What Is the Temporal Method?
Let me explain the temporal method directly to you—it's also called the historical method, and it's a way to convert the currency of a foreign subsidiary into the parent company's currency. You use this when the subsidiary's local currency isn't the same as the parent's. I want you to know that different exchange rates apply depending on the specific financial statement item you're translating.
Understanding the Temporal Method
If your company has operations or subsidiaries abroad, outside where the parent is based, you need to convert those foreign financial statements back to the parent's currency to figure out profits, losses, and overall statements. I refer to the parent's currency as the functional or reporting currency here.
You apply the temporal method if the subsidiary's functional currency isn't its local one. This lets you translate using exchange rates from when assets and liabilities were acquired or incurred, converting an integrated foreign entity's books to the parent's currency.
For monetary assets and liabilities, you use the exchange rate on the balance sheet date. Non-monetary ones get the rate from the transaction date. Any gains or losses from exchange rates go straight into net earnings.
Key Takeaways
- The temporal method converts a foreign subsidiary's currency to the parent's.
- The parent's currency is the functional currency.
- This technique helps report profits or losses and file statements for international subsidiaries.
- Exchange rate gains or losses appear in the parent's net earnings.
Example of the Temporal Method
Take subsidiary XYZ in Great Britain, where the local currency is the British pound. But if most of XYZ's clients are in continental Europe and it does business in euros, then euros become the functional currency. In this case, you'd use the temporal method to translate XYZ's statements back to the parent's currency.
You convert monetary assets like accounts receivable, investments, and cash at the balance sheet date's exchange rate. For non-monetary assets, such as property, plant, and equipment, you use the rate from when the asset was acquired. Since all foreign exchange gains and losses hit the parent's net earnings, this can make the parent's earnings more volatile if there's significant income from subsidiaries in various countries.
