Appreciating and Depreciating LC for All Current Method

Can someone help clarify this point. When ratios are calculated for Pure B/S and Pure I/S items,the ratios remain the same under the All current.But on page 266 of Book 2 the Interest Coverage ratio which is a Pure I/S item does not remain the same. For eg If Local Currency is appreciating,Interest Coverage ratio will be lower for All current method. refer to page 266.

My guess would be that it is because EBIT has COGS embedded in it. So COGS is being translated at the current rate, but sales and interest are being calculated at the average rate (as all income statement items are). If the local currency was appreciating then COGS appear more expenseive relative to the rate used to translate sales and interest. The higher COGS would make the numerator of the coverage ratio smaller. Because interest (denominator) is always smaller than EBIT (denominator) the ratio will decrease. So I guess this wouldn’t be a completely pure ratio because EBIT is not an account taken right off the income statement as COGS are necessary to calcuate EBIT and they are taken from the balance sheet (inventory). This is just my guess. I would be interested in other’s thoughts.

mwvt, isn’t COGS also translated at the average rate under all current method?

Yes it is. Ignore everything I said. I should have known better than to try to answer a FSA question.

I actually think I know the answer to this now. The ratio doesn’t change. What schweser is doing on page 266 is comparing the all current ratio relative to the temporal, so they are just saying that it will be lower COMPARED to the temporal. In absolute terms it shouldn’t change. Maybe somebody can confirm this as I haven’t looked at FSA in awhile.

EBIT has depreciation included which I think is historical rate under temporal but average rate under all current.

That wouldn’t change anything then^

Hi addotwumk, If you are comparing impact on Interest Coverage ratio under Temporal vs all current then If Local Currency is appreciating,Interest Coverage ratio will be lower for All current method as compared to temporal method. If you comparing impact on on Interest Coverage ratio before and after translation then under all current method it will remain same. I think the question of pure IS and BS item only arise when you are translating statements uner all current method and comparing ratios before and after translation and not with ratios calculated under temporal method. Hope this helps.

Ignore my previous post, I was thinking of a different question. mwvt9 has it right. They are saying that if prior to converting the financial statements with either temporal or all-current a company has an Interest coverage ratio of 1.5, then if you use all-current to convert the statements you will still have an interest coverage ratio of 1.5. If you use temporal method your interest coverage will no longer be 1.5 (usually) and depending on what the currencies are doing (appreciating/depreciating) , it will be higher or lower than 1.5.

Yeah. That is what I was saying. ^ Makes sense. The OP was talking about the currency effects to the parents statments (which wouldn’t change for a pure ratio…they just wash), but the chart on p. 266 is doing as wandering says.

Thanks all for your inputs.I now get it very much!

good job, mwvt9. very helpful discussion.