Many corporations doing business in foreign countries find themselves in the situation of holding foreign monetary assets. They then typically seek to account for the gain or loss on these assets due to foreign exchange rate fluctuations in the most appropriate way.
According to the best international accounting practices, foreign currency monetary assts are generally translated using the closing exchange rate observed at the conclusion of each reporting period.
Forex Gain/Losses Using Computerized Accounting Systems
These days, many companies prefer to use a computer based accounting system to manage many cash flows, including foreign receivables and assets. Even a relatively straightforward and inexpensive accounting system solution like QuickBooks can be used by smaller companies to keep track of their foreign currency cash flows and monetary assets.
In this computerized accounting environment, each transaction entered into the system that results in a foreign monetary asset will typically be assigned an exchange rate pertaining to the date when it was posted to the system’s ledger for accounting purposes.
Forex Gain/Losses Using Paper Accounting Systems
Alternatively, if a company has relatively few foreign monetary assets to keep track of, they might instead opt to use a paper based accounting system to manage the value of their foreign currency balances.
Companies that prefer this manual accounting method often translate each cash flow separately at the exchange rate that was prevailing when it occurred back into their domestic currency.
This method of calculating foreign exchange gain/loss on foreign monetary assets might be appropriate if foreign exchange transactions were performed to exchange the foreign currency receivables or assets into their domestic currency as soon as they were received.
Furthermore, their accountant might also use historical exchange rates that relate to the opening balance date and the closing balance date to translate those balances back into their primary accounting currency, which is generally their domestic currency.
Example of Calculating Forex Gain/Losses on Monetary Assets
For illustration purposes, consider the example of a small U.S. based company that sells a product in Japan for which it receives Japanese Yen. Engaging in this form of international trade typically results in the company accruing an accounts receivable balance in Japanese Yen over time.
The foreign exchange gain/loss on the Japanese Yen monetary assets accumulated over a one year accounting period would be computed manually as follows:
|Day 1 Opening Balance Accounts Receivable||= $12,500.00|
|USD/JPY Exchange Rate on Day 1||= 80.00 Yen/$1|
|JPY Amount||= 1,000,000 JPY|
|Yearly Product Sales on Credit||= $ 5,882.35|
|USD/JPY Exchange Rate for Sales||= 85.00 Yen/$1|
|JPY Amount||= 500,000 JPY|
|Cash Payments on Sales Received||= $ 2,941.18|
|USD/JPY Exchange Rate for Payments||= 85.00 Yen/$1|
|JPY Amount||= 200,000 JPY|
|Day 365 Closing Balance in USD||= $15,441.18|
|Day 365 Closing Balance in JPY||= 1,300,000 JPY|
|Implied USD/JPY Exchange Rate||84.19|
|Actual USD/JPY Exchange Rate on Day 365||= 90.00 Yen/$1|
|Revised Closing Balance in USD||= $14,444.44|
|Total Yearly Realized Gain/Loss||= ($ 996.74) Loss|
Basically, the yearly forex gain or loss on foreign monetary assets for this company is the difference in the USD amounts for the Closing Balance and the Revised Closing Balance Amounts observed at Day 365. In this example, the company experienced a -$996.74 loss over the year due to an adverse movement in the USD/JPY forex rate.