Foreign exchange gains and losses in foreign currency bank accounts

If your business holds funds in foreign currency bank accounts, you're aware that foreign exchange rates sometimes move in your favour, and sometimes they go against you.

Wave allows you to create bank accounts in foreign currencies, and records deposits and withdrawals from these accounts adjusted to your business's "home" currency. From time to time you will need to adjust the balances in these accounts to take account of currency exchange movements. This article shows you how.

Scenario

To aid understanding, this article will walk through some examples. We'll base the examples on the following scenario:

You start a part-time business on January 1st in Canada, with Canadian Dollars as your business currency. On January 2nd, you receive your first income (congratulations!), for CA$ 1,000, and pay it into your Canadian bank.

You have a potential deal in Mexico, which would require you to have some local currency, so you immediately transfer the money into a Mexican Peso account. After exchange costs, you wind up with Mex$ 15,423.30 in your Mexican account.

Nothing happens with the Mexican opportunity, and other priorities prevent you doing anything else with this business. On April 19th, you decide to move your money back from your Mexican account. Good news!... The Peso has recovered some strength against the Canadian Dollar. Instead of the CA$ 1,000 you originally transferred, you get back CA$ 1,112.55. Nice!

For the sake of completeness, we'll walk through each step of this scenario, looking not just at the transactions, but also the impact on this business' Income Statement (Profit & Loss Report) and Balance Sheet.

Step 1 - You receive CA$ 1,000 income and deposit it to your CA$ account

No surprises here: we have one Income transaction, landing in your CA$ bank account - let's call that ‘Checking Account.’

On the Income Statement we are expecting to see CA$ 1,000 of income that flows straight through to profit, and on the Balance Sheet we should see CA$ 1,000 of Checking Account asset, balanced by Current Year Earnings, under Owner's Equity.

Step 2 - You transfer the CA$ 1,000 to your Mex$ Foreign Currency Account

You record the movement in Wave using the technique described in this article to transfer between accounts in different currencies, using an ‘Undeposited Funds’ account to make sure each account sees the transaction in its 'natural' currency.

Unsurprisingly, there's no change in the Income Statement - we've just moved some money around. There is also no economic change to the Balance Sheet, but it is updated to show the new Mexican Peso Checking Account and the Undeposited Funds Account.

Important: Notice that although the transactions page shows the deposit (income) transaction into the Mexican Peso Checking Account as Mex$ 15,423.30, Wave actually accounts this in the Business' ‘Home’ currency at CA$ 1,000.

This is essential to understanding how your foreign currency account balances are reported: all foreign currency bank account balances are converted to your ‘Home’ currency at the time they are created or deducted, and your Income Statement and Balance Sheet are always reported in your ‘Home’ only.

Step 3 - You transfer Mex$ 15,423.30 back to your Canadian Dollar Checking Account

Having decided not to proceed with the opportunity in Mexico, you transferred all the Mex$ 15,423.30 back from your Mexican Peso Checking Account to your Canadian Dollar Checking Account. Again, you used the recommended steps to record the transfer via your ‘Undeposited Funds’ account.

As we set out in the scenario at the top of this article, the exchange rate moved your way. Bringing back the original Mex$ 15,423.30 brought you CA$ 1,112.55 — a profit of CA$ 112.55.

According to your Balance Sheet, your total assets remain CA$ 1,000, and there's no sign of the extra CA$ 112.55 on your Income Statement.

Look closely and you'll see the reason - Wave has calculated that you have a negative balance worth CA$ 112.55 in your Mexican Peso Checking Account, but that can't be right. You put in Mex$ 15,423.30, and took out Mex$ 15,423.30, so surely the balance should be zero?!

OK. Remember at the last step we noted a really important point about how Wave accounts for Foreign Currency Bank Deposits? They are accounted in your Business' ‘Home’ currency, converted at the time the balance is added or deducted. What Wave has accounted here is perfectly logical: you deposited Mexican Pesos worth CA$ 1,000; you withdrew Mexican Pesos worth CA$ 1,112.55, so Wave quite reasonably believes there is a defecit of CA$ 112.55 in that account. Of course, you understand the actual transaction a little better, so you're going to have to give Wave a little helping hand to understand it the way you do!

