Can anyone explain this? I’ll post the answer shortly 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) higher than the same ratio computed under the current rate method. B) equal to the same ratio computed under the current rate method. C) lower than the same ratio computed under the current rate method.
let me guess- they’re going to go with B since inventory bought “toward the end of the year”, so temporal you use historical, all-current you use current, but since end of the year is your historical, essentially historical = current and they’re the same? EDIT- i might have to rethink my answer b/c it says “toward” and not “at” the end of the year…
I hate that schweser makes you think like that when you answer these questions–the stuff in CFAI books is much more straight forward. The answer isn’t B, but I was thinking its either C or B. If local currency decreases in value COGS would be lower under the current valuation that they would be under historical (unless in this case you assume that current=historic given that inventory is bought at the end of the year). In any case, I would think that B or C are feasible answers, but don’t get that it is A. ______________________ Your answer: C was incorrect. The correct answer was A) 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.
fake #'s to get it straight in my head (i hope): beg us/german = 2 ave us/german = 1.5 end us/german =1 gross profit = (sales - cogs)/sales say cogs 50. temporal “toward end of year” lifo let’s say historical is like 1.25 = 62.5 USD AC 50 x 1 = 50 USD so AC is lower cogs translated, higher gross profit ratio if it’s toward and not at end of year? i haven’t looked at FSA in a while- always need to practice these sorts of q’s.
Thank you–your line of thinking is the same as mine. But unfortunately the fine folks at schweser don’t agree with us.
i am not exactly a FSA wizard, but if you had a german subsidiary, it’d make it’s money in german whatever they use. if the german depreciates vs the $$, then my fake #'s above work (takes less USD end of yr to buy a german whatever). yeah, i think they’re backwards. email them. or cpk or swaptiongamma or someone who is a F LOT better at FSA than me- chime in now. i’m going to shower and then i’ll be back quickly and hopefully someone will clarify before I go out for dinner then out tonight. this will bug me.
it has certainly been bugging me. I ran a mock scenario just like you did, and their answer made no sense to me. I’ve emailed them a number of times in the past, but haven’t ever received a meaningful response. I’d rather just ask the AF community so that I can get an intelligent answer.
hi there… they have the answer the same as yours Your answer: C was incorrect. The correct answer was A) higher than the same ratio computed under the current rate method. so where is their answer different from what you have done in your solution? (and Banni’s made up #s example)
in my made up #'s the all current ratio is higher. in the answer, says the temporal is higher…
that is correct. I am sorry… Temporal would be higher. Since purchases occured towards end of the year, and the Historic rate is to be used - this means the Current Rate would be the actual Historic Rate. With ur numbers, bannis… All inventory purchases happened towards end of the year. So 1E=1$ would be the rate the use. For the Current Rate method you would use the Average rate, so 1E=1.25$ so in the Current rate method: 50E = 62.5 In Temporal 50E = 50$ so COGS in Temporal will be lower. hence Gross profit will be higher.
bannisja, its the Euro nowadays. (Earlier Deutsche Mark). anyways, we have to compare 2 different accounting treatments (1) All-current vs. (2) temporal (1). All current Sales —> Avg. COGS —> Avg. Gross PM —> Avg. 2. Remeasurement Sales —> Avg. COGS —> HISTORICAL* GPM —> ?? The interpretation of historical in this context is important and depends on cost flow assumption. We use LIFO this implies that -COGS is remeasured at the rate when COGS were assumed to be sold during the year (here the problem says ‘toward the end’=most recent rate) If COGS would have been sold evenly throughout the year, we would have been using avg.rate. So this leaves us with: Sales —> Avg. COGS —> Current GPM…
LOL i’m a moron. translating cogs, not inventory. thank you thank you thank you. typical bannisja… stupid mistakes. cogs is historical under temporal, average under all current- all I/S items are. dumb dumb dumb. thank you and sorry willis to add to the confusion. i translated COGS as if i were translating inventory.
and apologies also on my lack of european currency knowledge barthezz. i like german automobiles a lot.
nothing to apologize for bannisja. we are all here to learn. 
I did the same thing bannisja–thanks all for clarifying!
I almost had a heart attack when I saw this, until I realized that I should have that table memorized. Let’s never forget this post. COGS is is translated at average rate under all-current method.
Here’s another one… 1. Jan.2008… 0.70EUR/USD Avg. 2008… 0.75EUR/USD Weighted Avg when inventory acquired…0.74EUR/USD 31. Dec 2008 … 0.80EUR/USD Inventory is measured at historical cost on FIFO basis. What would you use to remeasure COGS & Inventory? What rates?
Temporal: Historic for Inventory on Balance sheet. Since ending inventory would be the latest inventory - use Current Value 0.80. COGS - Historic would be used. But that is as of usage - so Old rate 0.70 would be used for COGS. Current Rate: 0.80 EUR/USD for Inventory (Current Rate) and 0.75 for COGS
Gross profit margin is Sales-Cost of goods Sold/Sales If using LIFO then inventory would contain the earlier items and COGS would contain the more recent items. hence COGS would use the more recent exchange rate. Since the exchange rate is decreasing, COGS sold would be lower than if you used the average rate (as you would in the current method). Hence the top of the equation would be higher, since you minus COGS. Hence answer being A. I know you’ve already had the explanation, but thought i’d add my two pence worth incase its not entirely clear.
“two pence worth”, haha awesome. From the UK?