Unlike the all-current method, the temporal method requires that most assets and liabilities be valued using the exchange rate in effect at the time the asset or liability was created. Only those assets and liabilities with fixed foreign currency values (monetary assets and liabilities) are translated at the current exchange rate.
Consider a business that starts a foreign subsidiary on July 30 with the following assets, liabilities and equity:
At the time the foreign subsidiary is established, the exchange rate is one foreign unit per dollar. Unfortunately, the company has poor timing and overnight the exchange rate plummets such that the foreign currency is only worth $0.50. If the company consolidates its foreign subsidiaryâ€™s results using the temporal (or remeasurement) method, the results will be adjusted as follows:
The value of inventory and fixed assets did not change. Theoretically, the change in exchange rates would not affect the value of such assets – they would simply be worth more units of the foreign currency. Since all liabilities in this simple example are monetary, they are all affected by the change in exchange rates. What is interesting is that the value of the assets falls by less than the value of the liabilities – so the parent company actually translates the change as a net gain.Â This can vary on a case by case basis depending on the size of the change in rates, the direction of the change, and the relative proportions of non-monetary assets and liabilities held.
Since assets and liabilities are affected in different ways, using the temporal method can result in changes to certain financial ratios as the balance sheet is converted into parent currency. In this case, before translation the subsidiary’s current ratio was 2.67 and debt as a percentage of assets was 42%. After translation, the parent would report the subsidiary’s current ratio as 3.67 and the debt/assets ratio as 26%.For more information, see all articles on: Accounting, Financial Statement Analysis, Fundamental Analysis See also: