This topic explains the accounting topics of handling gains and losses from foreign currency transactions and the treatment of General Ledger (GL) accounts that have receivables and payables at the end of a period. It describes what methods are employed by Aptify and offers a comparison of accounting methods and accounting periods to better explain Aptify's preferred approach to realizing foreign currency gains and losses during the order, payment, and GL batching transactions.
When an organization deals with foreign currency transactions, some accounting complexities occur that do not arise for domestic-only transactions. These complexities result primarily from the fluctuation in exchange rates of foreign currencies.
This topic contains the following sub-topics:
- About Recording Gains and Losses and Foreign Currency
- About Accounting Periods and Foreign Currency
- About Gains or Losses in Aptify
About Recording Gains and Losses and Foreign Currency
When an organization sells a product to a company in a foreign currency and the sale and the payment are simultaneous, there is no foreign currency gain or loss because there is no change in the value of the currency between the ship date and the payment date of the order. When a foreign currency sale is made on one date and payment is received on another date, however, a gain or loss in the value of the foreign currency may occur. These gains or losses must be recorded in the general ledger.
From an accounting standpoint, there are two ways to deal with the foreign currency risk that is acquired when a foreign currency sale and payment are not simultaneous:
The following example illustrates the effects of these two methods.
On January 1st Company A, which is based in the United States, sells 10 widgets to Company B whose preferred currency is euros (€). The amount of the transaction is €1050. The exchange rate value of €1.05/1 U.S. dollar makes the U.S. dollar value of the transaction $1000. Company A extends a 30-day credit policy to Company B, and Company B makes a payment of €1050 on January 30th. During that time, the exchange rate between U.S. dollars and euros changed resulting in a loss on this transaction. The exchange rates of the currencies are displayed in the following table.
Date |
U.S. Dollar ($) |
Euro (€) |
January 1 |
1 |
1.05 |
January 30 |
1 |
1.08 |
One-Transaction Perspective Accounting Method
The one-transaction perspective of handling gains and losses does not consider the transaction complete until the accounts receivable has been paid and converted to the default currency of the system.
Order GL Entries
Shipped Date |
Account |
Debit |
Credit |
January 1 |
Accounts Receivable |
USD 1,000.00 |
|
January 1 |
Sales |
|
USD 1,000.00 |
Payment GL Entries
Payment Date |
Account |
Debit |
Credit |
Description |
January 30 |
Sales |
USD 27.78 |
|
Adjustment |
January 30 |
Accounts Receivable |
|
USD 27.78 |
Adjustment |
January 30 |
Cash |
USD 972.22 |
|
Cash |
January 30 |
Accounts Receivable |
|
USD 972.22 |
A/R |
The net effect of the order and payment transactions is reflected in the following table.
Account |
Debit |
Credit |
Cash |
USD 972.22 |
|
Sales |
|
USD 972.22 |
This method is not acceptable under U.S. Generally Accepted Accounting Principles (GAAP) because it does not clearly disclose the fact that Company A could have received $1,000 on January 1st but instead suffered a loss of $27.78 (1,000-972.22) due to its credit policy with Company B. In order to comply with GAAP, the gains and losses that occur due to the extension and acceptance of credit terms need to be explicitly recognized rather than buried in Sales and Accounts Receivable in the form of adjustments.
Two-Transaction Perspective Accounting Method
The two-transaction perspective considers the sale and collection of payments as two separate and distinct transactions.
Order GL Entries
Shipped Date |
Account |
Debit |
Credit |
January 1 |
Accounts Receivable |
USD 1,000.00 |
|
January 1 |
Sales |
|
USD 1,000.00 |
Payment GL Entries
Payment Date |
Account |
Debit |
Credit |
January 30 |
Foreign Exchange Loss |
USD 27.78 |
|
January 30 |
Accounts Receivable |
|
USD 27.78 |
January 30 |
Cash |
USD 972.22 |
|
January 30 |
Accounts Receivable |
|
USD 972.22 |
The net effect of the order and payment transactions is reflected in the following table.
Account |
Debit |
Credit |
Cash |
USD 972.22 |
|
Foreign Exchange Loss |
USD 27.78 |
|
Sales |
|
USD 1,000.00 |
This method is considered U.S. GAAP compliant under Financial Accounting Standards Board, Statement 52, Foreign Currency Translation (FASB 52) because the gain or loss is handled in a separate account (Foreign Exchange Gain/Loss) instead of as an adjustment. Aptify posts transactions according to the two-transaction method.
The previous example shows all the General Ledger (GL) entries in one currency (U.S. dollar). When using Aptify, the GL entries for the transaction are posted in the foreign currency of the transaction and the gain or loss transactions are posted in the applicable organization's functional currency.
