The temporal method (also called the historical or remeasurement method) is a foreign-currency conversion technique used to convert the financial statements of a foreign subsidiary into another currency (typically the parent company’s reporting currency). Under the temporal method, different exchange rates are applied depending on whether an item is monetary or non‑monetary and depending on when the asset or liability was acquired. Foreign‑exchange gains and losses that result from remeasurement are recognized in the parent’s net income (not in other comprehensive income).
When is it used?
– Under U.S. GAAP and IFRS you must first determine the subsidiary’s functional currency. If the subsidiary’s functional currency differs from the currency in which its books are maintained (for example, the subsidiary’s functional currency is the parent’s reporting currency, or the subsidiary is highly integrated with the parent), the temporal method (remeasurement) is used to convert the subsidiary’s financial statements into its functional currency. If the subsidiary’s functional currency equals the local currency, the current rate (translation) method is used instead. [See FASB ASC 830; IAS 21; Investopedia.]
Key principles and translation rates
– Monetary assets and liabilities (cash, accounts receivable, accounts payable, loans, etc.)
• Translate at the current (closing) exchange rate at the balance sheet date.
– Non‑monetary assets and liabilities carried at historical cost (property, plant & equipment, inventory measured at historical cost, certain equity accounts)
• Translate at the historical exchange rate(s) in effect when the assets were acquired or the equity was issued.
– Non‑monetary items measured at fair value
• Translate at the exchange rate on the date the fair value was measured.
– Income statement items
• Translate at the average exchange rate for the reporting period (commonly used), except for expenses that are directly related to non‑monetary items (e.g., cost of goods sold that relates to inventory bought at historical cost, depreciation tied to an asset bought earlier)—these are translated at the historical rate(s) relevant to the related balance sheet item.
– Translation/remeasurement result
• All foreign exchange gains and losses from remeasurement are recognized in net income (this can make reported results more volatile than under the current‑rate method, where the translation adjustment goes to other comprehensive income).
Step‑by‑step practical process (checklist)
1. Determine the functional currency.
• Assess the foreign entity’s environment: primary economic environment is typically where cash flows are generated. If functional currency = local currency, use current rate method; if functional currency differs, use temporal.
2. Classify each balance sheet item as monetary or non‑monetary.
• Monetary: will be settled in fixed or determinable amounts of currency (cash, receivables, payables, debt).
• Non‑monetary: inventory (historical cost), fixed assets, equity accounts, prepayments (depending on measurement basis).
3. Gather exchange rates:
• Closing (balance sheet) rate,
• Historical rates (dates when non‑monetary items were acquired or when equity was issued),
• Period average (for general revenue and expense items, if used).
4. Translate the balance sheet:
• Monetary items at closing rate.
• Non‑monetary historical cost items at their historical rates.
• Fair‑value non‑monetary items at rate on valuation date.
5. Translate the income statement:
• Items related to translated non‑monetary balances use the historical rate for the related balance sheet item (e.g., depreciation, COGS linked to inventory).
• Other items typically translated at the period average rate.
6. Compute foreign exchange (remeasurement) gain or loss:
• The remeasurement gain/loss is the net difference that arises when translating monetary items at the closing rate vs. the amounts recorded in books (plus effects of translating income/expenses at differing rates). Recognize this gain/loss in net income.
7. Prepare disclosures and reconciliation:
• Disclose the methods and rates used, the location of translation gains and losses, and amounts of significant remeasurement gains/losses.
Illustrative example (simplified)
Facts:
– Parent reporting currency: USD.
– Subsidiary books are in GBP but its functional currency is USD (temporal method applies).
– Selected balances (GBP) at year end and relevant rates:
• Cash: 10,000 GBP (monetary)
• Accounts receivable: 20,000 GBP (monetary)
• Inventory (historical cost): 30,000 GBP (non‑monetary; historical rate 1.60 USD/GBP)
• PPE (cost): 50,000 GBP (non‑monetary; historical rate 1.60)
• Accumulated depreciation: (10,000) GBP (historical rate 1.60)
• Accounts payable: 15,000 GBP (monetary)
• Loan payable: 25,000 GBP (monetary)
• Common stock issued earlier: 30,000 GBP (historical rate 1.50)
• Income statement (GBP): Sales 120,000; COGS 70,000; Depreciation 5,000; Other expenses 20,000.
– Exchange rates: closing 1.30 USD/GBP; average for period 1.35; relevant historical 1.60 (inventory/PPE) and 1.50 (stock).
Remeasurement (selected conversions):
– Monetary items at closing 1.30:
• Cash = 10,000 * 1.30 = $13,000
• AR = 20,000 * 1.30 = $26,000
• AP = 15,000 * 1.30 = $19,500
• Loan = 25,000 * 1.30 = $32,500
– Non‑monetary historical cost items at historical rates:
• Inventory = 30,000 * 1.60 = $48,000
• PPE cost = 50,000 * 1.60 = $80,000
• Accumulated dep = (10,000) * 1.60 = $(16,000)
• Common stock = 30,000 * 1.50 = $45,000
– Income statement:
• Sales (use average) = 120,000 * 1.35 = $162,000
• COGS (related to historical inventory) = 70,000 * 1.60 = $112,000
• Depreciation (historical) = 5,000 * 1.60 = $8,000
• Other expenses (average) = 20,000 * 1.35 = $27,000
• Pretax income = 162,000 − 112,000 − 8,000 − 27,000 = $15,000
Outcome and impact
– The remeasurement process produces a translated balance sheet and income statement in USD. The foreign exchange (remeasurement) gain or loss that results from translating monetary balances at the closing rate and certain income/expense items at different rates is recognized in net income for the period. This treatment tends to increase reported earnings volatility compared with the current‑rate method (where the translation adjustment goes to other comprehensive income).
Practical tips and common pitfalls
– Always perform the functional currency assessment first—applying the wrong method is a common error.
– Carefully classify items as monetary vs non‑monetary—classification drives which rate to use.
– Maintain documentation of historical rates for individual non‑monetary transactions (purchase dates, valuation dates).
– Be consistent: for items measured at fair value, note and document the valuation date because that is the date whose rate must be used.
– Reconciliations: reconcile remeasured net income to changes in retained earnings to ensure translations flow through properly.
– Disclosures: provide clear disclosures on method, rates used, and the amount and location of recognized translation/remeasurement gains and losses.
Authoritative guidance and further reading
– Investopedia — Temporal method:
– FASB ASC 830 — Foreign Currency Matters (U.S. GAAP guidance on translation/remeasurement)
– IAS 21 — The Effects of Changes in Foreign Exchange Rates (IFRS guidance) — /
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.