CFM8029 – Accounting for foreign exchange: when to use the temporal method

When should a company use the temporal method?

While the closing rate/net investment method is the ‘normal’ method a company will use to translate the results of a foreign enterprise, SSAP20 says that the temporal method must be used in some circumstances.

These are where the subsidiary can be regarded as an extension of the parent company’s trade or business. The cash flows of the subsidiary impinge directly on the cash flows of the parent, so that the exchange rate between its local currency and sterling is of major importance in the subsidiary’s operations. SSAP20 gives some examples:

• The subsidiary acts as a selling agency, receiving stocks from the parent company, selling them locally and remitting the proceeds to the parent.
• The subsidiary is a supplier of raw materials or components to the parent company.
• The subsidiary is located overseas for tax, exchange control or similar reasons to act as a means of raising finance for other group companies.

In such situations, the temporal method – which treats the operations of the subsidiary as though they were the parent’s own operations – better reflects the underlying reality.