Companies often do business or have subsidiaries in foreign countries. The foreign exchange rate translates between local and foreign currencies. For example, a U.S. retailer might sell merchandise to its Canadian or European distributors in Canadian dollars or euros, respectively. However, it would record the transactions on its books in U.S. dollars. Exchange rates fluctuate, which means the value of accounts receivable and payable will also fluctuate. This could lead to realized or unrealized foreign currency gains or losses. Record an unrealized gain or loss in the "other" comprehensive income section of the income statement, which comes after the net income formulation.
Calculate unrealized foreign exchange gains or losses because of changes in the exchange rate. Use the closing exchange rate on the date of the transaction. For example, if you sell $10,000 Canadian worth of goods to your Canadian distributor on March 15 when the U.S. and Canadian dollars are at par, debit or increase accounts receivable and credit or increase sales by $10,000 each.
However, if the exchange rate is $0.9512 Canadian to $1 U.S. dollar on March 31 when you are preparing your quarterly income statement, the unrealized foreign currency gain is equal to ($10,000 divided by 0.9512) minus $10,000, or about $513. Debit or increase accounts receivable and credit or increase the foreign exchange gain account by $513 each.
Record the tax-adjusted foreign exchange gain/loss amount in the other comprehensive income section of the income statement. Continuing with the example, if there were no other foreign currency adjustments and the corporate tax rate is 20 percent, record $513 multiplied by (1 minus 0.20), or about $410, as the foreign exchange gain/loss in the other comprehensive income section. Note that comprehensive income is equal to net income plus other comprehensive income.
Accumulate unrealized foreign exchange gains or losses in the accumulated other comprehensive income account in the shareholders' equity section of the balance sheet. According to the AccountingTools website, once you realize a gain or loss, move it out of the accumulated other comprehensive income account and include it in the net income calculation. This also moves the amount into the retained earnings account in the shareholders' equity section.
Continuing with the example, if the Canadian distributor settles the invoice in cash on April 10 when the exchange rate is $1.04 Canadian to $1 U.S. dollar, the realized foreign currency adjustment is equal to $9,615 ($10,000 divided by 1.04) minus $10,000, which is a foreign exchange loss of $385. Credit or decrease accounts receivable by $10,000 plus $513, or $10,513; debit or increase cash by $9,615; and debit or increase the foreign exchange loss account by $10,513 minus $9,615, or $898. Include this amount in your net income calculation for the period because it is a realized loss.