We do inter-account transfers between two accounts that are in different currency. Manager automatically somehow calculates foreign exchange gain/loss and credits that GL account.
Any way to stop this?
In addition, looks like in the first month of this year there was a âforeign exchange revaluationâ based on my AR and Cash at bank. Turns out to be quite substantial and I really donât want to show this on my P&L.
It cannot be stopped because itâs part of the double-entry accounting mechanism. And double-entry mechanism is supposed to catch these kind of bookkeeping issues so it works as intended.
But generally speaking foreign exchange gains / losses are calculated based on your exchange rates entered under Settings tab then Currencies then Exchange Rates.
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From an accounting perspective, what you want does not matter The books must balance, meaning the accounting equation (Assets = Liabilities + Equity) must balance. To do this, your balance sheet must be stated in a single, equivalent currency (your base currency). When relative values between currencies change, the differenceâviewed from the perspective of your base currencyâis real. In other words, in terms of your base currency, you have gained or lost money. And that gain/loss must be posted somewhere on your profit and loss statement.
You may believe this has nothing to do with your business operations. But consider an extreme example. Suppose you maintain a bank account in a foreign currency to settle imported purchases. Imagine that your business in imported goods is booming, and that foreign-currency account grows to be 90% of your assets. Suddenly, the foreign government collapses, and its currency becomes worthless. You can no longer convert money in that foreign-currency account into any other currency. You would have lost money, just as if it had been stolen. A profit and loss statement that excluded the foreign exchange gain/loss would not represent your actual performance. You took on risk by operating partially in a foreign currency. The risk did not pay off. That is not conceptually different than buying the latest clothing fashions to sell and discovering your customers wonât buy them. You would be left with worthless inventory and have to write it off. That write-off would properly show up on your profit and loss statement. Your worthless foreign currency is not conceptually different.
Normal, day-to-day exchange rate fluctuations are seldom so severe. But they are just as real and just as necessary to consider for accurate accounting.
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Got it, thanks Lubos.
@Lubos there is an issue with this, let me explain. We have businesses that got long-term USD loans in 2017 until now majorly for asset investments. They operate in volatile exchange rates regimes and recent inflation pressure did not help either. So whenever we generate a P&L it produces the Foreign exchange gains (losses) to an extend that gross profit appears every month as negative while in essence they have a healthy Sales - Cost of sales ratio that covers the remaining business expenses and thus should show a net-profit as well.
I think that it is correct to have a correction for foreign exchange gains (losses) but do not think it belongs to the income side of the P&L. It would only be relevant at the point of making transactions related to paying off these forex loans and not as a permanent feature in the P&L.
Could you please consider changing this or allowing it to be frozen outside the P&L reports to reflect normal business.
You are describing unrealised profit / loss of an investment.
Local accounting laws likely govern how these must be treated / are best placed in Managers âProfit and loss Statementâ
- Taxed when realised or calculated.
- Distributed when realised or calculated.
Either way such investment returns often require different treatment to short term translation costs.
Not really, they are loans to the businesses paid in forex for why they bought for example land, equipment, etc. They are recorded as asset and the loan is the liability. Only at the moment of sales of such assets should they appear in P&L and the foreign exchange gains (losses) should change with it at such time (can be 10 years or more later). So it needs to be somewhere, ideally only on the balance sheet side as it is there were these gains (losses) are affected and when selling then it becomes income and added losses because of exchange rates.
Businesses operating in this manner should seek urgent professional advice!
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Good one! The reality of some locations in the world is that forex is expensive and the businesses I refer to are youth startups such as small commercial farms, restaurants, etc that are getting angel investments (better called development investments with recovery but no profit interest) in countries in sub-Saharan Africa. Sure their initial situation as far as high risk investments and extreme long recovery in volatile environments is from a pure business perspective madness but from a development perspective where job creation, entrepreneurship development, access to modern technology (think farm and restaurant automation and equipment) can contribute tremendously to a particular location and people.
However, @AJD would you care to explain why Foreign exchange gains (losses) should be on the income side of the P&L and thus part of the gross profit equation? I made clear that it is important to show these gains/losses but questioned its location to be reconsidered.
@ADJ in addition to my earlier reply our accounting experts had us assign the âcontrol accounts - special accounts for the loansâ to Financing activities rather than Operating activities because they are not related to operating transactions.
It is based on the assertion that allocating forex differences on forex loans to the operational classification would make operating profit appear volatile as I tried to explain. Therefore forex differences should be classified outside the operating category as we did to the financial one. Therefore presenting this in the financial statements is confusing also because forex differences also have no predictive value.
I also alerted to the fact that it does present anticipated forex gains or losses it should not be presented in P&L until such gains or losses are realized based on actual transactions.
An option that I would like @Lubos to consider is that when classified as Financing activity that it reports the anticipated Forex gains or losses under Equity in the Balance Sheet and when classified as Operating activity such as purchases and sales in forex that it is presented in P&L when realized under the Income group
As your business value in Manager is express itâs default currency, if the business value changes then their must be a corresponding entry in the P&L to account for it. It is up to your design of your businesses COA to ensure important information is readily shown.
