Temporal Method
Candlefocus EditorThe Temporal Method is one technique used to translate the foreign currency into the parent company’s functional currency. This allows the foreign subsidiary’s financial statements to be reported in the same currency as those of the parent company which in turn allows for greater transparency and comparison between the subsidiary and the parent company.
The Temporal Method entails converting the foreign currency using the exchange rate at the time when the transaction occurred. Essentially, this requires establishing a consistent period of exchange rates to use in the conversion; if the company is making year-end reports then the rates used would be the reported exchange rates for the date nearest to the time of the transactions. This method is beneficial in that it allows for the financial statements of the subsidiary to be used in the parent company’s currency and those transactions to be accurately divided throughout the year.
While the Temporal Method is relatively straightforward, it does not offer a total and accurate picture of the effect that fluctuations in exchange rates have on profits. If a rapid fluctuation in the exchange rate happens in a short span of time, the Temporal Method does not account for this change, and the parent company may not be able to accurately interpret the financial information of its foreign subsidiary unless it is seen in the context of a longer period.
The Temporal Method is an effective way for an international company to compare the performance of its foreign subsidiaries with that of its parent company by having consistent financial statements, and it is permitted under the rules of generally accepted accounting principles (GAAP). This technique should not be used in isolation however; if an international company wishes to analyse its foreign currency transactions in more detail, it should consider using the more comprehensive Current Rate Method, which takes into account daily exchange rate fluctuations.