- Foreign Currency Transactions and Their Effect on Accounting
- Buying or selling goods, services, or property
- Collection of foreign receivables
- Collection of foreign payables
- Borrowing or lending money
- Foreign tax credits
The digital age has allowed the world to transition to a much more global economy, and while this is great news for business, it does bring with it some administrative considerations. When dealing in foreign currency, there are legislations that have to be followed and accounting regulations that must be adhered to. Here’s a look at foreign currency transactions and how they impact accounting in your particular industry.
What’s a foreign currency transaction?
According to the US Securities and Exchange Commission: “A foreign currency exchange rate is a price that represents how much it costs to buy the currency of one country using the currency of another country. Currency traders buy and sell currencies through forex transactions based on how they expect currency exchange rates will fluctuate. When the value of one currency rises relative to another, traders will earn profits if they purchased the appreciating currency, or suffer losses if they sold the appreciating currency.”
If your company engages with an international company, you might enter into a transaction that is dominated by a foreign currency, rather than your functional currency. Your functional currency is essentially the primary currency used in your local economy. Some of the transactions that can be conducted include:
How does a foreign currency transaction impact accounting?
When it comes to foreign currency transactions between companies, you will need to remember three important concepts:
- The gain or loss is only recognised on the date the transaction is closed;
- Foreign currency is treated as property, rather than money with such transactions;
- While the goods will be recorded at the sale price, any gains or losses on this particular foreign currency transaction will only be recognised on the payment date.
In the real world, the value of one currency – relative to another – changes from day to day, so transactions must be recorded at the agreed-upon rate, while gains and losses are recorded on the date of the transaction. When you transact in a foreign currency, you need to record the functional currency according to that date for:
- Each asset
- Each liability
- The revenue
- The expense gain
- The loss
What about foreign currency and tax?
When it comes to determining the foreign tax credit on a transaction, the taxes are calculated using the average exchange rate for the taxable year. Any paid foreign taxes must be calculated at the exchange rate when payment is made. If there’s an accrual of foreign taxes, but the payment is made later in the tax year, then the foreign currency exchange rate may differ between when the taxes are paid and when the tax amount is calculated. However, if the taxes are paid within two years of being accrued, then foreign currency fluctuation between the accrual and paid rate is discounted.
What are the benefits of foreign currency transactions?
There are many reasons to engage to transact in the forex market, but it depends on your business operations and what will work for you. Some of the reasons companies find it beneficial in going this route are:
1. Easily facilitated
Most banks have the capability to wire funds in foreign currency, so these transactions are generally conducted quickly and easily. Your bank simply applies the current exchange rate to determine what you owe when sending money. For incoming funds, your customer pays in the local currency and the bank credits your account with the equivalent amount at home.
2. Better exchange rates
If you have a good relationship with your bank, you can enjoy preferential exchange rates. You might want to consider locking in certain exchange rates on a quarterly basis so that you’re not dealing with unanticipated fluctuations later on.
3. Pricing discounts
When importers pay for goods in a local currency, suppliers often offer a lower price on goods purchased. Those who remove the exchange rate risks when converting to local currency might benefit from a discount on the transaction.
What are some more benefits of multi-currency software?
Investing in multi-currency software for foreign exchange transactions is a smart move for your business. It not only minimises the time and hassle but also ensures you’re compliant with all accounting requirements. Some of the benefits include:
- Setting the rate: You can adjust the exchange rate as often as business or market changes dictate.
- Period rates: You can set up a range of exchange rates with expiry dates for retrospective transactions.
- Reporting features: You can compile reports in either the home or foreign currency.
- Cross-currency functionality: It doesn’t matter what currency you’re using on invoicing, the system can adjust to paying in another.
- Real-time operation: There is no need for manual entries, the system posts in real-time which means it automatically updates and reconciles.
- Revalue ledgers: You’re able to revalue your sales and purchase ledgers at any time.
Why choose Omni Accounts for foreign currency accounting?
If you’re looking to simplify the accounting process for your foreign currency transactions, then it’s worth investing in dedicated software that can assist with such multi-currency exchanges. One of the industry leaders is the Omni ERP Multi-Currency Module which allows for the management of businesses trading in multiple currencies.
Some of the functions you can enjoy with Omni Accounts Multi-Currency include:
- Creating customer, supplier and bank accounts in a foreign currency;
- Sending customer and supplier documents in a foreign currency;
- Managing currency fluctuations;
- Importing daily exchange rates;
- Handling VAT on imported goods;
Omni Accounts ERP can also create stock prices in different currencies with the nominal ledger values always retained in the home currency. Users can also print reports in the home currency or the foreign currency of the relevant accounts. Exchange rates can be set monthly, with a revaluation wizard available to revalue accounts at the latest exchange rate.