About Accounting Periods and Foreign Currency
When the books are closed at the end of an accounting period, balances in the receivable and payable accounts usually exist. When these balances reflect foreign currency transactions, there may be unrealized gains or losses due to the change in the value of the foreign currency. There are two approaches to handling the unrealized gains/losses:
The following example illustrates the effects of these two methods.
On December 15th Company A, which is based in the United States, sells 10 widgets to Company B whose preferred currency is euros (€). The amount of the transaction is €1,100 which corresponds to the U.S. dollar value of $1,000. Company A extends a 30-day credit policy to Company B, and Company B makes a payment of €1,100 on January 15th. Company A's books, however, need to be closed on December 31st. The following table shows the value of the euro and the U.S. dollar for the dates in this example.
Date |
US Dollar ($) |
Euro (€) |
December 15 |
1 |
1.10 |
December 31 |
1 |
1.12 |
January 15 |
1 |
1.05 |
The General Ledger (GL) entries for the sale are the same regardless of which approach is used for the ending balances.
Date |
Account |
Debit |
Credit |
December 15 |
Accounts Receivable |
USD 1,000.00 |
|
December 15 |
Sales |
|
USD 1,000.00 |
Deferral Approach
Using the deferral approach, foreign currency gains or losses are deferred on the balance sheet until cash is actually paid or received and require no General Ledger GL entries at the end of the period. When cash is paid or received, a realized foreign exchange gain or loss is included as income. Since the currency spot rate on January 15th was 1.05 euro to 1 U.S. dollar, the €1,100 transaction from December 15th is valued at $1,047.62 resulting in a gain of $47.62. This deferral approach is not compliant with U.S. Generally Accepted Accounting Principles (GAAP) but is used in some foreign countries.
Date |
Account |
Debit |
Credit |
January 15 |
Accounts Receivable |
USD 47.62 |
|
January 15 |
Foreign Exchange Gain |
|
USD 47.62 |
January 15 |
Cash |
USD 1,047.62 |
|
January 15 |
Accounts Receivable |
|
USD 1,047.62 |
Accrual Approach
The accrual approach toward unrealized foreign currency exchange gains and losses tracks the unrealized gain or loss from the foreign currency transaction during the period in which the exchange rate changes. A gain or loss gets recognized between the date the order was marked as shipped and the date the accounting period ended even though payment has not been received. Subsequent gains or losses between the accounting period end date and the date of payment are recognized in the accounting period in which they occur. This concept is also known as "marking assets/liabilities to market." The accrual approach is the method sanctioned by Financial Accounting Standards Board, Statement 52, Foreign Currency Translation (FASB 52).
In this example, the close of the accounting period is December 31st. The accrual approach generates the following entries which decreases the Accounts Receivable account by $17.86, reflecting the change in the exchange rate from €1.10 to €1.12 per 1 U.S. dollar. To make the source of income clear, the loss is posted to the Foreign Exchange Loss account rather than to the Sales account.
Date |
Account |
Debit |
Credit |
December 31 |
Foreign Exchange Loss |
USD 17.86 |
|
December 31 |
Accounts Receivable |
|
USD 17.86 |
On January 15th, Company A receives a €1,100 payment from Company B. Since the exchange rate is now 1.05 euro to 1 U.S. dollar and has changed from the value on December 31st, the effect (a foreign exchange gain) needs to be posted to the general ledger.
Date |
Account |
Debit |
Credit |
January 15 |
Accounts Receivable |
USD 65.48 |
|
January 15 |
Foreign Exchange Gain |
|
USD 65.48 |
January 15 |
Cash |
USD 1,065.48 |
|
January 15 |
Accounts Receivable |
|
USD 1,065.48 |
Handling foreign currency transactions using the accrual approach complies with U.S. GAAP and FASB 52 because the gains or losses are kept separate from the sales account.
About Gains or Losses in Aptify
To track gains or losses resulting from a change in the value of a foreign currency, Aptify uses currency spot rates. When foreign currency orders are marked as shipped, the effective currency spot rate is retrieved from the Currency Spot Rates service and is stored with the order. When payment is received on the order, the currency spot rate on that date is also stored. The Mark-To-Market object (see Using the Mark-To-Market Wizard) uses these values to generate the General Ledger (GL) entries for the gains and losses based on the stored spot rates. Currency spot rates are covered in more detail in Understanding Currency Spot Rates.
See Orders with Different Currency Payments for information on how Aptify accounts for payments in a currency that differs from the corresponding order's currency.
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