When do you use the temporal method vs the current rate method for foreign subsidiary translation?

The choice of translation method depends on the subsidiary's functional currency -- the currency of the primary economic environment in which it operates.

Decision Rule:

Exchange Rates Used:

*Some items like COGS and depreciation use historical rates under temporal because the underlying assets were acquired at historical rates.

Example -- Vanguard Global's European Subsidiary (Euros):

Subsidiary was established when EUR/USD = 1.10. Current rate: EUR/USD = 1.20. Average rate: 1.15. Inventory purchased when EUR/USD = 1.12.

Under Current Rate:

All assets/liabilities translated at 1.20. Income at average 1.15. The difference creates a Cumulative Translation Adjustment (CTA) in OCI (equity).

Under Temporal:

Cash and receivables at 1.20. Inventory at 1.12. Fixed assets at 1.10. Revenue at 1.15. COGS and depreciation at historical rates. The difference creates a remeasurement gain/loss on the income statement.

Key Ratio Impacts:

Exam Tip: The temporal method creates more income statement volatility because translation gains/losses hit P&L directly. The current rate method is smoother for reported earnings but creates OCI volatility.

Practice translation problems in our CFA Level II question bank.