Page 68 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

Comparing Results Using the Temporal
Method and Current Rate Method READING 16: MULTINATIONAL OPERATIONS

MODULE 16.6: RATIOS

Assuming end-of-period balance sheet figures, the key steps are:

1. Determine whether the foreign currency is appreciating or depreciating.

2. Determine which rate (historical rate, average rate, or current rate) is used to
convert the numerator under both methods. Determine whether the numerator of
the ratio will be the same, larger, or smaller under the temporal method versus
the current rate method.

3. Determine which rate (historical rate, average rate, or current rate) is used to
convert the denominator under both methods. Determine whether the
denominator of the ratio will be the same, larger, or smaller under the temporal
method versus the current rate method.

4. Determine whether the ratio will increase, decrease, or stay the same based on
the direction of change in the numerator and the denominator.

5. For example, let’s analyze the fixed asset turnover ratio, which is equal to
revenue divided by fixed assets. Assume the foreign currency is depreciating.

6. The numerator (revenue) is converted at the same rate (the average rate) under
both methods.

7. The denominator (fixed assets) is converted at the historical rate under the
temporal method and the current rate under the current rate method. If the
foreign currency is depreciating, the historical rate will be higher than the current
rate, which means fixed assets will be higher under the temporal method.

8. Since fixed assets are higher, turnover will be lower under the temporal method
(higher denominator).