Recognition and the accruals concept

Reporting exchange gains and losses: the accruals concept

It might be argued that you shouldn't recognize exchange gains and losses in the profit and loss account until they are realized, or that you should recognize losses but not profits.

This is more of a problem with long-term than with short-term items.

In addition, there is a link between exchange rates and interest rates. A company that borrows in Euros will pay a different rate of interest from one that borrows in sterling. Thus if a company included foreign currency interest that it pays (or receives on a loan or deposit) in the profit and loss account without including exchange gains or losses on the principal sum, its accounts would reflect only part of its economic situation.

If, however, there are doubts about the convertibility or marketability of the currency - for example, if a company has made a loan in a currency that is subject to exchange controls - prudence wins out over the accruals concept. The company can decide to restrict the exchange gains it recognizes in the profit and loss account.

Recognition of unrealized exchange gains and losses on long-term monetary items means that in some cases a company's profits might vary considerably from year to year because of exchange rate fluctuations alone. This is one reason why many companies hedge foreign exchange risks