A comprehensive overview of the temporal method, a technique for converting foreign currency transactions using the exchange rate from the date of the transaction. Contrasted with the closing-rate method, the temporal method takes exchange gains or losses to the profit and loss account.
The temporal method is an accounting approach used to translate foreign currency financial statements into a company’s reporting currency. This method requires assets and liabilities to be translated at the exchange rate prevailing at the time of the original transaction. If exchange rates have remained relatively stable, an average rate for the period may be used instead. This contrasts with the closing-rate method, which utilizes the exchange rate at the balance-sheet date and records exchange differences in reserves.
According to the Financial Reporting Standard Applicable in the UK and Republic of Ireland (Section 30), the temporal method should be used for reporting, except for:
Let’s consider a UK company purchasing goods worth USD 10,000 when the exchange rate was GBP/USD 1.25. The translated value will be:
If the exchange rate was stable and an average rate of 1.26 was used:
IAS 21, “The Effects of Changes in Foreign Exchange Rates,” governs how companies should translate financial statements in foreign currencies. The standard endorses the temporal method for monetary items and items measured at fair value.
| Aspect | Temporal Method | Closing-Rate Method |
|---|---|---|
| Exchange Rate Used | Transaction Date | Balance-Sheet Date |
| Treatment of Exchange Differences | Profit and Loss Account | Reserves |
| Stability Requirement | Average rate allowed if stable | N/A |
Q: When should the temporal method be used?
A: It should be used except for foreign currency monetary items and items measured at fair value.
Q: What happens if exchange rates fluctuate significantly?
A: If rates are unstable, the exact transaction date rate should be used, not an average.