Temporal Method

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.

Key Concepts and Methodology

• Original Transaction Rate: Under the temporal method, monetary assets and liabilities (e.g., cash, receivables, payables) are translated using the exchange rate at the transaction date.
• Average Rate: If exchange rates do not fluctuate significantly, an average rate for the period may be used as an approximation.
• Profit and Loss Impact: Any gain or loss arising from currency translation is recognized in the profit and loss account.
• Contrast with Closing-Rate Method: Unlike the closing-rate method, which uses the year-end exchange rate and takes exchange differences to reserves, the temporal method provides a real-time snapshot of gains and losses.

Applicability

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:

1. Foreign currency monetary items.
2. Items measured at fair value.

Formula for Transaction Translation:

Example Calculation

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:

International Accounting Standards (IAS 21)

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.

FAQs

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.

Related Terms

• Closing-Rate Method: Translation using the exchange rate at the balance-sheet date.
• Functional Currency: The primary currency in which the entity operates.
• Presentation Currency: The currency in which financial statements are presented.