Foreign Exchange Accounting Rules

By Carter McBride, eHow Contributor updated: July 13, 2010 Accountants must comply with generally accepted accounting principles (GAAP). When a company enters into a foreign transaction it will need to comply with the generally accepted accounting principles related to foreign currency exchange transactions. The most important rules deal with the company's functional currency, the steps involved in recording the transaction and the current exchange rates. Keeping these rules in mind, an accountant will be able to account for foreign currency exchanges.
Functional Currency

1. The functional currency is the currency in which the company does its principal business. The facts of each situation will determine the company's functional currency. The general rule of thumb is, whatever currency the business normally uses will be the functional currency of the business. For example, a United States business performs most of its transactions in the U.S. dollar. Occasionally, the company will perform transactions in the euro. The functional currency would be the U.S. dollar.
Transaction Steps

2. The company must record two transactions any time it has a foreign currency exchange transaction. The first transaction is dated as the day the company enters the transaction. For example, a U.S. company enters into a contract with a German firm to buy widgets for 500 euros. Since the functional currency of the U.S. firm is the dollar, the company cannot record the transaction in euros on its financial statement, so it must convert the amount to dollars using the current exchange rate. The second step is when the company actually pays in euros. If the foreign currency exchange rate changed, there will be either a gain or loss on the transaction. For example, if when they first enter the transaction 500 euros equals $400 and when they pay in euros,500 euros equals $350, then the company will have a $50 exchange gain.
Current Exchange Rate

3. The current exchange rate is what the company could obtain on the open market. Banks and currency exchanges will provide this amount when the company exchanges the currency. These rates are also available on financial websites such as X-Rates and Yahoo! Finance.

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References

Accounting Finance Tax: What is the Journal Entry for Foreign Currency Transactions? NYU: Accounting for Foreign Exchange Exposure - FAS 52

Resources

X Rates: Exchange Rates Yahoo! Finance: Currency Converter

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HOW TO ACCOUNT FOR GAINS AND LOSSES

Accounting for Foreign Exchange Gains & Losses

By Carter McBride, eHow Contributor updated: July 13, 2010
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.

Converting Foreign Currencies

1. 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

2. 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.
Recording a Gain When Completing Transaction

3. 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

4. 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

5. 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