Many businesses deal in more than one currency these days, both buying and selling, and this results in realised or unrealised gains or losses in their accounts. But what is the difference between realised and unrealised, and how do they arise?
In simple terms, a foreign exchange gain or loss is realised when a transaction is finalised, and unrealised whilst it is still in progress.
Let’s look at an example, and for ease let’s say that GBP £1 is worth US$ 2.
You buy $200 worth of goods from the USA on 30 days credit, so you have an expense in your accounts of £100 because at the date of the transaction it was $2:£1.
Before you pay the bill, the exchange rate shifts so that it is now £1 to $1, meaning it will cost you £100 more to settle that debt as $200 now equals £200, so you have an unrealised loss of £100. The loss only becomes realised when you settle the debt and lock in the exchange rate, until then it remains as unrealised.
Now let’s look at it the other way around, and say that after you bought the goods the exchange rate changed in your favour so that £1 is now worth $3. This means it will cost you fewer pounds to settle the dollar debt so you have made an unrealised gain, which becomes realised – or crystallised – when you pay the amount due.
It works the opposite way around if you are selling in a foreign currency. If you sold $200 worth of goods in the USA you would record a sale of £100. If the exchange rate moved to £1:$1, the $200 you receive back will now be worth £200, so you have made a £100 gain. If the exchange rate was £1:$3 then the $200 you receive will only be worth £66.66, so you have made a £33.33 foreign exchange loss.
The unrealised gain or loss will change as much as the exchange rate does, but most modern accounting software like Xero will automatically calculate the gains and losses for you and post them to your profit and loss account on an ongoing basis. Any losses are an allowable deduction for corporation tax purposes, but any gains are chargeable to it.
If you have any questions on foreign exchange gains or losses, then please get in touch.