Now suppose the auditors take a different view. BPI Americas sells three-quarters of its output back to the Indian parent, its castings are shipped from Pune, its working capital is funded by an intercompany line, and its pricing is set in Pune in rupees. Its functional currency is the rupee, its books happen to be kept in dollars, and the dollar figures have to be remeasured into rupees as though the transactions had been recorded in rupees all along.
The temporal method follows from that "as though". A rupee-functional entity records an asset at the rupee cost it paid on the day it bought it, and that cost never changes with the exchange rate. So:
| Item | Rate | Reason |
|---|---|---|
| Cash, receivables, payables, debt | closing | monetary: they are fixed numbers of dollars, worth different rupees each period |
| Inventory at cost | historical | non-monetary: carried at what was paid |
| PP&E and accumulated depreciation | historical | non-monetary |
| Share capital | historical | equity |
| Revenue, SG&A, interest, tax | average | transactions spread through the year |
| Cost of goods sold | historical, layer by layer | it is the cost of specific inventory |
| Depreciation | historical | it is the consumption of a specific asset |
| Remeasurement gain or loss | plug | goes to profit or loss |
Advertisement
How are cost of goods sold and depreciation remeasured?
BPI Americas' historical rates are ₹70.00 for the plant, which was built when the rupee was much stronger, ₹81.00 for the opening inventory layer and ₹85.50 for the closing layer.
Take this part a line at a time. Cost of goods sold is where the method bites. You don't just put closing inventory at a rate. You take opening inventory, plus purchases, less closing inventory, each at its own rate. Purchases are 36.0 + 15.0 − 12.0 = $39.0 million.
12.0 × 81.00 + 39.0 × 84.00 − 15.0 × 85.50 = ₹972.0m + ₹3,276.0m − ₹1,282.5m = ₹2,965.5 million = ₹296.55 crore
Against ₹302.40 crore under translation. The remeasured figure is lower by ₹5.85 crore because the inventory sitting in cost of goods sold was bought when the rupee was stronger. Depreciation is 3.0 × 70.00 = ₹21.00 crore, against ₹25.20 crore, lower by ₹4.20 crore for the same reason applied to a much older asset.
Where does the remeasurement gain or loss come from?
The plug is the remeasurement gain or loss, and it comes from the net monetary position. Monetary items are the ones whose rupee value moves with the rate: cash and receivables on one side, all liabilities on the other. Opening: (5.0 + 10.0) − 35.5 = −$20.5 million. Closing: (8.0 + 12.0) − 35.0 = −$15.0 million.
The entity was net monetary short all year, meaning it owed more dollars than it held. A weakening rupee makes dollar obligations more expensive, so you can expect a loss before you start the arithmetic. The arithmetic tells you how big it is.
Take the opening position at the opening rate, add the net monetary flow from operations at the average rate, subtract the dividend at its rate, and compare with what the closing position is actually worth. The flow is revenue less purchases less SG&A less interest less tax: 60.0 − 39.0 − 9.0 − 2.0 − 2.5 = $7.5 million, and it checks, because −20.5 + 7.5 − 2.0 = −15.0.
Expected: (−20.5 × 82.00) + (7.5 × 84.00) − (2.0 × 83.00) = −₹1,681.0m + ₹630.0m − ₹166.0m = −₹1,217.0 million = −₹121.70 crore. Actual: −15.0 × 87.00 = −₹1,305.0 million = −₹130.50 crore.
The gap is −₹8.80 crore, a loss, straight into profit or loss. Break it down the same way as for the current rate method: the opening position repriced, −20.5 × (87.00 − 82.00) = −₹10.25 crore; the flows repriced from average to closing, 7.5 × (87.00 − 84.00) = +₹2.25 crore; the dividend, −2.0 × (87.00 − 83.00) = −₹0.80 crore. Sum: −₹8.80 crore.
What do the remeasured statements look like?
The remeasured statements:
| Line | ₹ crore, temporal | ₹ crore, current-rate |
|---|---|---|
| Revenue | 504.00 | 504.00 |
| Cost of goods sold | (296.55) | (302.40) |
| Gross profit | 207.45 | 201.60 |
| SG&A | (75.60) | (75.60) |
| Depreciation | (21.00) | (25.20) |
| Operating profit | 110.85 | 100.80 |
| Interest | (16.80) | (16.80) |
| Remeasurement loss | (8.80) | none |
| Profit before tax | 85.25 | 84.00 |
| Tax | (21.00) | (21.00) |
| Net income | 64.25 | 63.00 |
| Inventory | 128.25 | 130.50 |
| PP&E, net | 315.00 | 391.50 |
| Total assets | 617.25 | 696.00 |
| Total liabilities | 304.50 | 304.50 |
| Net assets | 312.75 | 391.50 |
Prove the balance sheet independently. Opening remeasured net assets are (5.0 + 10.0) × 82.00 + 12.0 × 81.00 + 48.0 × 70.00 − 35.5 × 82.00, which is ₹1,230.0m + ₹972.0m + ₹3,360.0m − ₹2,911.0m = ₹2,651.0 million = ₹265.10 crore. Roll it: 265.10 + 64.25 − 16.60 = ₹312.75 crore, which is what the remeasured balance sheet says. There's no plug on the balance sheet at all under this method. The plug already went through profit.
Two gaps, both fully explained. Net assets differ by ₹391.50 − ₹312.75 = ₹78.75 crore, and that's entirely PP&E, 45.0 × (87.00 − 70.00) = ₹76.50 crore, plus inventory, 15.0 × (87.00 − 85.50) = ₹2.25 crore. Profit differs by ₹64.25 − ₹63.00 = ₹1.25 crore, and that's the cost-of-goods-sold difference of ₹5.85 crore plus the depreciation difference of ₹4.20 crore less the remeasurement loss of ₹8.80 crore.
Both reconciliations must close before you use either set of numbers. Errors tend to surface in the profit reconciliation. It's the only place the three separate effects meet.