Accounting when transaction is done in a different currency as opposed to functional currency

I would first like to stress this – in your accounting you can do entries in only one currency. Only one and this will be called your “functional currency”. You may however have various currencies in use when it comes to dealing with your suppliers, customers and why not your employees.

So how does one translate into another? In your accounting you can only use your functional currency and for your transactions you’re free to use whichever is businesswise the best and most efficient. 

To give you a simplified example, if your functional currency is A and you’re making a purchase in currency B (say 12B), with the exchange rate being at the date of the transaction 1A = 1.2B, you account for a liability and expense in the amount of 10A. The math itself is 12B (amount of the purchase), divided by the exchange rate B relates to A which is 1.2 (math itself 12 / 1.2 = 10).

Let’s presume that at period end you haven’t paid up the balance yet and you owe 10A to your supplier (according to your accounts). Note however that your supplier wants not 10A, but 12B from you. So as such, you must take the exchange rate at period end and find out how many A’s does 12B cost at period end. Say the rate is now 1A = 1B. So your liability now would be 12/1 = 12A. You’ve encountered a loss from exchange rates and this 2A is part of your non-operating expenses on your income statement (debit expense and credit liability). To your supplier you pay 12B still, but this 12B is more expensive at period end than it was when you first made the transaction.

I hope this cleared out some confusion there is out there regarding accounting when it comes to using different currencies.