Foreign Exchange Gain/Loss
Foreign exchange gain/loss refers to the gain or loss arising from the change in price of one currency against another. Typically, gains and losses on foreign currency transactions are recognized in the profit or loss for the period in which the transaction takes place.
Foreign exchange gain/losses arise due to changes in currency exchange rates. For example, suppose Company A holds 500 US Dollars and Company B holds 500 Canadian Dollars. If the exchange rate changes from 1.35 Canadian Dollars per US Dollar to 1.25 Canadian Dollars per US Dollar, Company A would have made a foreign exchange gain of 50 Canadian Dollars, while Company B would have incurred a similar dollar loss. Gains and losses on foreign exchange can occur when dealing with foreign currencies, or when purchasing products or services denominated in foreign currencies.
The accounting for foreign exchange gains and losses depends on the type of transaction involved. Gains and losses on foreign currency transactions resulting from cash conversions, settlements of financial instruments, or foreign exchange forward contracts are included in the income statement as gains or losses on foreign exchange. When dealing with non-monetary items (such as inventory), the gain or loss is adjusted against the cost of the item and is reported as a separate item in the income statement.
When dealing with hedging of foreign currency transactions, the foreign exchange gains or losses are deferred and reported until the hedged item is recognized in the income statement. For example, when entering into a forward contract to hedge a purchase in a foreign currency, the exchange gains or losses is deferred and reported in the income statement when the purchase is completed.
In addition, hedges of some foreign currency items are accounted for differently. For example, when a forecasted transaction is hedged using a forward contract, the gains and losses from the hedge itself are recognized in the income statement when the hedged item is recognized.
Foreign exchange gains and losses on foreign currency transactions can have a significant impact on a company’s financial statements, since foreign currency exchange rates can fluctuate greatly. Thus, companies need to be aware of their foreign currency exposure and have hedging strategies to limit their foreign exchange risk.