I have an operating profit shown before costs and income for which the business has less day to day control such as depreciation and u realised profit / loss.
Thanks @Patch, I moved it so that it now differentiates it from the Income from operations and related costs giving better insight into gross profit.
We differ on âbusiness valueâ to be expressed in profit and loss. Loans, Fixed assets, etc do not appear in P&L but in Balance sheet. Realized forex gains and losses at moment of transaction however must.
Yes, you can arrange the P&L statement to show net profit before Forex losses, but donât remove them from the report altogether.
Forex risk on foreign currency loans can devastate a business fairly rapidly and should be managed closely and methods of hedging, at least part of the risk, should be investigated and considered,
I agree with that but there is an issue that the tax authorities in some of the countries do not want it to see reducing the net profit (forex losses) as the losses would show in any yearâs P&L as the loans were given years ago and every year hypothetical show losses without actually being transacted. Hence the consideration to use the Equity group until gains or losses materialize through transactions in which they no longer are Financial but Operational activities.
This just emphasises that financial accounts and tax accounts are two different objects, although they share a lot in common.
There can be many adjustments to financial accounts to arrive at tax accounts
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Let me give a clear example and then I can learn. We give a loan of $300,000 to a young entrepreneur in Nigeria to purchase land with very gentle conditions. No interest for the first 5 years and repayment over 20 years. Forex in Nigeria is very volatile and we agreed to use for accounting the parallel (Black) market rates because if they have to repay it must be in US$ and not in Naira. For them to get dollar they are forced to buy it on the parallel market. However to comply with Government regulations we actually enter the official government ones but also these devaluated to a large extent.
Some facts. Land does not depreciate so can not subject its gains and losses in P&L as it will not materialize, only when selling but not when using. Meanwhile Manager does not put these type of forex gains and lossed in equity as part of a financing activity but in P&L as operating activity. This is what is being questioned here. We understand the risk and the need to record this but in cases where it involves assets and liabilities it would be ideally be accounted for in equity and not P&L.
Our auditors and accountants asked for this to be reviewed hence my posting. Risk needs to be presented but in this case it relates to what the business actually owns (land) and owes (loan) which only translates into P&L when repayments are made or land is sold (i.e. transactions) and these relate to gross and net profit that relate in a country like Nigeria to corporate taxes. It artificially reduces the tax as the presented forex loss reappears every year but has never been realized. Maybe in 10 years time it is all reversed and the Naira stronger than the dollar. Even then as long as you do not transact it it is an anticipated gain or loss not an actual one in terms of operations but definitely should be recorded as a financial activity. The risk must be shown but the argument I try to make is that it is different for sales and purchases in forex that belong to P&L and in loans for assets that belong to Balance sheet. Loans are not income for a business and therefore never recorded as such. The forex gains and losses on a loan therefore should never show in P&L until actual transactions are made (repayment and sales of assets).
The land will be appreciating in Nigerian dollars and probably also in your Manager businesses currency. Entering those unrealised gains would result in a more accurate business status.
It isnât the value of the land that is showing up on the P&L. It is changes in the asset value and loan liability as converted to Naira (your base currency). When you drill down to the asset or liability themselves, they will not have changed in the currency in which they are denominated (neglecting for this discussion any loan payments).
I have to disagree with this. Forex gains/losses are not imaginary. Here comes one of my little thought experiments. Suppose you purchased two identical assets at the same equivalent price on the day of purchase, but one is purchased in dollars and the other in Naira. Further suppose that the purchase of each is financed 100% with two different currencies, dollars and Naira, under equivalent repayment terms. After 10 years, as the two currencies drift apart in value (it doesnât matter which way they go), one loan will be harder to pay off than the other, because its currency will be worth more.
You took risks by borrowing money. You made two different bets, and one worked out better for you than the other. You said, âRisk needs to be presentedâŚ.â The different risks are contained in the balance sheet by showing asset and liability figures in the different currencies. But position also has to be shown, and the forex gains/losses during an accounting period allow you to do that in a single currency. The only way to avoid this would be to have different businesses for the different currencies.
Continue the thought experiment by imagining that the currencies had drifted in the other direction. Instead of showing steady losses, you would be showing steady gains. In other words, that business bet would have worked out better for you, because instead of being harder to pay off, the loan would be easier. You would look like a business genius, with no accounting tricks having been applied.
Regardless of social motivations, it is better in my opinion to train new entrepreneurs on proper accounting practices so they can make decisions that keep themselves in business. They are already getting breaks by being given better-than-market terms on loans.
Unfortuantely this is not the case, the value of the Naira (is the name of the currency not naira dollar) is declining and artificially upheld by forex sales by the government. Insecurity also cause the value of farm land to decrease with actually thousands of farmers afraid to go back to their farms. So it loses value not gains and the fact when you purchased it by the much more stable US$ loans that need to be paid back in US$ there are serious issues.