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HMRC internal manual

Corporate Finance Manual

Accounting for corporate finance: foreign exchange: foreign operations: temporal method

Where a company undertakes activities through a foreign operation, but these are merely an extension of the company’s main activities, then it is likely that the foreign operation will be viewed as having the same functional currency as the company as a whole. Likewise, in this scenario under SSAP 20 a similar treatment is achieved by using the ‘temporal method’. Where the temporal method is used to translate the results of a foreign operation, the company essentially accounts for the assets, liabilities and transactions of the operation as if they were its own.

If using the temporal method the reporting entity must translate each of the monetary assets and liabilities of the foreign operation into the reporting entity’s local currency at the closing rate. The exchange gain or loss that arises goes through profit or loss. Non-monetary assets and liabilities are translated into the reporting entity’s local currency at the historical rate. This follows the basic rules for preparing the accounts of a single company (CFM26040).

An example of the use of the temporal method is shown below. The facts are the same as in the closing rate/net investment method example at CFM26250, but the result is different. This table summarises the effect on the reporting entity’s profits:

  Profit after tax attributable to foreign operation Exchange gain (loss) included in this profit Exchange gain (loss) taken to reserves
CR/ NI average rate method £60,000 Nil £25,417
Temporal method £63,723 £117 Nil

CFM26290 explains when it is appropriate for a company to use the temporal method.

Note that FRS 23, IFRS and New UK GAAP does not refer to the temporal method. However, under those standards, where a foreign operation merely acts as an extension of its parent without significant autonomy, it should adopt the same functional currency as its parent. This has the same practical effect as the temporal method, with exchange gains and losses on individual foreign currency monetary assets and liabilities going through the profit and loss account of the foreign operation and on consolidation in the reporting entity.