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Reading 21: Question 2 (Profit margin in Temporal vs. Current)

Profit margin is highest in an inflationary environment using?

A.  FIFO & Temperoral

B. Weighted

C. FIFO & Current

Looking at the answer, I think the book (C) is wrong.  Temporal converts GOGS at historical (lower in inflationary), which gives a higher profit margin wihle current uses average (higher in inflationary).  

p. 243 also shows margin higher under temporal.

Am I doing it wrong?

"Wiley's prep material was a huge part of my success." - Lindsey G., USA

Using the current rate i,e the average for CoGs. You can convert 10 UAH into $1 (inflationary exchange rate). Meaning if you spent UAH10 you convert this to $1 in CoGs.

Using temporal, which is historic you convert CoGs where 5UAH into $1 (better exchange rate). So if you spent 10UAH you conver this to $2 in CoGs.

Therefore the Current has $1 CoGs and Temporal has $2 CoGs. The current has the better GP margin.

Hope this helps

High inflation weakens exchange rate and Low inflation strenghtens exchange rate.

Under the temporal method, if exchange rate strengthens, Sales strenghtens faster than COGS so Profit margin is increased.  If exchange rate weakens, Sales weakens faster than COGS so Profit Margins is decreased.

Under the current rate method, translation of income statement ratios are preserved regardless of what exchange rate is in use.  

bloodline wrote:

High inflation weakens exchange rate and Low inflation strenghtens exchange rate.

Under the temporal method, if exchange rate strengthens, Sales strenghtens faster than COGS so Profit margin is increased.  If exchange rate weakens, Sales weakens faster than COGS so Profit Margins is decreased.

Under the current rate method, translation of income statement ratios are preserved regardless of what exchange rate is in use.  

I understand the above comment but in the CFAI questions… one of the explanations is:

“In an inflationary environment, FIFO will generate a higher gross profit than weighted-average cost. For either inventory choice, the current rate method will give higher gross profit to the parent company if the subsidiary’s currency is depreciating.”

Does that go against the comment posted above? i understand inflationary is currency depreciating so your COGS using FIFO will be higher… which means your profit/margin will be lower… help pls