Small and medium businesses trading internationally often make or receive payments in foreign currencies. Forex accounting involves keeping track of how much money is gained or lost during these transactions that involve foreign currency (FX) conversions. This business-friendly guide has been designed to help SMBs demystify forex accounting so they can take better control of the money they send, receive or convert in foreign currencies.

Forex Accounting Demystified: What is Forex Accounting?

When an SMB trades internationally, it generates cash flows, i.e. ”payables” or “receivables” in foreign currencies. They need to track these flows. This is where forex accounting comes in.

Let’s take an example.

Singapore-based  ABC, Pte Ltd. designs bespoke software solutions for businesses in the USA, UK and Australia. Each foreign transaction involves exchange rate fluctuations, so ABC, Inc. needs to do forex accounting to maintain control over its cash flows.

Here’s how the forex accounting process would work

The company translates the value of its receivables into its own currency.

It uses the spot exchange rate, i.e. the exchange rate applicable on the date when the transaction is recognised.

The exchange rate between the company’s base local currency and each foreign currency continuously fluctuates.

These fluctuations cause changes in the SGD value of its receivables.

After conversion from foreign currencies to SGD, the final SGD amount could reflect either gains or losses.

The company updates the value of all assets and liabilities at every reporting period using the spot rate.

At the end of the reporting period, ABC can gauge whether it’s foreign transactions led to an overall profit or loss.

Forex Accounting for ABC : The Role of Exchange Rates

When making or receiving payments in foreign currencies, exchange rate fluctuations can affect the company’s bottomline.

Customer Name

Country

Customer’s Payment Currency

Intelliverse Corp

Philadelphia, USA

USD

Kit & Matheson Associates

Liverpool, UK

GBP

Roo Technologies Ltd.

Melbourne, Australia

AUD

For each customer, the accounts receivables for ABC. would be different:

 

Intelliverse Corp

Kit & Matheson Associates

Roo Technologies Ltd.

Debit

Credit

Debit

Credit

Debit

Credit

Accounts receivable

$100,000

---

£80,000

---

A$125,000

 

Sales

---

$100,000

---

£80,000

---

A$125,000

Each transaction was entered on 30th June 2020 when the spot exchange rates between SGD and the three other currencies were as follows:

1 SGD = 0.7 USD | 1 SGD = 0.5 GBP | 1 SGD = 1.1 AUD

So on 30th June 2020, ABC. would invoice the 3 customers for these SGD amounts and make these accounting entries:

Customer

Amount in foreign currency

Exchange rate

30th June

Amount in SGD

Intelliverse Corp

$100,000

0.7

SGD70,000

Kit & Matheson Associates

£80,000

0.5

SGD40,000

Roo Technologies Ltd.

A$125,000

1.1

SGD137,500

Between the time these payments were entered (30th June 2020) and the time payments were actually received (25th September 2020), foreign exchange rates between SGD and other currencies have fluctuated. The SGD has gained, so ABC updates its accounts as follows:

Customer

Amount in foreign currency

Exchange rate

25th September

Amount in SGD

Change in SGD

Intelliverse Corp

$100,000

0.85

SGD85,000

+15,000

Kit & Matheson Associates

£80,000

0.6

SGD48,000

+8,000

Roo Technologies Ltd.

A$125,000

1.15

SGD143,750

+6,250

On 25th September 2020, the new accounting journal entries might look like this:

 

Intelliverse Corp

Kit & Matheson Associates

Roo Technologies Ltd.

Debit

Credit

Debit

Credit

Debit

Credit

Cash

SGD85,000

---

SGD48,000

---

SGD143,750

 

Foreign Exchange Currency Gain

---

SGD15,000

---

SGD8,000

---

SGD6,250

Accounts receivable

 

SGD70,000

 

SGD40,000

 

SGD137,500

If the SGD loses value against the other currencies, ABC will make a loss.

Customer

Amount in customer’s currency

Exchange rate with SGD on 25th September 2020

Amount in SGD

Change in SGD

Intelliverse Corp

$100,000

0.68

SGD68,000

-2,000

Kit & Matheson Associates

£80,000

0.48

SGD38,400

-1,600

Roo Technologies Ltd.

A$125,000

1.05

SGD131,250

-6,250

New accounting journal entries on 25th September 2020:

 

Intelliverse Corp

Kit & Matheson Associates

Roo Technologies Ltd.

Debit

Credit

Debit

Credit

Debit

Credit

Cash

SGD68,000

---

SGD38,400

---

SGD131,250

 

Foreign Exchange Currency Loss

---

SGD2,000

---

SGD1,600

---

SGD6,250

Accounts receivable

 

SGD70,000

 

SGD40,000

 

SGD137,500

ABC does currency conversion calculations at “mid-market rates”. However, “marked-up exchange rates” and hidden fees can take a huge bite out of profits, especially if it relies on international bank transfers. That’s why the firm must find a cheaper way to receive its international payments.

Forex Accounting: Some Important Terms

Mid-market rate

The mid-market rate is the “actual” exchange rate between two currencies. Sometimes called the “spot rate”,  it is the midpoint between its supply and demand. It is also known as the “interbank rate” because this is the rate at which banks trade currencies with each other. However, it’s not the rate banks use when they trade currencies with customers like ABC.

Foreign currency transaction

A foreign currency transaction is recorded at the exchange rate applicable on the date of the transaction. Exchange differences arising when transactions are settled are reported as profits or losses.

Exchange difference

This is the difference resulting from translating a currency into another currency at different exchange rates.

Exchange rate mark-ups

When banks sell foreign currencies to customers or convert international payments into different currencies, they add a ‘spread’ to the mid-market rate, which can range from anywhere between 0.07%-7%. Therefore, the customer ends up losing money, especially if their local currency is weaker than the other currency.

Hedge accounting

Unlike foreign exchange accounting, hedge accounting is an optional technique that modifies the normal accounting basis for recognising gains and losses on associated hedging instruments and items.

Wallex: A Cheaper Alternative to International Bank Transfers

When international payments and receipts are routed through banks or money transfer providers, poor exchange rates, significant mark-ups, conversion fees and additional transaction charges work against SMBs like ABC, Inc. Over time, these fees affect their cash flows and bottomlines.

Wallex is different. With a Wallex multi-currency account, SMBs can easily manage dozens of currencies – and thus their international payments – from one place at low cost and with fully transparent fees. Wallex also offers easy-to-use local currency accounts that enable businesses to receive payments in their customers’ local currency, with no mark-ups or hidden charges. Plus, SMBs like ABC, Inc. get greater control over disbursements, they can avoid unfavourable exchange rates and even choose whether to wallet or transfer their funds. For more information, visit our website.