Temporal Method

You run a multinational corporation. You receive revenue in a lot of different currencies. However, you're headquartered in NYC, so you report your income statements in dollars. When your quarterly report gets released, all those other currencies have to get translated into U.S. dollars so you can come up with an integrated bottom line.

You aren't necessarily exchanging these currencies in real life. You're only making an exchange for record-presentation reasons. Your French subsidiary gets paid in euros, compensates its employees in euros, and keeps all its profits in French banks (still in euros). Those euros never get turned into dollars.

The functional currency for that subsidiary is euros. However, you have to provide earnings statements in dollars. So, on paper, you have to do a translation. One way to do it would be to just look up the euro-to-dollar exchange rate on the day you put together your earnings report and use that figure. That choice might not give a very accurate reading, though.

Another option exists. The temporal method. Under this procedure, the exchange rates involved in the earnings statement get figured at different times ("time" and "temporal" mean close to the same thing). The moment assets and liabilities are added to the books is when the exchange rate is figured...the rate at that particular moment. Because once those assets and liabilities are acquired, they aren't getting exchanged. They'll remain in their functional currencies from then on. The exchange rate doesn't impact them. The rate only matters at the moment they were acquired.