Temporal Method for Translation of Foreign Statements

Temporal method is one of the methods of translating a local currency to a functional currency.

  • In the instances where a foreign subsidiary’s local currency is different from the functional currency, the temporal method must be employed to convert the local currency to the functional currency.
  • Temporal Method & the Income Statement: translation gains and losses that result from translation using the temporal method are reported on the consolidated income statement.
  • Temporal Method & Exchange Rates: in order to employ the temporal method, three exchange rates are relevant.
  1. Current Exchange Rate: rate that exists on the date of financial statement reporting.
  2. Historical Exchange Rate: rate in place on the date of a specific transaction.
  3. Weighted Average Exchange Rate: rate that captures the exchange rate movements which took place over the accounting period.
  • The temporal method translates the balance sheet first and the income statement second.

Steps in the Temporal Method

Step 1: Translate the different balance sheet items based on their exchange rate rules

Monetary ItemsTranslate using current exchange rates; this includes: cash, accounts receivable, accounts payable, long-term debt, and other assets or liabilities that are measured in currency outside of general price level changes.
Nonmonetary ItemsItems reported at historical cost are translated using historical exchange rates that existed when the assets were purchased. This includes: inventories, fixed assets, and intangible assets.
Capital Stock (Equity) IssuedTranslate using the exchange rate in existence on the date of the stock issuance.
Retained EarningsThis is not translated, but is a plug value used in balancing assets with liabilities + owner's equity on the balance sheet.

Step 2: Move to the income statement and translate items based on their exchange rate rules:

Non-Balance Sheet ItemsSales and some expenses (see Balance Sheet items below for the exceptions) are translated using the weighted average exchange rate for the accounting period.
Balance Sheet ItemsExpense items linked to specific non-monetary balance sheet items are translated with the associated rate for the balance sheet item. Expenses translated in this manner include: cost of goods sold, depreciation, and amortization.

Income Statement Translation Gain & the Temporal Method

Naturally, the income statement and the retained earnings segment of equity on the balance sheet must be consistent.

The following equation must balance:

Retained Earnings End = RE Beginning + Net Income – Dividends

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