Foreign exchange accounting

Foreign exchange accounting or FX accounting is a financial concept to define the corporate treasurers’ exercise consisting of reporting all the company’s transactions in currencies different than their functional currency.

Note: It is important not to confuse foreign exchange accounting, applicable to all companies that transact in foreign currencies with hedge accounting, an optional technique that modifies the normal accounting basis for recognising gains and losses on associated hedging instruments and hedged items, so that both are recognised in P&L (or OCI) in the same accounting period.

When international companies import goods and services from foreign providers or sell their products in overseas markets, they generate cash flows in foreign currencies. To report these payables and receivables in the financial statements, the company has to first translate their value in the functional currency of the organisation, using the spot exchange rate of the date when the transaction is recognised.

For instance, a European company, whose functional currency is the euro sells products to a UK company, for the value of 100,000 British pounds. The day of the sale, the company issues an invoice and records the contract in euro on their balance sheet, with a daily exchange rate of EURGBP 0.88.

FX Accounting entries
60 days after having received the invoice, the buyer, as agreed, pays the GBP 100,000 to the European company. However, the exchange rate is no longer 0.88, but 0.92, thus the company must register an FX loss.

FX gain/loss entry
The impact of the appreciation of the functional currency has caused an FX loss for the exporter. Conversely, if instead of a receivable, the European company of the example would have made a purchasing transaction, in the same circumstances, they would have recorded an FX gain on the payment date.