the variance analysis frequently stops on the before-tax income line, and we follow
this convention in this chapter.
The variance analysis, illustrated in Exhibit 25.11, shows details of revenues and
cost of sales; these details are of importance when we discuss the impact of chang-
ing exchange rates later on. At times, companies are managed with attention being
concentrated on the gross margin, or gross profit, by upper-level management. Local
details above the gross profit line are regarded as responsibilities of the affiliates
themselves rather than of the region, the division, or the parent company. In the dis-
cussion that follows, we will assume that all upper levels of management are, indeed,
interested in revenue and cost details.
(e) Variance Analysis for Parent Company Use. Exhibit 25.12 extends the example
just discussed to the parent company by showing how LC Company’s results would
be reflected in the parent company’s statements, if we assume an exchange rate of LC
1 = PC 1 in the profit plan against a rate of LC 1 = PC 0.9 for actual 20X0 results.
(i) Functional Currency Determination. We have to introduce one additional ele-
ment—the concept of “functional currency.” Under FASB No. 52, the parent com-
pany determines the currency basis (functional currency) to be used for translation
purposes: either (1) the parent company’s currency or (2) the affiliate (local) com-
pany’s currency. The illustration in Exhibit 25.12 is based on the concepts included
in FASB No. 52, where the functional currency is the currency of the parent com-
pany. For example, if PC Company is located in the United States and LC Company
in Turkey, assuming a hyperinflationary economy in that country, FASB No. 52 re-
quires that the U.S. dollar be used as the functional currency.
(ii) Analysis If Functional Currency Is That of Parent Company. The data in the PC
column follow logically from the above exchange rate assumptions. Two lines need
further explanations. The beginning inventory has to be converted at the historical
rate of exchange in compliance with FASB No. 52. For the purposes of this illustra-
tion, we are assuming that inventories are valued on a FIFO basis and that the profit
plan rate is the same as the historical rate, namely LC 1 = PC 1. The actual ending
inventory has an average exchange rate of LC 1 = PC 0.9, as the old inventories have
been used up and only the latest inventories are held in stock. The other line that
shows an unusual exchange rate conversion is the one showing the depreciation ex-
pense; that item also follows the requirement of an historical conversion rate (which
in our example is LC 1 = PC 1) if the functional currency is the currency of the par-
ent company, regardless of whether the exchange rate has changed since the assets
were acquired originally.
Before considering the variance analysis of the parent company, we restate our
principle of using the base period (profit plan) exchange rate as that which underlies
our comparison. It reinforces the highly desirable result that the basic variance analy-
sis at the parent company office will look the same as that obtained by the local sub-
sidiary or affiliate. Thus, if we look at the variance analysis columns of Exhibit 25.12,
we see that the results of the analysis—the bottom line for volume, price, cost, and
expense—are exactly the same as those of Exhibit 25.11, except that all data are
stated in PC. This is solely due to an assumption of a base period exchange rate of
LC 1 = PC 1. In all real situations, this is most unlikely, but proportionately the re-
sults will always have to be the same.
25.8 PROFIT PLANNING CONTROLS 25 • 17