Guest Author - Consuelo Herrera, CAMS, CFE
If you are an accountant or a consultant dealing with international trade you should be aware of the ins and outs of Foreign exchange transactions, the risks involved, and the accounting treatment. This holds true even if you work for a bank.
The Comptroller of the Currency (OCC), Administrator of national banks, states that most importers, exporters, manufacturers, and retailers tend to let banks handle their foreign exchange needs. They rely on banks to make and receive their foreign currency payments, to provide them with foreign currency loans, to fund their foreign currency bank accounts, and to purchase their excess foreign currency balances. They may ask banks to provide such services for immediate delivery, i.e., at spot (short-term contracts, perhaps up to 10 days), or they might contract to buy or sell a specified amount of foreign currency for delivery at a future date. In either instance, the rates for such services may be established prior to the finalization of the commercial transactions, and the related costs may be calculated and often passed on to the buyers.
Revaluation and Accounting Systems
The OCC emphasizes that such systems should accurately determine actual as well as estimated future profits and losses and present them in such a manner as to facilitate proper income analysis by management, bank supervisory personnel, and the public. One system widely used by banks is illustrated below. This system is capable of presenting separately, each of the following:
o Actual realized profit or loss as determined by applying current spot rates to balance sheet accounts as well as contracts of very near maturities.
Adjustments to the local currency book values would either be allocated and posted to each of the applicable local currency ledger accounts or, for short interim periods, be charged to a separate “foreign exchange adjustment” account with an offset to P&L.
o Unrealized (estimated future) profit or loss on future transactions are determined by applying the appropriate forward rates to the net positions reflected for each future period appearing in the bank’s gap or maturity reports. An “estimated profit (loss) on foreign exchange—futures” account would be charged for the amount of the adjustment with an offset to P&L. Provided that the amount of that adjustment is the difference between the existing forward rates and the actual contract rates, each month’s entries
merely involve reversing the adjustment from the prior revaluation and submitting the new figures.
Expecting to make money easily, many individual have fallen victim of fraud schemes perpetrated by unscrupulous individuals that pride themselves of being “Forex experts.” They use powerful advertising online, through radio, and printed magazines and newspapers. Another powerful way is through seminars. For example, John Smith attended a seminar where he was told that he could make money in a fast and safer way. John did not do his homework and due diligence before making a decision. He invested $115,000. When a statement reflected that he had earned a profitable return on his investment, he decided to invest additional money. His enthusiasm was great, to the extent that he even took out a loan of $650,000. That money was immediately deposited a Forex company. John Smith was informed that that his funds would be invested more aggressively. John Smith never was told that even in a legitimate transaction Forex losses could be very large in a single day. John Smith was so thrilled by the “return on his investment” that he invited friends, co-workers, and church members to join this venture. They were very receptive to John’s idea. All of them were promised that they have their principal safe and in addition, they would have higher and guaranteed profits. What actually happened was far from these expectations. John and his friends’ money use used to pay interest to earlier investors and to recruit and train a sales force of “executive sales representatives” that were brain washed through lies. One single phony organization trained more than 120 representatives who disseminated false and misleading information about returns on foreign exchange transactions.
The U.S. Department of the Treasury defines the foreign exchange market as the market for buying and selling different currencies. It is primarily an over-the-counter market with trades between large commercial banks accounting for most foreign currency transactions. Other participants in the foreign exchange market include:
o Brokers, who match buyers and sellers in the market
o Customers of banks or brokers, mainly large businesses who engage in international trade and/or investment, and
o Central banks
The Federal Reserve Bank explains that by law and custom, the Secretary of the Treasury is primarily and directly responsible to the President and the Congress for formulating and defending U.S. domestic and international economic policy, assessing the position of the United States in the world economy, and conducting international negotiations on these matters. It states that foreign exchange markets are closely linked to money markets and to questions of monetary policy that are within the purview of the Federal Reserve.
Be aware of these transaction and potential fraud schemes. Encourage your clients to have a due diligence process in place if they are dealing with foreign exchange transactions. The market volatility makes the FOREX transactions even more vulnerable to losses and fraud schemes perpetrated by those looking for opportunities at the expense of trustful investors and business people. Doing nothing could be very costly. Forensic accountants act and connect the dots.