# Exchange loss

An exchange loss consists of an extraordinary expense as a result of a fluctuation in the exchange rate . This variable is relevant for those companies and individuals that carry out transactions in foreign currency.

For example, suppose that a Spanish bank grants a credit in dollars. If the US currency loses value against the euro , the principal amount of the loan will be reduced by converting it to the European currency. Therefore, an exchange loss occurs for the lender . We will explain this better with an example in the following lines.

An exchange loss is the opposite of an exchange gain .

## Foreign exchange loss of a creditor

The exchange losses of a creditor are generated when the exchange rate rises , when this variable is expressed as the amount of foreign currency necessary to buy a unit of national currency.

For example, this would be the case of Banco XZ – based in Portugal – which extended financing of US \$ 2,000 in February. When approving the operation, the exchange rate was US \$ 1.1 per euro. In other words, the value of the debt was € 1,818.18 euros (2,000 / 1.1).

After three months, when the first installment of the loan expires, imagine that the price of the euro rises to US \$ 1.12. Consequently, the value of the principal will fall to € 1,785.71 (2,000 / 1.12), producing an exchange loss that is calculated as follows:

(2,000 / 1,1) – (2,000 / 1,12) = – € 32,47

Such exchange loss from the lender would represent an exchange gain for the debtor .

It is worth noting that if we express the exchange rate as the amount of national currency necessary to compare a unit of foreign currency, the above explained happens in reverse. In other words, it is when the exchange rate falls that the creditor suffers a loss. To verify this, we will use the data from the example presented above.

If 1 euro = US \$ 1.1 then US \$ 1 = € 0.9091
If 1 euro = US \$ 1.12 then US \$ 1 = € 0.8929

Given that the loan is US \$ 2,000, when the exchange rate falls from € 0.9091 to € 0.8929, the value in euros of the principal decreases:

2,000 · (0,8929-0,9091) = – € 32,47.

## Exchange loss from accounts payable

Foreign exchange losses may come from accounts payable . This, when a company carries out operations in foreign currency.

For example, suppose a Peruvian company makes a purchase on credit to a US supplier for \$ 1,500. On the day of the acquisition, the exchange rate is S / 3.2 (Peruvian soles) per dollar. So the value of the transaction would be:

1,500 x 3.2 = S / 4,800

Assuming that the General Sales Tax or IGV (Equivalent to VAT ) is 16%, the following accounting entry will be recorded:

 Should To have Purchases 4,800 VAT payable * 768 Debts to pay 5,568

* The paid taxes will be deducted in the IGV payable account, where it is calculated what must be paid to the treasury.

Subsequently, on the day of payment (which is in a single installment), consider that the exchange rate rises to S / 3.32 per dollar. Therefore, the value of the debt in the Peruvian currency increases:

1,500 x 3.32 = 4,980

Thus, an exchange loss is generated for the borrower :

4,980-4,800 = 180

The accounting entry for the payment would be as follows:

 Should To have Debts to pay 4,800 Exchange rate loss 180 Cash / Banks 4,980