A UK business keeps its books in sterling, but customers and suppliers do not always invoice in pounds. An invoice for €10,000 is worth one amount in pounds when it is issued and a different amount when it is paid. The difference is an exchange gain or loss, and it has to go somewhere other than sales or purchases.
The accounting rules come from FRS 102 Section 30 (foreign currency translation); the VAT rules from HMRC. They work differently, so this page treats them separately.
Step 1: record the invoice at the rate on the day
Translate each foreign currency invoice into sterling at the exchange rate on the transaction date, normally the invoice date. Most accounting software fetches a daily rate automatically when you set the invoice currency. For businesses with many small transactions, using an average rate for a week or month is acceptable if rates do not move much in that period.
Example: a sale in euros. On 3 May you invoice a French customer €10,000 for consultancy (no UK VAT, under the place of supply rules for business services). The rate on 3 May is €1 = £0.85.
| Account | Debit | Credit |
|---|---|---|
| Trade debtors (€10,000) | £8,500 | |
| Sales | £8,500 |
The sale is fixed at £8,500 and does not change later, whatever happens to the euro.
Step 2: book the realised difference when it is paid
On 2 June the customer pays €10,000. You receive it into a sterling account at €1 = £0.87, so £8,700 arrives.
| Account | Debit | Credit |
|---|---|---|
| Bank | £8,700 | |
| Trade debtors | £8,500 | |
| Foreign exchange gains and losses | £200 |
The £200 is a realised gain: the euro strengthened between invoice and payment. A weaker euro would have produced a realised loss. Post it to a dedicated foreign exchange account, not to sales or bank charges, so the sales figure stays at what you actually sold for. Bank fees deducted on the transfer are a separate cost and should be posted to bank charges.
The same logic applies to purchases in reverse: a supplier invoice in dollars is recorded at the rate on its date, and the difference on payment is a gain or loss on exchange.
Step 3: revalue open balances at the period end
If the invoice is still unpaid at your month end or year end, the debt is a monetary item and must be retranslated at the closing rate on the balance sheet date. The difference since the invoice date is an unrealised gain or loss, also taken to the profit and loss account.
Continuing the example, suppose the invoice was unpaid on 31 May and the rate that day was €1 = £0.86. The debtor is revalued to £8,600, with an unrealised gain of £100. When payment arrives in June at £8,700, the further £100 is realised then.
Many systems post the revaluation automatically and reverse it on the first day of the next period. Either way, the period’s profit includes the effect of currency movements on balances you held.
What is revalued: foreign currency debtors and creditors, foreign currency bank balances and foreign currency loans. What is not: stock, fixed assets and prepayments bought in a foreign currency stay at their historical sterling cost.
Foreign currency bank accounts
If you keep a euro or dollar account, record it as its own bank account in its currency. Payments to and from it then involve no conversion until money moves to sterling. Its sterling value is revalued at each period end like any other monetary balance. Use one nominal account per currency account, reconcile it to the bank statement in the foreign currency first, and post the revaluation difference to a single “Exchange gains and losses” account in the profit and loss account.
VAT must be in sterling
Where an invoice carries UK VAT and is in a foreign currency, the VAT amount must also be shown in sterling on the invoice, and that is the figure that goes in your VAT return. HMRC accepts the UK market selling rate at the time of supply or its published period rates of exchange, which you can use consistently instead of daily rates; see HMRC’s guidance on exchange rates for VAT. Once VAT has been declared at that rate, later exchange movements do not change it: they are accounting gains and losses only.
For purchases from overseas, check whether the reverse charge applies instead of the supplier charging UK VAT; see reverse charge VAT for services.
Common mistakes
- Entering the sterling amount that hit the bank as the sale. The sale is then wrong by the exchange movement, and the debtor never clears cleanly.
- Posting exchange differences to sales or cost of sales, which distorts margins.
- Forgetting the year-end revaluation of foreign currency debtors, creditors and bank balances.
- Revaluing non-monetary items such as stock or deposits on fixed assets.