How does the temporal method handle inventory carried at cost when translating foreign subsidiary statements?

The temporal method (also called the remeasurement method) is used when the subsidiary's functional currency is the parent's currency — meaning the subsidiary is an extension of the parent's operations.

Key translation rules under temporal method:

Worked Example — Inventory at Cost:

Hendricks Corp (US parent) owns Tokyo Parts Ltd (Japanese subsidiary). Tokyo Parts' functional currency is USD (the parent's currency), so the temporal method applies.

Exchange rates (JPY per USD):

Tokyo Parts Balance Sheet (in JPY millions):

Notice that inventory at cost uses the historical rate from when it was purchased (146), not the current rate (152) or the average rate.

COGS follows inventory:

If Tokyo Parts uses FIFO and the beginning inventory was purchased at a rate of 143:

• COGS (JPY 2,400M) is translated at the historical rates corresponding to the inventory layers sold
• This might be a blend: some at 143 (beginning inventory) and some at 146 (purchases during the year)

The remeasurement gain/loss:

Under the temporal method, the translation gain or loss goes to the income statement (P&L), not OCI. This is the opposite of the all-current method.

The gain/loss arises because monetary items are translated at the current rate while the overall equity position includes historical-rate items. If the subsidiary has net monetary liabilities in a depreciating foreign currency, a remeasurement gain results (you owe less in parent currency terms).

Comparison summary:

Exam tip: The temporal method treatment of inventory is a classic trick question. If inventory is at cost, use the historical rate. If it has been written down to NRV (market), use the current rate. COGS must use the rate that matches the inventory cost flow assumption.

Explore our CFA Level II multinational operations module for more practice.