So, after the initial investment of $25,000, various purchases, sales, and other transactions reduce the companys working capital to $20,500. This amount agrees with the result of subtracting, on May 31, current liabilities from current assets. Its obviously a lot quicker to do one simple subtraction than it is to trace every transaction during the period, particularly when a company typically has many more transactions than the six listed earlier.
This simple subtraction is informative, certainly its the quickest way to determine working capital and therefore how it varies over time. But it doesnt give you any real insight into how the company is carrying out the process of investing and disinvesting that creates profit (or loses it).

What Doesnt Affect Working Capital


Transactions involving only current accounts have no net effect on the amount of working capital. That sort of transaction affects the components of working capital, of course, but not the result of subtracting current liabilities from current assets. The same is true of noncurrent accounts. A transaction that does not involve a current account does not change the amount of working capital. An example is depreciation. Suppose your business owns a truck that it bought for $20,000. You keep it on your books as a fixed asset worth $20,000. But the truck loses value over time that is, it depreciates and you record that amount of loss periodically. The

amount of loss you record is determined by which one of several methods for determining depreciation you and your accountant decide on. That method might tell you to record $300 in depreciation for the first month your company owned the truck. You record $300 as a debit to an expense account, perhaps named Depreciation, and also as a credit to a fixed asset account, perhaps named Truck:Accumulated Depreciation. Neither account is a current asset account, therefore the transaction has no effect on working capital. Note: Although depreciation is recorded in expense and in fixed asset accounts, and thus does not affect working capital, it still needs to be accounted for when youre calculating working capital. This issue is explained at the end of this post.

What Does Affect Working Capital

There are some transactions that are typical in the increase and decrease of working capital. Among them are the following: Net income. The sale of product for more than it cost to acquire the product is a typical source of working capital. But net income often must be adjusted before adding it in with other sources. The reason is that some expenses that are subtracted from gross profit to arrive at net income do not involve current accounts. In fact, one of the purposes of analyzing the sources and uses of working capital is to clarify the reasons for a difference between net income and working capital provided by a companys operations. Acquisition of fixed assets. Buying equipment with cash, including cash obtained via borrowing, is a typical use of working capital. Acquiring the asset in exchange for stock involves no current account and has no effect on working capital. Paying off long-term debt. Assuming, as is usually the case that a company uses current assets to retire a long-term debt, paying off the debt is a use of working capital. A long-term debt is not carried in the current accounts payable liability account. Acquiring long-term debt. When a company takes out a long-term loan, the money borrowed goes into a current asset, usually a cash account. The company also acquires a noncurrent liability, the debt itself. Tyour transaction involves a current asset and a noncurrent liability, and is therefore a source of working capital. Selling a fixed asset. A company might occasionally sell equipment, a building, or even land in return for cash, because the company no longer has use for the asset or is in desperate need of funds. Tyour involves a current and a noncurrent account and is therefore a source of working capital. Suppose the asset is sold at a loss: A building purchased for $200,000 in 2005 is sold for $150,000 in 2009. Even though the sale represents a loss, it nevertheless increases working capital by $150,000.

Tracking Changes in Working Capital


Its helpful to know that a company has increased or decreased its working capital from one period to the next. Knowing that is often more helpful than knowing the change in cash assets, or net sales, or even net income. But merely knowing that a companys working capital increased by $103,355.59 during 2011 for example, doesnt help you to understand how its being managed. Its good to know that the company has over a hundred thousand dollars more to work with, but whether youre a potential employee, a manager, a stockholder, or creditor, you should want to know more. Whats the main source of the increase in working capital?

Long-term debt? Then maybe you should be extra careful about loaning the company more money. A recent stock issue? If newly floated shares were snapped up, maybe you should seriously consider the job offer they gave you. Net income? The only people who are unhappy when net income builds a companys working capital are the short-sellers. The notion of working capital focuses on assets that are available for use in the near term as well as liabilities that must be satisfied in the near term. It is the difference between the two amounts, so the amount of working capital is the companys accessible assets less the near-term liabilities that it has already incurred. It is the amount of resources available to invest in new business, by converting cash to equipment, hiring additional staff, purchasing additional inventory, and so on.