A US company buys inventory from a European supplier and agrees to pay in euros in 60 days. The company's books are in dollars. The invoice is recorded on the purchase date at the dollar equivalent. By the time the cash leaves the bank, the exchange rate has moved. The difference is not an inventory cost. It is a transaction gain or loss in the income statement, and the balance sheet at every period end has to reflect the current rate.
Small clients often leave foreign currency balances at their original dollar amounts until payment, or push the rate difference into the cost of the goods. Both are errors. This guide covers the measurement rules, the settlement entries step by step, the one exception that sends exchange differences to other comprehensive income, and the evidence an auditor needs.
What is a foreign currency transaction?
A foreign currency transaction is a transaction whose terms are denominated in a currency other than the entity's functional currency. The functional currency is the currency of the primary economic environment in which a distinct and separable operation operates. Measurement, in ASC 830 terms, is the process of expressing a transaction denominated in a foreign currency in the functional currency. Translation is a different process: it expresses a foreign entity's functional currency financial statements in the reporting currency, with the effect going to the cumulative translation adjustment in other comprehensive income. This post covers measurement. Translation and functional currency determination are separate decisions.
Changes in functional currency amounts from the measurement process are transaction gains and losses, and they are included in net income.
Which balances are remeasured?
The answer depends on whether the item is monetary or nonmonetary.
| Monetary: remeasure at each reporting date | Nonmonetary: stay at the historical rate |
|---|---|
| Cash, trade receivables and payables, notes payable, lease liabilities, deferred tax assets and liabilities, held-to-maturity debt investments | Inventory, property and equipment, goodwill and intangibles, right-of-use assets, prepaid expenses, equity investments, common stock |
One edge case comes up in audit files. A contract liability that will be satisfied by delivering goods or services is nonmonetary, even if the customer paid in foreign currency in advance.
Monetary items are remeasured at the current exchange rate at each reporting date, and the adjustment goes to the income statement as a foreign currency transaction gain or loss. Nonmonetary items are not remeasured after initial recognition.
Worked journal entries
An illustration. The company's functional currency is the US dollar. It buys goods on account for EUR 100,000 on November 1 and pays on January 20. The year end is December 31.
| Date | Rate (USD per EUR) | Payable in USD |
|---|---|---|
| November 1 | 1.10 | 110,000 |
| December 31 | 1.05 | 105,000 |
| January 20 | 1.02 | 102,000 |
November 1, purchase.
| Account | Debit | Credit |
|---|---|---|
| Inventory | 110,000 | |
| Accounts payable (EUR) | 110,000 |
December 31, remeasurement. The payable is a monetary liability. It falls from $110,000 to $105,000.
| Account | Debit | Credit |
|---|---|---|
| Accounts payable (EUR) | 5,000 | |
| Foreign currency transaction gain | 5,000 |
January 20, remeasure to the settlement rate, then pay. Remeasure first so the payable equals the cash required.
| Account | Debit | Credit |
|---|---|---|
| Accounts payable (EUR) | 3,000 | |
| Foreign currency transaction gain | 3,000 | |
| Accounts payable (EUR) | 102,000 | |
| Cash | 102,000 |
The inventory stays at $110,000. It is a nonmonetary asset and is not adjusted for later rate changes. The total gain of $8,000 is split between two periods: $5,000 in the year ended December 31 and $3,000 in the following year.
Do rate changes after year end require an adjustment?
No. Financial statements are not adjusted for rate changes that occur after the reporting date. When a significant rate change affects material foreign currency transactions, consider disclosing it as a nonrecorded subsequent event. See /us/blog/subsequent-events-type-1-type-2-asc-855.
The exception: long-term intercompany balances
Gains and losses on a foreign currency intra-entity balance that management does not intend to settle in the foreseeable future go to the cumulative translation adjustment, not income, when the entities are consolidated, combined or accounted for by the equity method. PwC and KPMG guidance highlights the following points:
- Management intent drives the conclusion. KPMG says the key factor is whether repayment is presently planned or anticipated, that the standard gives no definition of the foreseeable future, and that an advance or demand note can qualify if payment is not planned. A loan that management intends to repay, even with uncertain timing, does not qualify.
- Intent must be supported by the ability to control repayment, and management should document it. KPMG's example is a parent advance to a limited-life subsidiary, where repayment is not under management's control.
- Periodic interest receivable or payable is treated differently. Exchange differences on interest go to earnings and survive consolidation.
- In the foreign subsidiary's own separate statements, the same exchange differences are recognized in income.
An illustration. A US parent lends $50,000 to its Mexican subsidiary, whose functional currency is the peso. The loan date rate is 10 pesos per dollar and the quarter-end rate is 13. In the subsidiary's separate books the loan grows from 500,000 to 650,000 pesos, a 150,000 peso remeasurement loss in income. In the consolidated statements, that loss, translated at the average rate for the quarter of 11, is $13,636. Because the loan is of a long-term-investment nature, it is reclassified to the cumulative translation adjustment, and the consolidated income statement shows no loss from the loan.
Gains and losses on effective hedges of a net investment in a foreign entity also go to the cumulative translation adjustment.
Audit angle
Foreign currency balances are an area where small errors are systematic: the same wrong rate gets applied to every balance. A good program:
- Identify the exposure. Ask management for a list of every vendor, customer, bank account and loan denominated in a foreign currency. Compare it to the vendor list and bank confirmations. See /us/standards/au-c-505 for confirmations.
- Test the rate source. Agree the year-end and settlement-date rates to a published source used consistently, and recompute each remeasurement.
- Check classification. Check that inventory, fixed assets and prepaid expenses are not being remeasured, and that receivables, payables and loans are.
- Trace the gain or loss. The sum of remeasurement and settlement gains should equal the foreign currency gain and loss account, and the account should not contain amounts capitalized into inventory.
- Review intercompany balances. For any intercompany loan treated as long-term, obtain a written statement of management's intent, read the loan agreement and repayment history for evidence that contradicts it, and test the interest components separately.
- Read the subsequent events. Review rates for the period after year end for a large move.
Common misstatements: leaving payables at the transaction-date rate, remeasuring inventory, booking the rate difference to cost of goods sold, and treating a loan the parent plans to collect as a long-term-investment balance.
CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.
Sources
- KPMG, Handbook: Foreign currency (intercompany transactions of a long-term investment nature, monetary and nonmonetary items): https://kpmg.com/us/en/frv/reference-library/2026/handbook-foreign-currency.html
- PwC Viewpoint, Foreign currency guide, 4.4 Subsequent measurement of foreign currency transactions: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/foreign_currency/foreign_currency__2_US/chapter_4_foreign_cu_US/44_subsequent_measur_US.html
- PwC Viewpoint, Foreign currency guide, 7.5 Accounting for long term intercompany loans and advances: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/foreign_currency/foreign_currency__2_US/chapter_7_intercompa_US/75_accounting_for_lo_US.html
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