Temporal Method vs Current Method
Date: April 17, 2009 10:53AM
I keep missing the boat on questions of this type, and I am not sure what I am doing wrong. Let me explain how I am reading this.
1. Euro is depreicating against the dollar (from $2.0 / euro to $1.5 / euro).
2. LIFO - most recent inventory purchases at the lower euro rate will hit COGS.
3. All inventories purchased at year end with a weaker euro.
4. The temporal rate is using the historic rate of calculating COGS. In this case $1.5 since using LIFO.
5. A lower FX rate times COGS produces a lower COGS. For example euro 200*$2 = 400 (higher COGS) vs euro 200 *$1.5 =300.
But this is not working...I am not sure what I am missing. I feel like I am missing both parts of the question with regard to temporal and gross margin. Thanks for your help!
Fronttalk Company is a U.S. multinational firm with operations in several foreign countries. It has a 100% stake in a German subsidiary. The foreign subsidiary's local currency has depreciated against the U.S. dollar over the latest financial statement reporting period. In addition, the German firm accounts for inventories using the last in, first out (LIFO) inventory cost-flow assumption and all purchases were made toward the end of the year. The gross profit margin as computed under the temporal method would most likely be:
A) equal to the same ratio computed under the current rate method.
B) higher than the same ratio computed under the current rate method.
C) lower than the same ratio computed under the current rate method.
Your answer: C was incorrect. The correct answer was B) higher than the same ratio computed under the current rate method.
The basis for using the all current method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency.
The foreign company uses LIFO so new purchases are flowing to cost of goods sold (COGS) and most purchases occurred toward the end of the year, so the current rate of exchange is our best guess for the COGS account. Since the local currency is depreciating, it is taking more foreign currency units to buy a dollar in the more recent periods and as a result, COGS as measured in U.S. dollars is lower and the gross profit margin is higher under the temporal method.
Date: April 17, 2009 11:04AM
All Current = GPM = AR - AR / AR
Temp (LIFO) = GPM = AR - CR / AR
Euro depreciating = AR>CR
(AR - AR) < (AR - CR)
Numberator of Temp (LIFO) greater.
Therefore, Ratio greater for Temporal.
Date: April 17, 2009 11:12AM
swaptions explain is simple and perfect
Date: April 17, 2009 11:48AM
So it's safe to say that assuming FIFO is used for inventory, as it is supposed to be and usually is, GPM is lower under temporal method because COGS is higher, but if LIFO is used, then all bets are off and you should just remember that current rate is used for COGS?
Date: April 17, 2009 12:10PM
So since sales are at the average rate and COGS is at the current rate and given a weaker euro, COGS will be lower thus improving margin.
Average rate: $1.75
Beg. rate: $2.0
Current (end) rate : $1.5
euro sales of 200 * $1.75 - 150 * $1.5 =
350 - 225 = 125
euro sales of 200 * $1.75 - 150 * $1.75 =
350 - 262.5 = 87.5
Temporal margin > Current margin.
OK, this makes sense.
Date: April 17, 2009 12:46PM
I understand the math of it, but am I right that you just have to memorize that under LIFO, you use the current rate to value COGS? It seems like that's just arbitrary, unless I'm missing something...after all, Schweser's answer above says "so the current rate of exchange is our best guess for the COGS account."
Date: April 17, 2009 12:54PM
I have said this multiple times before. If you do not have the statement made that "Inventory is bought and sold uniformly thro' the year" -- and you have LIFO - use the FLOW option....
In this case LIFO Flow wise - old in COGS, new in Ending Inventory. So Historic COGS, Current Inventory.
FIFO Flow wise - new in COGS, old in Ending Inventory. Historic Ending Inventory, Current COGS.
Date: April 17, 2009 01:06PM
I'm sorry cpk what is "flow option?" (I searched for that term and didn't find where you mentioned this.) And Schweser's answer, as I mentioned above, says to use the Current COGS, but you said "In this case LIFO Flow wise - old in COGS, new in Ending Inventory. So Historic COGS, Current Inventory," so you're saying I should use Historic COGS, current inventory?