Foreign currency accounting entries

accounting for foreign currency

accounting for foreign currencyForeign currency accounting entries cause problems for businesses of all sizes. I’ve seen multi-million euro businesses with operations in various countries doing it wrong. I’ll show you the right way to do it.

International trade is open to the smallest of traders these days. Amazon, Ebay and others have opened up markets previously unavailable to micro enterprises. Any business with an e-commerce website has the potential to sell anywhere in the world.

This new level of accessibility to global markets brings different challenges to the micro and small enterprise. One of those is the treatment of foreign currency transactions.

Your business will have a ‘functional’ currency. This is the currency used for its accounts. The key to foreign currency accounting entries is this:

every transaction must be in the functional currency.

This means that

transactions in a foreign currency must be converted to the functional currency when entered in to the accounts.

There are 2 common mistakes made when accounting for foreign currencies

  1. out of date exchange rates used
  2. the mistaken assumption that the accounts should show the foreign currency balance

What exchange rate should I use?

Technically, the official rate at the date of the transaction should be used (available on Central Bank website). Alternatively, an average rate can be used (available from Revenue website).

However, modern accounting software, such as Kashflow, can apply the daily rate automatically.


Record the foreign currency value in the comments to facilitate reconciliation

I don’t understand why my foreign bank account is shown in euro in my accounts.

It is because your accounts are in euro.   What some people try to do is show a withdrawal (a credit) in the euro account for €1,000 and a lodgement (debit) in the sterling account for 850.  As all accounting entries must have an equal and opposite entry, there must be another debit for 150 to make it balance.  This difference is often charged to a foreign exchange gains/loss account.  This is wrong, as there has been no movement in the exchange rate to give rise to a gain or loss.  In other words, if the £850 was transferred back to the euro account on the same day you would still have €1,000!

I invoiced a customer in sterling what happens in my accounts?

If you issue an invoice a customer in a foreign currency you convert the invoice to euro in your accounts. So, if you issue an invoice £1,000, you record a sale of (say) €1,200; and an amount due of €1,200.  When the customer pays the £1,000 you convert it at the rate on the day of payment.

Say the customer pays 2 weeks later and sterling has weakened in that time, and the £1,000 is only worth €1,100 what happens then?

The €1,100 is recorded in the bank as a lodgement and clears down the amount due by the same amount.  But, there will still be an amount of €100 showing as due.  It’s very unlikely that you can ask the customer for this, as far as they are concerned they were billed £1,000 and paid £1,000.  To adjust for this you must record a loss on foreign exchange. This will be shown as an expense in the profit and loss account.

One last thing to do:

At the end of each reporting period (and at least annually) you must take your foreign currency balances (bank accounts, debtors, creditors) and adjust them for the exchange rate on that day.

Sound complicated?

This may sound overly complicated to begin with.  If you put the right processes in place it should run smoothly, especially if you have accounts software that can translate foreign currencies automatically.

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