Page 65 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

Why Do the Two Methods Report
Significantly Different Results? READING 16: MULTINATIONAL OPERATIONS

MODULE 16.5: EXAMPLE

Income before translation gain/loss is different between the two methods. This is because COGS and depreciation are translated/remeasured
at different rates under the two methods. Under CRM, COGS and depreciation expense are translated at the average rate thereby reflecting the
depreciating local currency. Under the TM, COGS and depreciation expense are remeasured at historical (actual) rates, and thus, do not reflect the
depreciating local currency.

The translation gain/loss is different between the two methods; it’s not even the same sign. CRM results in a translation loss, while the TM
results in a translation gain. This is NOT an unusual occurrence. Under the CRM, Vibrant’s net assets (assets > liabilities) are exposed to the
depreciating local currency. Under the temporal method, Vibrant’s net monetary liabilities (monetary liabilities > monetary assets) are exposed.
Holding net monetary liabilities in a depreciating environment results in a gain.

Net income is different between the two methods. This is because of the different exchange rates used to translate/remeasure COGS and
depreciation expense as previously discussed. In addition, the gain/loss recognized under the two methods are reported in different financial
statements. Under the current rate method, the translation loss is reported in shareholders’ equity as a part of the CTA. Under the temporal method,
the remeasurement gain is reported in the income statement. Reporting the gain or loss in the income statement results in more volatile net income.

Total assets are different between the two methods because inventory and net fixed assets are different. Inventory and fixed assets are
translated at the current rate under the current rate method thereby reflecting the depreciating local currency. Under the temporal method, the
historical rate is used, thus, inventory and fixed assets do not reflect the depreciating local currency.