Step 4 - Record the Extra Income Earned through Currency Exchange

We know — just Wave doesn't know yet — that you've made an extra CA$ 112.55 in income through the currency exchange rate moving in your favor. To tell Wave about this, we're going to create a Journal Transaction. Here goes:

  1. On the left navigation Bar, click Accounting, then Journal Transactions. On the Journal Transactions page, click the Add transaction button.
  2. On the Add Journal Transactions page, you'll want to give the transaction a helpful description that will remind you why you created it. And if you don't already have an income account set up where you'd like to record this extra income, you'll want to click the '+' button to add one.
  3. Here's the completed Journal Transaction ready to save. As you can see we are increasing (Crediting) our new Income account, and balancing this by Debiting our Mexican Peso Checking Account. (Remember, Debiting an Asset account increases its balance, so we're adding CA$ 112.55 into our Mexican Peso account, which previously had a CA$ 112.55 deficit.) 
  4. Save the Journal Transaction, and you're done!

With that done, let's take another look at the Income Statement and the Balance Sheet:

Now everything looks the way we would expect: our Income Statement is showing the correct total income of CA$ 1,112.55, made up of CA$ 1,000 Sales and CA$ 112.55 currency gain. And our Balance Sheet is correctly now showing a zero balance in our Mexican Peso Checking Account. Success!

What about the Transactions in the Foreign Currency Account?
I now have an extra (Journal) Transaction.

When you create a Journal transaction that involves a bank account, Wave shows the Journal Transaction within your overall transactions data. Note that the transaction is shown in the currency of the bank account, in this case in Pesos.

You might think this is going to make the Foreign Currency Account balance hard to track, but in fact it is very easy. Simply filter your Transactions data to show only the Foreign Currency account, and only mark the 'physical' transactions Verified. Leave any Journal Transactions Unverified.

By verifying only the 'physical' transactions, you will be able to track and verify your actual Foreign Currency account balances, while also keeping your ‘Home’ currency accounting correct!

Frequently Asked Questions

I see how to record a Gain on a Foreign Currency Bank Account. What if I made a loss?

Handling a Loss on a Foreign Curreny Bank Account is much the same, but in reverse. In the example above, if we'd made a loss on our Mexican Pesos returned to Canadian Dollars, Wave would show us still with a positive (CA$) balance after the withdrawal, instead of the negative balance of our example. We'd then have wanted to post a Journal to an Expense account, which we might have called something like Loss on Foreign Currency Bank Deposits.

Can I apply the same approach to other Foreign Currency Gains and Losses?

The method shown here is applicable to Foreign Currency Bank Deposits, and to other ‘Stores of Value’ such as inventories recorded in Foreign Currency. It would apply also to to Foreign Currency liabilites such as loans.

Gains and Losses on Foreign Currency Transactions, including Sales Invoices and Purchases (Bills) are handled automatically by Wave, as explained in this separate article on Accounting for Foreign Currency Transactions.

How often should I journal adjustments for my Foreign Currency Bank balances?

There's really no ‘right’ answer to this. It depends how material your Foreign Currency balances are within your total cash assets, and to a large extent what you prefer. Some business owners with a small Foreign Currency account will be happy to reconcile for Gains/Losses once a year when they prepare their final accounts. Others may like to adjust monthly, while some very large businesses that trade internationally will adjust for currency movements daily, or more often. If you are unsure what is right for you, this is a good topic to discuss with your Accountant.

Can I track unrealized gains and losses in this way?

Certainly you can, although the detail is beyond the scope of this article. If you are interested in tracking Unrealized gains and losses, take some time to read and understand in detail the Accounting for Foreign Currency Transactions article to understand how Unrealized Gains and Losses are tracked through both Income / Expense accounts AND Asset / Liability accounts until they become Realized, then follow the same principles with your Journal Transactions. Again, this would be a great topic to involve your Accountant on.

I can see existing Accounts in Wave for Realized and Unrealized Gains and Losses on Foreign Exchange, but I can't journal to or from these. Why?

That's correct. These are System Accounts used by Wave for automatc bookkeeping of Realized and Unrealized Gains / Losses on Transactions. To ensure system integrity, you cannot Journal to/from these Accounts. Instead, create similar accounts for yourself to handle Gains/Losses on Foreign Currency Bank Accounts.

 

Oops! Looks like this content is meant for a different version of our accounting application. Head back to the Help Centre home page to search another topic or check out the related articles on the right.