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Foreign Currency Gain or Loss

Lesson
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The value of one currency compared to another can be unstable. The value of one can drop and the other can increase.

This makes it difficult to predict the value of a promised future payment that was set in terms of a foreign currency.

As such, there's a three step process to record such transactions.

  1. Record the transaction as if it were in the local currency at time of sale.
  2. At year end (if payment has not yet been received), add an adjustment to account for any currency fluctuations at that point.
  3. When payment is received, add another adjustment to ensure that the actual value of payment has been recorded.
Question
Your business, Harvey Co., sells to international markets, and you need to add some journal entries for a recent sale.

The only relevant information you've discovered is as follows:

  • At the end of the initial fiscal (accounting) year, the value of the foreign currency had decreased by $4,000.00.
  • The cost of goods sold is $85,000.00.
  • Between the end of the initial year and the cash payment in the subsequent year, the value of the foreign currency had increased in value by $7,000.00.
  • Your firm has agreed to accept foreign currency as payment, equivalent of $111,000.00 at time of sale.
What are the necessary journal entries to cover the facts?
Answer
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👉 Answer:

  • Journal Entries
    Accounts Receivable     $111,000.00    
         Sales Revenue     $111,000.00    
    Cost of Goods Sold     $85,000.00    
         Inventory     $85,000.00    
    Loss on foreign exchange     $4,000.00    
         Accounts Receivable     $4,000.00    
    Accounts Receivable     $7,000.00    
         Gain on foreign exchange     $7,000.00    
    Cash     $114,000.00    
         Accounts Receivable     $114,000.00    

👩‍🎓 Here are the steps to figure it out:

  1. First we account for the sale, assuming that there will be no changes to the current (spot) exchange rate.
    Journal Entries
    Accounts Receivable     $111,000.00    
         Sales Revenue     $111,000.00    
  2. Next, we have to account for our changes to inventory.
    Journal Entries
    Accounts Receivable     $111,000.00    
         Sales Revenue     $111,000.00    
    Cost of Goods Sold     $85,000.00    
         Inventory     $85,000.00    
  3. Now we need to update our records at the end of the first year, so we can close our books and report our financials.
  4. Let's account for the changes to currency value so far.
    Journal Entries
    Accounts Receivable     $111,000.00    
         Sales Revenue     $111,000.00    
    Cost of Goods Sold     $85,000.00    
         Inventory     $85,000.00    
    Loss on foreign exchange     $4,000.00    
         Accounts Receivable     $4,000.00    
  5. Once we have payment in hand, we need to record the payment and make updates for our gain or loss on foreign exchange.
  6. Let's start with the gain or loss on foreign exchange.
    Journal Entries
    Accounts Receivable     $111,000.00    
         Sales Revenue     $111,000.00    
    Cost of Goods Sold     $85,000.00    
         Inventory     $85,000.00    
    Loss on foreign exchange     $4,000.00    
         Accounts Receivable     $4,000.00    
    Accounts Receivable     $7,000.00    
         Gain on foreign exchange     $7,000.00    
  7. Finally, we'll record the payment (now that we know what it is).
    Journal Entries
    Accounts Receivable     $111,000.00    
         Sales Revenue     $111,000.00    
    Cost of Goods Sold     $85,000.00    
         Inventory     $85,000.00    
    Loss on foreign exchange     $4,000.00    
         Accounts Receivable     $4,000.00    
    Accounts Receivable     $7,000.00    
         Gain on foreign exchange     $7,000.00    
    Cash     $114,000.00    
         Accounts Receivable     $114,000.00    
  8. As always, it's a good idea to go through the journal entries and make sure that the debits equal the credits, which, in this case, they do.
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