Can someone tell me why gross profits go up if subsidiary’s currency is depreciating with the current rate method compared to the temporal method?
okay I found the answer, it has to do with the way that inventory is measured. using FIFO means you have older FX rates in COGS and so on. as I talk to myself on AF…
Actually I am confused about the same thing. FIFO is a different matter, why should profit increase, regardless of inventory method, if the subsidiary’s currency is depreciating ?
I am not studying, but I ll take this opportunity to practice. Begin rate: Parent currency 1.0/local currency End rate: PC0.5/LC avg rate: 0.75 --> LC depretiating, PC appretiating. under current rate we use avg rate for COGS. Local subsidiary cogs: 100 Temporal method translation using historic: 100 x 1 = 100 cogs in PC Current method translation using avg rate: 100x 0.75=75 cogs in pc. pc will have lower cogs and higher profit. In the EOCs, FIFO and LIFO are also being considered. Incorporating FIFO and LIFO in the same problem: remember in this case, LC depretiating. Recall from level 1, under deflationary environment, LIFO produces lowest COGS, FIFO produces highest COGS. So in this case, combining 2 effects of inventory valuation plus currency translation, LIFO + current method will give us the lowest translated cogs and highest profit.
wtf i cant edit my msg anymore? I made an error for my above post. Regarding Inventory Valuation effect on currency translation, please note: if the sub currency is depritiating, it means that it’s economy is inflationary. under inflationary environment, FIFO has the lowest COGS. therefore, FIFO + current rate method will yield the lowest cogs and highst profit after translation.
Thanks passme, except that I guess LC depreciating is the same as an inflationary environment and not deflationary
current rate method—> COGS is at average rates —> if local currency went down, then COGS will be LOWER than temporal method where we value COGS at the higher, historical level. Therefore lower COGS= higher gross profit with CRM. If the local currency went up, then COGS valued at average rates would be HIGHER than if we were using temporal and valued COGS at the higher, historical rates. Don’t get confused with the FIFO/LIFO stuff. If the company is using FIFO with temporal, then that will distort things because they are selling the old stuff, but because it’s temporal, they are holding COGS down at that historical rate, not letting it depreciate or appreciate. But sales is translated at average rates, so this creates a mismatch. If they used LIFO, then everything would be cool because they are selling recent stuff which would probably be valued at average prices, so that is accurate.
+1 to Andrew’s explanation. Adding to Andrew’s point about LIFO… keys I have seen in mocks/questions They will give large hints at using average by 1) Saying purchases were made evenly throughout year = avg 2) A balance sheet showing lifo reserve increasing or the same, ie all COGS were from new purchases therefore you did not eat into LIFO layer