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What is a Foreign Exchange Rate?
A Foreign Exchange Rate is utilized when a transaction and/or group of transactions occur in an exchange rate that differs from an entity's functional currency.
Depending on the type of transaction it will need to be converted to the entity's functional currency which can trigger other accounting impacts such as gain/loss on foreign exchange, among others.
What is a Gain/Loss on FX?
Foreign exchange (FX) refers to translating leases from local currency to functional currency. For example, a lease in Mexico (pesos) will need to be converted to US dollars in order to be reported on the US set of books.
This translation uses exchange rates, the value of one currency in another at a moment in time.
Rates fluctuate minute by minute, hour by hour. For our purposes, we’ll only worry about daily rates and average rates over the course of a fiscal period.
In order to get the correct journal entries at close, for a lease in foreign currency, we’ll need to take the relevant rates and apply them to the journal entries that were initially written in local currency.
Occupier will automatically calculate the gain/loss based on FX rates entered by the user during the close process as described more here.
What are the Types of Currency?
- Local Currency: The currency a region does business in. The US uses USD, Canada uses CAD.
- Functional Currency: Functional currency represents the primary economic environment in which an entity generates and expends cash. This is not necessarily the same as the local currency.
- Reporting Currency: The accounting currency is the monetary unit used when recording transactions in a company's general ledger, also commonly referred to as the company's "books" or accounting records. The accounting currency may also be called the reporting currency.
The currency written in the lease is the local currency for our purposes. This currency may need to be translated into functional and reporting currencies.
As an example, let’s say there is a US based company with an EU subsidiary that has leases in the Czech Republic.
- Local currency: Czech Koruna
- Functional currency: Euro
- Reporting currency: USD
Occupier allows the user to store the local, functional and reporting currencies. Local is at the lease level. Functional is the legal entity level. Reporting is at the primary legal entity level.
For more information on how to apply FX Rates in Occupier, refer to this article How do I Utilize FX In Occupier and How Does Foreign Currency Impact ASC 842