What is the best practice for the cash application process when the invoice is in U.S. dollars and the customer pays in Canadian dollars?

Best practice is to specify payment currency in the contract agreement and reinforce it on the invoice. Where it is not specified, the situation you describe may arise. From your question, we presume you have deposited the payment, and the only issue is how best to handle the mismatched payment due to currency exchange rates, which comprises two problems: one, applying the payment to the correct invoice (if there is remittance information attached to the payment, this may not be a problem); and two, accounting for the difference between billed and paid.

In regards to the conversion, below is a summary of the journal entries that would impact the cash application of the conversion. We assume your accounting system is based in USD and does not have foreign currency conversion capability; if this is not the case and it does, then please consult your software vendor on how best to apply. 

For illustrative purposes only, this example assumes the billing invoice is $100 USD and the customer paid you $100 CAD; exchange rate= 0.9460 USD per CAD (the AR Network has a currency conversion tool).

Cash: $94.60 DR (conversion rate= $100 CAD X .9460= $94.60 USD)
Exchange loss: $5.40 DR
A/RL $100.00 CR

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