Main / Glossary / Temporal Method

Temporal Method

Temporal Method, in the field of accounting and finance, refers to a method of currency translation used by multinational companies to convert the financial statements of their foreign subsidiaries into the parent company’s reporting currency. The temporal method is employed when the subsidiary’s functional currency differs from the parent company’s reporting currency.

Explanation:

The temporal method is an important tool for financial reporting for businesses operating in multiple countries. It is specifically used to translate the financial statements of foreign subsidiaries that maintain their accounting records using a different currency than the parent company. This method ensures the consolidation of financial statements is accurate and reflects the economic reality of the business.

When applying the temporal method, the functional currency of the foreign subsidiary is determined first. The functional currency is typically the currency of the primary economic environment in which the subsidiary operates. Once the functional currency is identified, the temporal method is utilized to convert the subsidiary’s financial statements into the parent company’s reporting currency.

The temporal method consists of two main steps:

1) Translation of balance sheet items: Under the temporal method, monetary assets and liabilities such as cash, accounts receivable, accounts payable, and short-term debt are translated at the current exchange rate, while non-monetary assets and liabilities such as property, plant, and equipment are translated at historical exchange rates.

2) Translation of income statement items: Revenues and expenses are translated at average exchange rates during the reporting period, except for non-monetary items such as depreciation and amortization, which are translated using historical exchange rates.

The temporal method ensures that the financial statements are presented in a manner consistent with the economic environment of the foreign subsidiary. This method takes into account fluctuations in exchange rates and provides a more accurate representation of the subsidiary’s financial performance.

Usage:

The temporal method is widely used by multinational corporations to translate the financial results of their foreign subsidiaries. This method enables the parent company to consolidate the financial statements accurately and analyze the performance of its global operations. It allows managers and stakeholders to make informed decisions based on a consistent and comparable financial picture.

Moreover, the temporal method helps in assessing the exposure to exchange rate fluctuations. It allows businesses to identify gains or losses that arise from changes in exchange rates, which can have a significant impact on the financial position and profitability of the company.

Overall, the temporal method ensures transparency, comparability, and reliability in the financial reporting of multinational companies.

Example:

To illustrate the application of the temporal method, consider a US-based multinational company with a subsidiary located in Japan. The Japanese subsidiary maintains its accounting records in Japanese yen (JPY), while the parent company reports its financial statements in US dollars (USD).

In order to consolidate the financial statements, the temporal method is used. The subsidiary’s balance sheet items such as cash, accounts receivable, and accounts payable are translated at the current exchange rate, while non-monetary assets such as property, plant, and equipment are translated at historical exchange rates. Similarly, the income statement items are translated using average exchange rates during the reporting period.

By employing the temporal method, the parent company can accurately consolidate the financial results of the Japanese subsidiary into its reporting currency, thereby providing a comprehensive view of the overall financial performance of the multinational business.

In conclusion, the temporal method is an essential tool for multinational companies to translate the financial statements of their foreign subsidiaries accurately. By applying this method, businesses can ensure consistency, comparability, and reliability in their financial reporting, enabling stakeholders to make informed decisions based on a comprehensive and transparent financial picture.