Temporal Method Meaning Example How It Works

What is Temporal Method?

The temporal method entails a majority of assets and liabilities to be evaluated by utilizing the rate of exchange in effect at the time of the creation of a particular asset or liability. Only those assets and liabilities that include a fixed foreign currency value translate at the prevailing (current) exchange rate.The rate of exchange used is dependent upon the valuation technique employed. For assets and liabilities valued at current prices, the present exchange rate is used. On the contrary, the assets and liabilities valued at historical prices involve using historical exchange rates.Income-generating assets like property, inventory, plant, equipment, etc., are updated regularly to reflect their market values by utilizing this method of currency translation. The profits and losses resulting from translation directly go to the consolidated income statement. Due to this, it affects the consolidated earnings regularly, making them somewhat volatile.

According to FASB Rule number 52, you also apply the temporal rate method if the operations at your firm carry out in an exceedingly hyperinflationary environmentHyperinflationary EnvironmentHyperinflation is merely an accelerated level of inflation that tends to quickly destroy the actual value of the local currency since there is a rise in the cost of all products and services, and it causes people to lower their holdings in that particular currency as they opt to participate in foreign currencies that are relatively more stable.read more.

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Temporal Method Example

Consider a company based in the U.K. that acquires 70 % of the share capital of another company based in Tajikistan (where the native currency is TJS). Let’s name the acquiring company as Company ABC and the acquired company as Company XYZ. So ABC acquired 70 % of XYZ.

Now, ABC paid £ 2,600 for the acquisition of XYZ’s 70 % share capitalShare CapitalShare capital refers to the funds raised by an organization by issuing the company’s initial public offerings, common shares or preference stocks to the public. It appears as the owner’s or shareholders’ equity on the corporate balance sheet’s liability side.read more. And for acquiring the reserves of XYZ, ABC had to pay down a sum equivalent to TJS 3,200 on the date of acquisition.

Now consider that the following rates apply:

Now, the P/L statement of Company XYZ looks like the following:

Now, the following table shows which rate will apply to each of the above items as per the temporal method example and what will be the £ values of these items after applying these rates:

Item wise treatment

The conversion of different balance sheet and non-balance sheet items under the temporal rate method for foreign currency translation includes some item-wise nuances. The conversion is done based on various exchange rate rules for particular items. Here are some of those items and the standards used for their conversion:

Non-monetary items: Items reported at the historical price translated by utilizing historical exchange rates that existed when the assets were purchased. Such items are inventories, fastened assets, intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can’t touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more, etc.Monetary items: Translated by currency exchange rates; They include money, receivable accounts, payable accounts, long-term debt, and alternative assets or liabilities that measure in currency outside of the general rate of exchange changes.Issued capital stock: Translated by using the rate that existed on the date of the issuance of stock;Retained earnings: Retained EarningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more is not required to be translated. However, it could be used to balance the assets with liabilities & owner’s equity on the balance sheet.Balance sheet items: Expenses, coupled with specific non-financial balance sheet items, are translated with the associated rate on the balance sheet item. Expenses translated in this way include COGSCOGSThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.
read more, depreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year.
read more, and amortizationAmortizationAmortization of Intangible Assets refers to the method by which the cost of the company’s various intangible assets (such as trademarks, goodwill, and patents) is expensed over a specific time period. This time frame is typically the expected life of the asset.read more.Non-balance sheet items: Sales and a few expenses are translated by using the weighted average rate of exchange at the time of accounting.

Exchange rates used for the Temporal method

Specific exchange rates are included in the translation methodology used in the temporal rate method of currency translation. The exchange rates used are:

Applications

The temporal method applies the present rate of exchange to all the financial assetsFinancial AssetsFinancial assets are investment assets whose value derives from a contractual claim on what they represent. These are liquid assets because the economic resources or ownership can be converted into a valuable asset such as cash.read more and liabilities (short-term as well as long-term).

Current exchange rate: the rate of exchange which exists of the date of financial reportingFinancial ReportingFinancial reporting is a systematic process of recording and representing a company’s financial data. The reports reflect a firm’s financial health and performance in a given period. Management, investors, shareholders, financiers, government, and regulatory agencies rely on financial reports for decision-making.read more
Historical exchange rate: the rate of exchange that prevailed on the date when a specific transaction took place.
Weighted average exchange rate: a rate that captures the change in rates of an exchange over a long accounting periodAccounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company’s overall performance.read more;

The physical (non-financial) assets evaluated at past rates are translated at past rates. The different assets of an overseas subsidiary will, in all cases, be acquired over a very long period. Now, the exchange rates do not remain stable for such long periods. Hence, many different exchange rates are applied for translating these foreign assets into the multinational’s home currency.

However, the utilization of this method will result in changes in different financial ratios when the balance sheet is converted into the presentation currency because the assets and liabilities are affected in several ways.

Advantages

Lines up with a valuation basis utilized in accounting; Therefore, the numbers have the most consistent internal meaning.However, they will still be misspecified just to the extent the underlying accounting numbers already are.

Disadvantages

The financial statements of the firmFinancial Statements Of The FirmFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more will have a lot of volatilityThe mixing up of valuations makes a lot of confusion.

Temporal Method Video

Conclusion

As a result of the rapid globalizationGlobalizationGlobalization is defined as the extension of trade, commerce and culture of an economy across different nations.read more of markets and the company’s presence across the globe, the businesses are not dealing in just their native currencies. Instead, they need to deal with various currencies on a very regular basis. This is why foreign currency translation becomes something that cannot be avoided. Thus, several methods are designed to ensure a consistent foreign currency translationForeign Currency TranslationThe accounting method in which companies with international businesses translate the financials of their international subsidiaries into their domestic or functional currency in order to meet financial reporting requirements is known as foreign currency translation.read more; and the temporal method example is one among them.

The accounting standards incorporate foreign operations to use the temporal or historical rate method in cases where the native currency differs from the functional currency.

Therefore, a subsidiary of a Canadian company with foreign operations in a small country where all business transpires in U.S. dollars, not the country’s native currency, would use the temporal rate method.

Once you apply the temporal rate method, you update income-generating assets on the balance sheet and profit-and-loss statement items by using the historical exchange rates of transaction dates; or from the date that the organization last assessed the fair market price of the account. You acknowledge this adjustment as current earnings.

What is Temporal Method?#

Temporal Method Example#

Item wise treatment#

Exchange rates used for the Temporal method#

Applications#

Advantages#

Disadvantages#

Temporal Method Video#

Conclusion#

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