How to Calculate Forex Gain or Loss
Compared to other financial markets the currency markets are different. Whereas for the stock investment we can say that it is just a bet that you place in a company, and a position of foreign exchange is bet on the whole currency value that is relative to other currencies.
For instance, if you’re thinking that the euro will have increased value, you; won’t simply purchase euros. You will need to look out for other currencies against which you consider that euros appreciate well. Thus, you can purchase EUR/USD, which can effectively be said as a bet that the euro appreciates well in values against the U.S. dollar.
What is Gain/Loss in Foreign Exchange?
Before moving on straight to how to calculate forex gain or loss we must firmly understand Gain/Loss in Forex. When someone sells any form of services and goods in foreign currency there is a possibility of gain or loss in foreign exchange. The total value of the foreign currency, while it gets converted to local seller currency varies depending on the exchange rate that prevails. When the currency value inclines after converting, the seller gets gain in foreign currency.
However, when the currency value declines the post-conversion process, the seller incurs a loss in foreign exchange. When it becomes impossible to find out present exchange rates while the transaction gets recognized, further the available rate of exchange is used for calculating the conversion outcome.
Forex Gains/Losses – Realized and unrealized
Gains and losses in realized and unrealized form through forex transactions vary on whether or not the entire transaction gets finished till the end of the total accounting period.
Gains/Losses – Realized and unrealized
Realized gains and losses are losses and gains that are completed. This would mean that the customer already gets settled for the invoice before the closure of the accounting period.
To take an example, let’s assume that the customer buys items that are worth $1000 through the U.S. seller and the invoice gets valuation at $1,100 on the date of the invoice. The customer than settles the invoice at 15 days post the date of sending the invoice, and the total valuation of the invoice was $1200 while it was converted to USD at the present rate of exchange.
Here in this case, the seller would have realized gains from foreign exchange of $100 ($1,200 – $1,100). Currency gain gets recorded in the income section’s income statement.
Gains and losses that are unrealized that the seller expects to earn while the invoice gets settlement but the customer fails to pay the invoice after the closure of the accounting period. The gains and losses get calculated b seller that would get sustained when the customer pays invoice by the accounting period’s end.
Let’s suppose when the seller sends invoices worth 1,000 EUR, the valuation of the total invoice will remain at 1,100 USD as in the date of the invoice. Now, if the customer doesn’t pay invoices as of the accounting period’s last day, and the invoice gets valued at $1,000 at that time.
Upon preparing financial statements for accounting period, the whole transaction gets recorded as a $100 unrealized loss at actual payment was to be actually received. The losses or gains that were unrealized get recorded in the balance sheet in the owner’s equity section.
Foreign Exchange Gains/Losses Examples
ABC Company is a business operating from the U.S. that specializes in the manufacture of parts for motor vehicle giants Maybach and Bugatti. The company has sold its parts to distributors across France and United Kingdom. In the previous financial year, the ABC company sold spare parts of worth 100,000 EUR to France distributors and parts of worth GBP 100,000 to distributors in the United Kingdom.
While sending invoices, the value of 1 GBP was at 1.3 USD, while and 1.1 USD was for 1 EUR. Upon receiving invoice payments, one GBP got equal to 1.2 USD, while at that time one Euro value was at 1.15 U.S. Dollars.
Therefore, to know how to calculate forex gain or loss in conversions we need to apply the following:
Sales in France
= (1.15 x 100,000) – (1.1×100, 000)
= 115,000 – 110,000
= $5,000 (Foreign currency gain)
Total sales in UK
(1.2 x 100, 000) – (1.3 x 100, 000)
=120,000 – 130, 000
= -$10,000 (Foreign Currency loss)
Recording Forex Gains/Losses
While preparation of yearly financial statements, companies need to report their transactions in the home currency for making it simple for all stakeholders to know all financial reports. This would mean that all foreign currency transactions need to be converted in home currencies at current exchange rates when businesses recognize transactions.
Foreign exchange gain or loss accounting example
In ordinary life we have a lot of examples of realized gains and losses based on currency exchanges.
A gain or loss is “realized” at the moment when the customer pays the invoice. For example, there is a US seller and EUR buyer.US seller posts an invoice for 100 EUR to a European customer. On the Invoice Date, 100 EUR is worth 123 USD. On the date that the customer pays the invoice, 100 EUR has risen to 127 USD. Therefore the seller makes a realized gain of 4 USD.
Although, the little math applied here for how to calculate forex gain or loss would first appear daunting, but calculating losses and gains in foreign exchange is just like converting one currency to another time to time.