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Cogs using Temp vs Current with LC depreciating

Can someone elaborate on this for me? I got it right, but I am still confused. In particular can you highlight the differences on the inputs for the temporal vs. all current methods.

#8999

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) lower than the same ratio computed under the current rate method.

B) higher than the same ratio computed under the current rate method.

C) equal to the same ratio computed under the current rate method.

D) indeterminate relative to the same ratio computed under the current rate method.

Your answer: B was correct!

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.

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Ok. I think I get it. I would like some back me up on my understanding though.

Since we are talking about COGS based on LIFO inventory accounting in both scenarios all we are really examining is the different rates that would be used for remeasuring/translating COGS.

With the all current method we will use the average rate over the reporting period for COGS. Normally with the temporal method we would use a convention of even purchases throughout the year (average rate) and beg inventory at the historical rate and COGS would be a plugged figure, but in this case we are told purchases are at year end.

So we know that the LC has depreciated when the year end value (temporal method) is compared to the average value (all current) used for remeasurement/translation. This depreciation will lead to lower COGS in dollar terms for the temporal method and conseqently higher gross profit margin.

Is this correct? Am I confusing anything? Thanks.

^This question makes me think everything I wrote above is wrong. I am not sure I am even understanding the question now.

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Hann Company is a U.S. multinational firm with operations in several foreign countries. Hann has a 100% stake in a French subsidiary. The foreign subsidiary’s local currency has appreciated against the U.S. dollar over the latest financial statement reporting period. In addition, the French firm accounts for inventories using the first in, first out (FIFO) inventory cost-flow assumption. The gross profit margin as computed under the current rate method would most likely be:

A) higher than the gross profit margin as computed under the temporal method.

B) lower than the gross profit margin as computed under the temporal method.

C) equal to the gross profit margin as computed under the temporal method.

D) a comparison of the ratio between the two methodologies is not possible.

Your answer: D was incorrect. The correct answer was B) lower than the gross profit margin as computed under the temporal method.

The average rate is used to convert sales under both the temporal method and the current rate method. Hence, the only difference between the two computations is on cost of goods sold (COGS). Since the firm uses FIFO, older materials are flowing into COGS and an older exchange rate applies. Since in the past the foreign currency bought fewer dollars, the gross profit under the temporal method will be higher than that of the current rate method

I think I have it now, but it is after midnight so I am going to bed and ending my string of posts to myself. Still looking for feedback though.

It is very nice you put these 2 problems side by side. It helped my understanding as well.
For temporal method, we should use historical exchange rate for COGS.

If LIFO is used, the historical exchange rate will be close to current rate assuming the purchase were make toward the end of year.
While for FIFO, we need to use the exchange rate a long time ago. They will have different relationship with average exchange rate when LC appreciating or depreciating.

CFA level II Candidate.

This question (the first one) threw me to start with.

Hopefully people might find this explanation of some use.

You’re told LIFO is used.

Remember: the temporal method re-measures GOGS at the historic rate and the current method translates GOGS at the average rate.

We’re told all purchases were made towards the end of the year. Because of this we can estimate that these purchases were made at roughly the end of period rate (i.e. the current rate).

Therefore this will be the ‘historic’ rate used under the temporal method – the exchange rate at the time the latest inventory was purchased (remember we’re told the firm uses LIFO, so COGS reflects the value of the last units added)

It’s much simpler for the Current rate method – because we know COGS are translated at the average rate.

So we know in this example;

COGS under the temporal method @ End of period rate (given the information about purchases in the question)

COGS under the ‘current rate’ method @ Average rate

Therefore all we need to know is which rate is higher.

Because we’re told the Local Currency has depreciated over the course of the year, it MUST be that the average rate > end-of-period rate

Therefore:
GOGS (current-rate) > COGS (temporal)

Thus the profit margin is HIGHER under the temporal method. (choice B)