We asked a Chartered Accountant to explain foreign exchange gains and losses and this is what he had to say.IAS 21 The Effects of Changes in Foreign Exchange Rates outlines how to account for foreign currency transactions and operations in financial statements, and also how to translate financial statements into a presentation currency. An entity is required to determine a functional currency (for each of its operations if necessary) based on the primary economic environment in which it operates and generally records foreign currency transactions using the spot conversion rate to that functional currency on the date of the transaction.
Foreign exchange gains and losses refer to an Increase or decrease in a cash flow caused by a change in the exchange rate of two currencies, such as when an invoice denominated in one currency is paid in another. See also translation exchange gain or loss.
A foreign exchange difference is the difference resulting from translating a given number of units of one currency into another currency at different exchange rates. Foreign operation: a subsidiary, associate, joint venture, or branch whose activities are based in a country or currency other than that of the reporting entity.
When the exchange rate changes between the original purchase or sale transaction date and the settlement date, there is a gain or loss on the exchange. Whoever views the denominated currency (the currency the transaction takes place in) as the foreign currency takes the gain or loss.
A foreign currency translation adjustment is the process of expressing aforeign entity's functional currency financial statements in the reporting currency.Translation adjustments are included in the cumulative translation adjustment(CTA) account, which is a component of other comprehensive income.
Any resulting gain or loss is recorded to an unrealized gain and loss account that is reported as a separate line item in the stockholders' equity section of the balance sheet. The gains and losses for available‐for‐sale securities are not reported on the income statement until the securities are sold.
International Accounting Standard 21 (IAS 21) defines functional currency as “thecurrency of the primary economic environment in which the entity operates”. The same Standard defines presentation currency as “the currency in which the financial statements are presented”.
Currency translation is the process of quoting the amount of money denominated in one currency in the denomination of another currency on a balance sheet. Currencytranslation is done using current exchange rates.
The purpose of IAS 21 is to set out how to account for transactions in foreign currencies and foreign operations. The standard shows how to translate financial statements into a presentation currency, which is the currency in which the financial statements are presented.
An unrealized gain is a profit that exists on paper, resulting from an investment. It is a profitable position that has yet to be sold in return for cash, such as a stock position that has increased in capital gains but still remains open. A gain becomes realized once the position is closed for a profit.