Find out more by getting in touch with Omni Accounts today.
Do you work at a multi-national organisation? Are you involved in the import and export industry, or rely on foreign labour? Then you likely have to keep an eye on changes in the currency exchange rates.
This can be a difficult balancing act because there are so many factors that come into play – a war between Russia and Ukraine has an impact on European currencies which affects consumer goods prices down the line.
Here’s a look at the foreign exchange rates, their impact, and how this affects international business.
What affects the currency exchange rate?
Economists have their work cut out for them! There really are so many factors that impact the currency exchange rate on a daily basis. Here’s a look at some of the biggest influencers.
- Inflation: This is the purchasing power of one currency compared with another – so where it costs a single unit of currency to buy a loaf of bread in one country, that same loaf could cost several hundred units of currency. Those countries with a lower inflation rate generally have stronger currencies.
- Public debt: Many developing countries have to borrow money to finance their economic growth. Unfortunately, where the debt is growing faster than the economy, the currency devalues.
- Political instability: As we’ve witnessed with the Russian war on Ukraine, instability events within the country devalue the local currency.
- Interest rates: Central bankers have to adjust the country’s interest rates as a way to balance the inflation and attract foreign capital. Higher interest rates increase the value of a country’s currency.
- Balance of trade: This is the difference between a country’s exports and imports, with countries that export more than they import perceived to have better economic health and better currency exchange rates.
- Investor confidence: Traders will consider factors like election outcomes, unemployment figures and other economic news for investment options. These views, however, are often short-lived and not necessarily based on fact.
How does the currency exchange rate impact business?
The fluctuating currency exchange rate impacts us all in some way or another. Most businesses will either benefit from or lose out on sudden changes. Here’s a look at some of the ways it impacts international business and the risks involved.
If you work with foreign suppliers then an adjustment to the currency exchange rate could mean you save money if it shifts in your favour, or lose out because you’re paying more for the same goods or services. You will need to consider this well in advance as it can determine whether you order goods upfront or decide to buy as you go.
Changes in currency exchange rates also make it incredibly difficult for international businesses to perform accurate sales forecasting. Where sales might be going really well in an international branch, the amount coming in can shift drastically if the exchange rate suddenly turns against you.
Finance directors have an incredibly tough time when working out the value of assets or liabilities as they have to factor in fluctuating exchange rates. This is impactful for businesses when it comes to tax regulations as well as loans taken out in foreign currencies.
We’re all acutely aware of the rising fuel prices against the backdrop of global political instability, but this doesn’t just impact individual households but also businesses. The fluctuating exchange rate could mean a depreciation of the local currency and a rise in transportation costs and, therefore, sold goods.
Mergers and acquisitions
The value of businesses themselves is also very much tied to the currency exchange rate. This means that a business located in a country with a stronger currency is more likely to consider mergers and acquisitions with companies located in regions with a weaker currency.
Travel and tourism
The current currency exchange rate has a massive influence on the travel and tourism industries. Where the currency depreciates, the area becomes a more attractive tourism offering as visitors will be able to get more for their money. This shows that there are actually indirect benefits of a weaker currency.
How do you manage changes in currency exchange rates?
There are several ways you can attempt to mitigate the risk presented by ever-fluctuating currency exchange. Here are some of the preferred options.
This is where you enter into an agreement with other parties that protect your business from any fluctuations in the exchange rate. This means that items such as imported or exported materials or products remain at a fixed rate. (No matter whether the exchange rate goes up or down.)
Buy in bulk
If your business has the means, it might be worth buying goods in bulk. (When they’re available at a reasonable rate.) When you go with a need-to-buy option, you’re taking the risk of an unfavourable exchange rate down the line.
Transact in your currency
Is your company in a strong competitive position? Then you might be able to negotiate for transactions in a currency of your choice. This allows you to pass the risk of currency exchange on to the supplier.
The advances in financial technology (FinTech) have made international transactions much safer and swifter which means that aren’t delays in payments. For a small upfront fee, you can pay money overseas on the day so you don’t have to worry about currency exchange rate fluctuations.
Big multinational companies even build foreign exchange fluctuations into contract clauses. This means that their revenue can be recouped when the exchange rate deviates from the agreed amount. This, once again, passes the risk onto the supplier.
It’s also important to adopt enterprise resource planning (ERP) software that allows for the management of trade in multiple currencies. The ERP software manages daily activities – accounting, procurement, compliance, project management and supply chain operations – so it’s important that it’s able to operate across currencies, and make the necessary adjustments when the foreign exchange rate fluctuates.
If you need help with these elements in your business, please feel free to contact the Omni team for assistance.