A common question that comes up for new users of Kashoo is “what is the Gain/Loss on Exchange account and how do I get rid of it?”
This income account is used to show the amount of money (or just economic value) in your native currency that you have gained or lost as a result of foreign currency transactions. Here is the simplest example of a gain made on exchange rates:
- On January 1st, you transfer $120 CAD to your US bank account as $100 USD
- On January 30th, you transfer $100 USD back to your Canadian bank account as $125 CAD
- You’ve gained $5 CAD because of your foreign currency “investment”, your Gain/Loss on exchange will have increased by $5 during this period
A foreign currency invoice which is issued and paid with a different exchange rate is a very similar scenario, except instead of transferring cash we have a receivable that gets paid:
- On January 1st, you invoice a US customer for $100 USD; income has to be reported using the exchange rate on the day the income was earned, so you enter the exchange rate for that day and report $120 CAD in income
- On January 30th your customer pays you $100 USD, and after exchanging this for CAD you deposit $125 CAD into your Canadian bank account.
- Since you actually earned $5 more than you had originally reported, you’ve actually had a Gain on Exchange – even though you didn’t invest in cash you had, apparently, invested in a USD receivable which can still fluctuate in value depending on the exchange rate!
What gets many people is that they often see Gain/Loss on Exchange reported on the Income Statement before they have even entered the payment. How, they are wondering, is that Gain/Loss on Exchange calculated if I haven’t entered the final exchange rate?
Behind the scenes, Kashoo maintains a database of current exchange rates that it uses when generating reports. The standard Balance Sheet and Income Statement reports must be given in your own local currency. When a report is generated, the appropriate exchange rate for the date of the report is used to convert any foreign currency amounts to your business’ home currency amount for that date.
The Gain/Loss on Exchange income account is a special account that has balances in multiple currencies whose balance is calculated according to the previous currency exchange transactions that have been performed. When generating a report, all the foreign-currency balances are converted to your home currency and added to the home currency balance; the result will be the difference in value between those foreign currency assets and liabilities at the time they were recorded and the value using the exchange rates at the time of the report. This appears as either a gain or a loss.
This sounds pretty complicated, but it’s necessary in order to maintain two important rules for your Balance Sheet:
- The Balance Sheet must be reported in your business’ home currency
- The sum of your asset values must be equal to the sum of your liabilities and equity values
If the Gain/Loss on Exchange account were not calculated, then your “Net Income” would not fluctuate with exchange rates in the same way that your foreign-currency valued assets (like cash and receivables) or liabilities (payables or loans) did, and the Balance Sheet would go “out of balance.”
If you’re not an accountant these rules might seem like a bit of a pain, since they could be causing you some confusion. However, when you really get into accounting the importance of these rules becomes very, very clear. For now I suggest that you accept that this is how things are done and that there are very good reasons for it.
If you’ve reached this point and you’re still not really clear about Gain/Loss on Exchange, don’t worry – you’re not alone, and you don’t have to understand it fully to use (or ignore) it.
Here are some tips on troubleshooting a Gain/Loss on Exchange that looks out of line:
- Make sure you’ve entered payments on your invoice; I’ve seen cases where people are using the system to only track income and expenses, but instead of marking each income item as “paid” they set terms or a due date but never add a payment. Thus, the Accounts Receivable balance goes up and up and results in a lot of Gain/Loss on Exchange
- Make sure you’ve correctly entered the exchange rate for your payment and for the income. When you enter or add a payment separately from adding an invoice, you have to enter its exchange rate separately
- Check whether the balances on your balance sheet, like bank, credit card, receivables, and payables are similar to what you really have or owe. Sometimes you’ll get a large Gain/Loss on Exchange because you’ve forgotten to record some transactions to remove cash from the business, or to record times where you have exchanged the foreign currency amounts for local amounts. Bank statement reconciliation can be very helpful for catching errors like this