Exchange gain or loss - What is an exchange gain or loss?
An exchange gain or loss is caused by a change in the exchange rate between when an invoice was issued and when it was paid. When an invoice is entered in at one rate and paid at another, this will generate an exchange gain or loss.
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Suppose your company invoices a customer abroad and therefore you invoice for these goods in a different currency from the currency you normally bank in.
Whilst you will have correctly converted your prices, when the customer goes to pay for this invoice, the rate of exchange will invariably be different from when you booked the invoice in your accounting system. Consequently, you’ll receive a slightly different amount in payment than you invoiced for.
This difference is called an exchange gain or loss, depending on which way the exchange rate has changed, i.e., whether the currencies involved have increased or decreased in value (a gain or loss).
In most accounting systems the chart of accounts will include an account or nominal code for exchange differences.
When you create a customer or supplier, you can select the currency in which they operate (you can change it if it differs from your base currency). When you process the receipt or payment, this entry must be in the same currency as the original transaction in order for two important functions to occur:
First, so that the invoice will be matched and subsequently removed as an “Open item”
Second, so that any exchange difference brought about by this will be posted to the exchange rate account or nominal code within your chart of accounts
The way you should deal with a gain or loss caused by currency exchange differences is similar for both invoices created by your business, as well as expenses encountered. They should be recorded on your balance sheet appropriately.
When it comes to the expenses side, there are two types of losses:
Unrealised gain/ loss:
An unrealised gain or loss would be noted as an exchange loss in the asset section of your records. It would also be recorded as an exchange loss in the liability section.
A realised loss would be registered as an expense and would specify that it’s a loss related to currency exchange.