I understand that in an inflationary environment, FIFO will lead to higher gross profit compare to LIFO.
If the subsidiary’s currency is depreciation, why does the current rate method as oppose to the temporal method give higher gorss profit to the parent company?
All else equal, if price is rising, then COGS for current will be higher than temporal, right? How does exchange rate affect the calculation? Thank you.
Temporal uses historical versus the current rate’s average. If the currency is depreciating then it would take more of your currency (and a HIGHER conversion rate) to sell the same COGS, versus the historical.
ex: was 1.5 to $1.00, now 1.75 to $1.00 (this is the currency depreciating, takes more of X to buy $$)
average = 1.6 to $1.00
So Rev = $100
COGS = $50
Rev (average for both) = 100 x 1.6 = 160
COGS (current = average rate) = 50*1.6 = 80
Gross = 50% --> (80/160)
COGS (temporal = hist) x 1.5 = 75
Gross = 53% --> (85/160)
Now this is under FIFO, under LIFO we would most likely use average or a given adjusted current rate, usually lowering the gross and increasing COGS due to the absolute increase in inventory costs
**NOTE** if you’re going to USD$ here then the currency ($USD) has APPRECIATED, leading to the inverse affect
Current method:
COGS Average higher
Temporal method:
COGS Historical lower
(Sales - Cogs) is higher under temporal method -> gross profit is higher than under the current rate