CFM8027a – Accounting for foreign exchange: example of the temporal method
Temporal method - example
The facts are the same as in the example at
CFM8026b. The UK company set up the US
subsidiary many years ago when the exchange rate was £1 = $2.
It is preparing consolidated accounts for year ended 31 December
2004, and relevant exchange rates are:
31 December 2003: £1 = $1.6
31 December 2004: £1 = $1.2
Average rate for year: £1 = $1.5
Because it is necessary to translate non-monetary items at
the historical rate, additional information about the fixed assets
is needed. Assume they were purchased in two tranches:
| Date of acquisition | 1 January 1999 | 1 July 2004 |
| Exchange rate at acquisition date | £1 = £1.66 | £1 = $1.80 |
| Book value at 31/12/2003 | $80,000 | |
| Additions at cost | $62,700 | |
| Depreciation for year | $48,000 | $4,700 |
| Book value at 31/12/2004 | $32,000 | $58,000 * |
The company had no stock at either 31 December 2003 or 31
December 2004. (Stock is also a non-monetary asset - if the company
had stocks in its balance sheet, they would also need to be
translated at the historical rate. In practice, the company would
use an average rate for the period over which the stocks were
acquired).
When the temporal method is used, the translation of the
profit and loss account is as follows:
| $ | Rate | £ | |
| Profit before depreciation | 182,700 | 1.5 | 121,800 |
| Depreciation | (52,700) | 1.66/1.8 | 31,527 |
| Profit on ordinary activities before taxation | 130,000 | 90,273 | |
| Exchange difference | 117 | ||
| Taxation | ( 40,000) | 1.5 | (26,667) |
| Profit after taxation | ( 90,000) | 63,723 |
Strictly, individual transactions should be translated at the
rate for the day on which they took place, but companies will
normally use an average rate as an approximation.
Depreciation is translated at the historical rate proper to
the asset concerned.
The exchange difference is the balancing figure.
The sterling profit figure is obtained from the translation
of the balance sheet - see below.
Translating the balance sheet is gives:
| 31/12/2003 | 31/12/2003 | 31/12/2004 | 31/12/2004 | |||
| $ | Rate | £ | $ | Rate | £ | |
| Fixed assets | 80,000 | 1.66 | 48,193 | 90,000 | 1.66/1.8 | 51,499 |
| Current assets | 30,000 | 1.6 | 18,750 | 95,000 | 1.2 | 79,167 |
| Current liabilities | (45,000) | 1.6 | (28,125) | (30,000) | 1.2 | (25,000) |
| Long-term loan | (15,000) | 1.6 | (9,375) | (15,000) | 1.2 | (12,500) |
| Net assets | 50,000 | 29,443 | 140,000 | 93,166 | ||
| Share capital | 1,000 | 2.0 | 500 | 1,000 | 2.0 | 500 |
| Retained profits | 49,000 | 28,943 | 139,000 | 92,666 | ||
| 50,000 | 29,443 | 140,000 | 93,166 * |
The difference between retained profits at 31 December 2004, £92,666, and retained profits at 31 December 2003, £28,943, gives the profit for the year £63,723 that is shown in the profit and loss account above.
