In QuickBooks the home currency adjustment is calculated based on the difference between the exchange rate recorded with each transaction and the exchange rate as of the home currency adjustment. It’s calculated on:
- Open Accounts Payable transactions in a foreign currency
- Open Accounts Receivable transactions in a foreign currency
- Balance sheet account balances for which transactions in a foreign currency are supported (i. e., bank accounts and credit cards)
It’s important to note that income and expense accounts, as well as other asset and liability are always recorded in the firm’s home currency. Therefore, home currency adjustments do not apply to these account types.
Home currency adjustments are recorded on the Company->Manage Currency->Home Currency Adjustment menu selection.
A home currency adjustment represents the unrealized gain or loss from holding balances in a foreign currency after the original transaction date (for open transactions) or after the date the transaction was closed. For example, if a firm did not extend credit to customers (i. e., it has no Accounts Receivable), did not receive credit from vendors (i. e., it has no Accounts Payable), and had no bank or credit card balances, its home currency adjustment would be zero.
From the Home Currency Adjustment window, QuickBooks automatically posts home currency adjustments by a General Journal entry to the Exchange Gain or Loss account that is automatically created by QuickBooks as an Other Expense account type. Therefore, debits to this account will represent exchange losses and increase this expense; credits will represent exchange gains and decrease this expense.
Home currency adjustments are normally recorded to prepare financial statements, so that balances held in foreign currencies can be converted to the exchange rate as of the financial statement date. If foreign balances were not adjusted to current exchange rates, the balances reported on the balance sheet could materially mis-state a firm’s financial position. The home currency adjustment records an exchange gain or loss to reflect the change in the value of a firm’s balance sheet accounts.
Transactions in a foreign currency involve both realized and unrealized gains/losses. For closed Accounts Payable and Accounts Receivable transactions in a foreign currency, the difference between the exchange rate recorded with each transaction and the exchange rate at the time the transaction was closed (i. e., the vendor bill or the customer invoice was paid) represents a realized gain or loss. Thereafter, holding foreign account balances (i. e., bank and credit card balances) that result from closing such foreign transactions produce unrealized gains or losses. Holding open Accounts Payable and Accounts Receivable balances similarly produces unrealized gains or losses.
The Exchange Gain or Loss account automatically created by QuickBooks records both realized and unrealized gains/losses.
A few examples will better illustrate how QuickBooks calculates and records home currency adjustments. In all cases, the home currency is the US Dollar (or simply, USD).
Example 1 – Home Currency Adjustment for an Open Customer Invoice
An customer is invoiced for 10,000 € (Euros, or simply EUR) on 12/15/2012 and the invoice is unpaid. The exchange rate recorded with the transaction is 1 EUR = 1.5 USD.
The exchange rate later became 1 EUR = 1.75 USD; after this exchange rate change, the open customer invoice was more valuable in USD. The result would be an unrealized gain of $2500, or the difference between the converted value as of the home currency adjustment date ($17,500) and the converted value as of the transaction date ($15,000).
The Home Currency Adjustment records a General Journal entry as a debit (increase) to the foreign balance Accounts Receivable asset account and a credit (decrease) to the Exchange Gain or Loss other expense account.
Example 2 – Home Currency Adjustment for a Closed Customer Invoice
An customer is invoiced for 10,000 € (Euros, or simply EUR) on 12/15/2012 and the invoice is initially unpaid. The exchange rate recorded with the transaction is 1 EUR = 1.5 USD. A short time later, the customer paid the invoice in full after the exchange rate changed to 1 EUR = 1.6 USD.
Immediately upon recording the customer payment at the new exchange rate, QuickBooks records a realized exchange gain for $1000, or the difference between the converted value as of the date the transaction was closed ($16,000) and the converted value as of the original transaction date ($15,000). This realized gain is not the home currency adjustment. Because both realized and unrealized exchange gains/losses are recorded in the Exchange Gain or Loss account, that’s where we’ll find this gain. Here’s a QuickZoom report of the Exchange Gain or Loss account after recording the customer payment.
After the customer payment, the company’s foreign bank account transacting in Euros has a balance – the funds just received from the customer. If the exchange rate then changed to 1 EUR = 1.75 USD, this would represent an unrealized gain that occured as a result of holding a foreign bank balance. However, only part of the overall gain is unrealized: the difference between the converted bank balance as of the home currency adjustment date ($17,500) and the converted value of the transaction as of when it was closed ($16,000). The home currency adjustment is only the unrealized portion of the overall gain, or $1500.
The overall exchange gain from this series of transactions is the same as the first example – a gain of $2500, because in both examples the exchange rate changed from 1 EUR = 1.5 USD to 1 EUR = 1.75 USD. Here’s the QuickZoom report for the Exchange Gain or Loss account showing the overall exchange gain/loss:
The first line is the realized portion of the exchange gain; the second line – the General Journal entry – is for the unrealized home currency adjustment.
This second example illustrates another aspect of foreign exchange gain/loss reporting: if every transaction were recorded using the same exchange rate, there would be no realized gains or losses. All exchange gains or losses would be unrealized and result from the difference between the converted value on the financial statement date and the converted value as of the transaction date for each foreign balance on the balance sheet. These foreign balances can include Accounts Payable, Accounts Receivable, bank accounts, and credit cards. If you do not record transactions using accurate exchange rates as of the transaction date, you’ll magnify the amount of the unrealized exchange gains or losses shown on financial statements when you do decide to perform a home currency adjustment.