CFA CFA Level 2 Temporal Method – Which rate to use?

Temporal Method – Which rate to use?

  • This topic has 17 replies, 5 voices, and was last updated Mar-17 by Sarah.
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    • vincentt
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      As far as i’m aware for temporal method, the following rates are used:

      Common stock – historical
      Monetary assets/liabilities – current
      revenue & SG&A – average
      NI & equity – mixed
      COGS – historical (unless otherwise stated, could sometimes be average)

      what about taxes? Interest expense? Inventory?

    • Sarah
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      @vincentt interesting question.

      Inventory is a monetary assets so that would be current.

      I don’t recall seeing a question about taxes and interest expense (yet) and I’ll be horrified to learn that I also have to know this!

    • Sophie Macon
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      Actually @Diya, @Vincentt

      Inventory is a non monetary asset, hence historical rate must be used under temporal.

      Other income statement items are remeasured at the average exchange rate under the assumption that they occur evenly throughout the period.

      However, if they were a balance sheet item, say deferred taxes, or accrued interest – you have to know if they are monetary or nonmonetary liabilities. In this case, they should be both monetary liabilities.

      Here are some examples:

      Monetary assets – Cash & marketable securities, accounts receivable
      Monetary liabilities – acc. payable, short term debt, long-term debt, accrued expenses, notes, deferred taxes
      Non-monetary assets – Inventories, PP&E, Intangibles
      Non-monetary liabilities – Deferred (unearned) revenue (unlikely to be tested on this, but FYI)

      Hope this helps!

    • vincentt
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      @diya @sophie well that’s what I understood as well, apart from the list given above (first post), everything else should be historical rate under the temporal method.

      However, the explanation to the question i’m working on seems to place inventory under historical rate (when they use average for COGS as requested) and taxes/interest expense under average.

      Again, I could post the question if needed. As I thought I’m asking specifically how these items were classified. It seems like they are using different rates for different questions which is very confusing.

    • Zee Tan
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      @vincentt I had trouble with this in Level 2 as well. Would be happy to dive into the details with you if you post it here.

    • Sophie Macon
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      @vincentt, I don’t fully understand your question. Inventory is a non monetary asset, hence historical under temporal. Your question’s explanation seems correct then.

      As mentioned, taxes/interest expense are considered “other income statement items” not listed in the lists above, hence would be average.

    • vincentt
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      Basically the question is to use the temporal method (making the functional currency as the EURO), what would the translation gain/loss be?

    • vincentt
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      Monetary assets – Cash & marketable securities, accounts receivable
      Monetary liabilities – acc. payable, short term debt, long-term debt, accrued expenses, notes, deferred taxes
      Non-monetary assets – Inventories, PP&E, Intangibles
      Non-monetary liabilities – Deferred (unearned) revenue (unlikely to be tested on this, but FYI)

      Thansk @sophie for this list, i got most of it apart from accrued expense, notes and deferred taxes, gonna include that into my list.

      @vincentt, I don’t fully understand your question. Inventory is a non monetary asset, hence historical under temporal. Your question’s explanation seems correct then.

      As mentioned, taxes/interest expense are considered “other income statement items” not listed in the lists above, hence would be average.

      As for this:

      Beg. Inventory + purchases – COGS = End. Inventory
      (very useful method way of understanding which you have mentioned in the other post last week or so)

      However, I know that COGS is always historical under temporal but the question specifically mentioned inventory purchase occurred evenly across the year and should use the average rate, hence I would assume that COGS and inventory should use the average rate. (In the answer, COGS is using average but not inventory!)

      But logically (in real life), taxes and interests are paid at a certain time of the year, so wouldn’t that be right to use the historical rate (something like a to use the rate at the time when common stocks were issued?)

      Just trying to reason it out with my logic, so I could remember them easily.

    • fabian
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      Was looking through all of this – thanks for posting the question @vincentt.

      I would say that although purchases occur throughout the year, inventory is stable and they use LIFO accounting, so inventory is still the same inventory they bought on Jan 1st.

