About Realized and Unrealized Gains and Losses

For example, a U.S. company purchasing items from a British company that requires payment in British pounds must exchange dollars ($) for pounds (£) to settle the transaction. This exchange of one currency into another involves the use of an exchange rate. If the U.S. company had purchased items for £1,000 from a British company on June 1, when the exchange rate was $1.40 per British pound, $1,400 would need to be exchanged for £1,000 to make the purchase.

Because the U.S. company maintains its accounts in dollars, the transaction would be recorded as follows:

Payment of Invoice #1725 from Sterling Co.

£1,000; exchange rate: $1.40 per British pound

For example, assume that on July 10, when the exchange rate was $.004 per yen (¥), a purchase for ¥100,000 was made from a Japanese company. Since the U.S. company maintains its accounts in dollars, the entry would be recorded at $400 (¥100,000 X $.004), as seen below:

Invoice #823

¥100,000, exchange rate: $.004 per yen

If on the date of payment, August 9, the exchange rate had increased to $.005 per yen, the ¥100,000 account payable must be settled by exchanging $500 (¥100,000 X $.005) for ¥100,000. In this case, the U.S. company incurs an exchange rate loss of $100, because $500 was needed to settle a $400 debt (accounts payable). The cash payment would be recorded as follows:

Cash paid on Invoice #823

¥100,000, or $400, current exchange rate: $.005 per yen

All transactions with foreign companies can be analyzed as in the examples above. For example, assume that on May 1, when the exchange rate was $.25 per euro, a sale on account for $1,000 from a U.S. company to a French company was billed in euros (€4,000). The transaction would be recorded as follows:

Invoice #7782

€4,000, exchange rate: $.25 per euro

If the exchange rate had increased to $.30 per euro on May 31, the date of receipt of cash, the U.S. company would realize an exchange gain of $200. The gain was realized because the ‚€4,000, which had a value of $1,000 on the date of sale, had increased in value to $1200 (€4,000 * $.30) on May 31 when payment was received. The receipt of the cash would be recorded as follows:

Cash received on Invoice #7782

€4,000 or $1,000, exchange rate: $.30 per euro

For example, a German company purchasing items from an U.S. company pays in euros. The U.S. company must then exchange euros for U.S. dollars to settle the transaction. In this case, the German company is making partial payments rather than paying the balance in full. The transaction would occur as follows:

For example, assume that a sale on account for $1,000 had been made to a German company on December 20, when the exchange rate was $.50 per euro (€), and that the transaction had been recorded as follows:

Invoice #22

€2,000; exchange rate: $.50 per euro

If the exchange rate had decreased to $.45 per euro on December 31, the date of the balance sheet, the $1,000 account receivable would have a value of only $900 (€2,000 X $.45). This "unrealized" loss would be recorded as follows:

Invoice #22

€2,000 X $.05 decrease in exchange rate

Assuming that €2,000 are received on January 19 in the following year, when the exchange rate is $.42, the additional decline in the exchange rate from $.45 to $.42 per euro must be recognized. The cash receipt would be recorded as follows:

Cash received on Invoice #22

€2,000, or $840, exchange rate: $.42 per euro

If the exchange rate had increased between December 31 and January 19, an exchange gain would be recorded on January 19. For example, if the exchange rate had increased from $.45 to $.47 per euro during this period, an exchange gain would be credited for $40 ($.02 X €2,000).