What it means
Accountants split a balance sheet into monetary and non-monetary items. Monetary items are claims to, or obligations to pay, a set number of currency units, so a $5,000 customer invoice is $5,000 whether prices rise or fall, while inventory, buildings and machinery are non-monetary because their prices can move.
The split becomes important when a business holds foreign currency balances. A monetary item denominated in a foreign currency, such as a receivable from a European customer, is retranslated at the closing exchange rate at each reporting date, and the difference is recognised as an exchange gain or loss in profit or loss.
Non-monetary items are treated differently. Those carried at historical cost, such as a factory bought years ago, stay at the exchange rate on the purchase date and are not retranslated, which avoids constant revaluation of assets that are not fixed in currency terms.
Monetary items also matter in high inflation. A company holding large cash balances sees their purchasing power erode as prices rise, while a company with large monetary liabilities benefits because it repays in cheaper money, and inflation accounting rules in some situations capture this as a gain or loss on the net monetary position.
Finance teams manage the exposure by watching the net position. If foreign currency monetary assets and liabilities are roughly equal, gains on one largely offset losses on the other, and the company can also hedge the remaining difference with forward contracts.
Equity is not a monetary item, and nor are prepayments for goods or services, since they will be settled by delivery and not by receiving cash. Classification can need judgement, so teams usually document how each balance sheet line is treated.
In practice
Real-world examples.
Example
A manufacturer has a bank loan of 2,000,000 units of a foreign currency. At each month end the finance team retranslates the loan at the closing rate and records the difference as an exchange gain or loss.
Example
A software company has a receivable of $80,000 due in 60 days from a domestic customer. It is a monetary item, but because it is in the company's own currency there is no exchange difference to record.
Example
A retailer in a high-inflation economy holds large cash balances. The accountant notes that the cash buys less each month, and in the restated accounts the loss in buying power appears as a monetary loss.
Formula
Calculation
Exchange gain or loss on a monetary asset = Foreign currency amount x (Closing rate - Original rate)
Exchange gain or loss on a monetary liability = Foreign currency amount x (Original rate - Closing rate)
A US company invoices a customer 100,000 euros when the rate is $1.10 per euro, recording a receivable of 100,000 x $1.10 = $110,000. At the year end the rate is $1.15, so the receivable is retranslated to 100,000 x $1.15 = $115,000. The gain is 100,000 x ($1.15 - $1.10) = $5,000. If the same amount were a payable instead, the company would record a $5,000 loss, because it would owe more dollars to settle the same number of euros.Case study
Seen in the real world.
Eastmoor Components is an illustrative, fictional exporter that invoices most customers in euros while reporting in dollars. At the end of its first year, the controller reviewed the balance sheet and found 1,400,000 euros of receivables and 600,000 euros of payables.
She identified both as monetary items and calculated the net exposure at 800,000 euros. When the euro fell by $0.05 against the dollar during the quarter, the net exposure produced an exchange loss of 800,000 x $0.05 = $40,000, which surprised the sales director, who had focused only on the receivables.
The fictional company reduced the exposure by paying more suppliers in euros and by agreeing a forward contract for the remaining amount. The lesson was that the exchange result comes from the net monetary position, not from the sales figure.
Watch out
Common mistakes.
- Treating inventory or equipment as monetary items, when their value is not fixed in currency units.
- Retranslating non-monetary items carried at historical cost at the closing rate, which misstates assets.
- Looking at receivables alone and forgetting that payables and loans in the same currency offset them.
Questions
People also ask.
Is cash a monetary item?
Yes, because it is already in currency units. Foreign currency cash is retranslated at the closing rate.
Are prepayments monetary items?
Generally not, because they will be settled by receiving goods or services and not by receiving cash. The classification can depend on the facts, so check the accounting standard.
Where does the exchange difference go?
Usually to profit or loss for the period for monetary items, although some special cases such as net investments in foreign operations are treated differently. Always confirm the rules in your reporting framework.
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