Foreign Exchange Gain or Loss Journal Entry

Foreign Exchange Gain or Loss is the fluctuation of company transactions that incur in other currency and it impacts the company recording in functional currency. It happens when the company sells or buy goods or service in other currencies, and that exact currency changes its value compared to the functional currency.

In the business nowadays, company is able to do business across the country. They purchase the product from one country to sell in the local market. Moreover, some companies manufacture the product and export it to other countries.

When company purchases goods overseas, the supplier may bill in a different currency. The company will convert the amount to functional currency and record it as accounts payable. On the due date, company needs to settle the accounts payable, but the amount must be equal to the foreign currency. If the exchange rate change, the amount paid will different from the original accounts payable. If the company pays more than the accounts payable, the difference will be recorded as a loss on foreign exchange. If the company pays less than accounts payable, it is the gain on foreign exchange.

Similar to accounts payable, the foreign exchange gain/loss also happens to the accounts receivable when company sells products in other currencies. The company sells goods overseas and bills in other currencies. However, they record accounts receivable in functional currency. When customers payback, it is based on the foreign currency, so it will be different from accounts receivable. It’s again when cash received is higher than accounts receivable. If the cash received is less than receivable, it will a loss.

Foreign Exchange Gain or Loss Journal Entry

Gain on Foreign Exchange

Gain can on both accounts payable and accounts receivable.

For accounts payable, it means the company pays less than the book value due to the change in the exchange rate. The accounts payable record is based on the one exchange rate, while the payment is based on foreign currency and has different exchange rates.

The journal entry is debiting accounts payable and credit cash, Foreign exchange gain.

For the accounts receivable, the company bills invoice in other currency and record them in functional currency. It is an exchange rate gain when company receives cash more than the AR record. The reason is exchange rate fluctuation.

Loss on Foreign Exchange

It happens when the company pays more to settle the accounts payable. The difference is due to the exchange rate increase.

Opposite from the above case, the company receives cash less than the AR recorded.

Foreign Exchange Gain or Loss Journal Entry Example

ABC is a manufacturer that purchases material from China and produces the final product. They will ship the product to sell in Europe. Its functional currency is USD.

• On 01 May, ABC purchased raw material cost CNY 10,000, and the exchange rate is 1 CNY = 0.15 USD. On 15 May, ABC settle the payment with the supplier while the exchange rate is 1 CNY = 0.16 USD
• On 02 June, ABC sell goods to customers overseas for 10,000 Euro while 1 EURO = 1.11 USD. Due to the requirement, ABC has to issue the invoice in Euro. On 15 June, the customer settle the payment in Euro while the exchange rate is 1 EURO = 1.13 USD.

Please prepare journal entry of foreign exchange gain/loss.

On 01 May, company purchase material for CNY 10,000 = USD 1,500 ( 1 CNY = 0.15 USD). Accountants need to record accounts payable of $ 1,500 as the functional currency is USD, so they have to convert the transaction to USD.

The journal entry is debiting inventory $ 1,500 and credit accounts payable $ 1,500.

On 15 May, it is the due date and ABC must settle the accounts payable. The amount that ABC needs to pay is CNY 10,000, not $ 1,500. On the payment date, CNY 10,000 = 1,600 USD (1CNY = 0.16 USD). ABC needs to spend $ 1,600 to settle CNY 10,000, but A/P is only $ 1,500, so the difference is exchange loss.

Foreign Exchange Loss = $ 1,600 – $ 1,500 = $ 100

Journal entry is debiting accounts payable $ 1,500, Foreign exchange loss $ 100, and credit cash $ 1,600.

On 02 June, ABC sells the product Europe for EURO 10,000 = USD 11,100 based on the exchange rate. ABC needs to record in USD as it is their functional currency.

On 15 June, ABC receive payment from the customer which is equal to EURO 10,000. Accountant needs to convert to USD for recording. Base on exchange rate on 15 June, EURO 10,000 = USD 11,300. It means company receives cash more than A/R, the difference is gained on the exchange rate.

Foreign exchange gain = $ 11,300 – $ 11,100 = $ 200

Journal entry is debiting cash $ 11,300 and credit A/R $ 11,100, Foreign exchange gain $ 200.