      My take is that inventory is historical because it was bought all at once at the 1st of Jan, then with LIFO accounting the inventory was kept stable, meaning that all new inventory that was purchase would have been shifted to COGS (therefore using average rate), and the inventory at the end of the period would still be the inventory bought at the 1st of Jan. So historical rate should apply here.

      Inventory depends on date of purchase
      COGS depends on date of sale

      I’m literally writing this from work (shh…) from no reference so I could be wildly wrong here. Just my 2 cents 😀

    • vincentt
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      I would say that although purchases occur throughout the year, inventory is stable and they use LIFO accounting, so inventory is still the same inventory they bought on Jan 1st.

      My take is that inventory is historical because it was bought all at once at the 1st of Jan, then with LIFO accounting the inventory was kept stable, meaning that all new inventory that was purchase would have been shifted to COGS (therefore using average rate), and the inventory at the end of the period would still be the inventory bought at the 1st of Jan. So historical rate should apply here.
      😀


      @fabian
      :-O !!! That’s explains the used of historical rate for inventory!!! thank you!!! That’s a very evil question!

      Inventory depends on date of purchase
      COGS depends on date of sale

      Why would COGS depends on date of sale? Wouldn’t COGS be the actual cost when you purchased the specific item?

    • Zee Tan
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      @fabian awesome explanation!

      I agree with @vincentt – it should be date of purchase too. In this question COGS = goods purchased throughout the year so that’s an average rate.

    • fabian
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      @zee @vincentt whoops, you’re right. my bad 🙂

    • vincentt
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      thanks for that guys @sophie @fabian but, what about the tax and interest expense bit?

    • Sophie Macon
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      LOL @vincentt now you can see how tricky the questions can be. Underlining these key ‘extra’ info is always useful.

      But logically (in real life), taxes and interests are paid at a certain time of the year, so wouldn’t that be right to use the historical rate (something like a to use the rate at the time when common stocks were issued?)

      Just trying to reason it out with my logic, so I could remember them easily.

      Definitely, logic is always my preferred method as I’m terrible at memorizing. But in this case, even in CFAI studies for temporal method it is just assumed that these Other Income Statement items (excluding COGS, depreciation etc that have specific treatment) occur throughout the year, therefore using average exchange rates. I suppose it’s a simplification as I think they did enough havoc in this section.

    • Zee Tan
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      It’s been a while and I’m particularly weak on this, but I’ll dive deeper into this and try and come up with a better high-level way of understanding all-current and temporal. Watch this space 🙂

    • vincentt
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      LOL @vincentt now you can see how tricky the questions can be. Underlining these key ‘extra’ info is always useful.

      But logically (in real life), taxes and interests are paid at a certain time of the year, so wouldn’t that be right to use the historical rate (something like a to use the rate at the time when common stocks were issued?)

      Just trying to reason it out with my logic, so I could remember them easily.

      Definitely, logic is always my preferred method as I’m terrible at memorizing. But in this case, even in CFAI studies for temporal method it is just assumed that these Other Income Statement items (excluding COGS, depreciation etc that have specific treatment) occur throughout the year, therefore using average exchange rates. I suppose it’s a simplification as I think they did enough havoc in this section.

      So to summarize, under the temporal method:

      Balance Sheet items are usually historical apart from cash (please add onto my list if i missed anything out, I promise to put ur name as credit in my notes ) 😛

      Income statement:
      Rev & SG&A – average
      NI – mixed
      depreciation & COGS – historical

      everything else should be average?

    • Sophie Macon
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      So to summarize, under the temporal method:

      Balance Sheet items are usually historical apart from cash (please add onto my list if i missed anything out, I promise to put ur name as credit in my notes ) 😛

      “… usually historical apart from monetary assets or liabilities“. Cash itself is too restrictive a term. You have the examples listed earlier for monetary assets and liabilities. Note that inventory is a non-monetary asset, hence historical.

      Other than that your summary is pretty good for temporal (aside from some tricks on questions which you’ve experienced).

    • Sarah
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      Thanks guys, I think I need to give this topic lots of time. Except more questions regarding this soon.

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