The analytical procedures are exactly the same as those just illustrated, and the
volume, price, cost rate, and expense variance continue to reflect the same relation-
ships after translation into PC, as they did in the original LC example. There is, how-
ever, a change in the currency variance between Exhibits 25.12 and 25.13.
If PC is the functional currency, the currency variance is a negative PC 81; if LC
is the functional currency, the currency variance is a negative PC 36. The difference
of PC 45 is, of course, the currency effect of using historical currency rates (dual cur-
rency accounting) for purposes of Exhibit 25.12—a situation which no longer applies
under the assumptions for Exhibit 25.13. (The negative currency variance of PC 36
can be arrived at independently by multiplying the pretax income of PC 324 with the
11.11% change in currency values.) It is evident that, in those situations where LC is
used as functional currency, we achieve an improved analysis of results, as the cur-
rency variance represents a true measure of the effect of the changed currency values
without being encumbered with accounting conventions which have little meaning in
the eyes of management.
The results of the variance analysis, if LC is the functional currency, are therefore
the following:
PC
Higher volumes accounted for 100
Lower prices reduced earnings by (60)Cost rate lower by (^120)
Local gross profit (margin) improved by 160
Expenses higher by (25)
Local factors accounted for an earnings improvement of 135
Weakened local currency caused currency losses of _(36)
Before-tax income improved by ____ 99
(f ) Assessment of Variance Analysis Approaches. Variance analysis is a methodol-
ogy which explains the differences in results when we are comparing two income
statements; the technique is the same, whether we compare actual income with the
profit plan or one period with another, say the same quarter of the previous year. Such
analysis serves as a “control,” not only over operations, but also over currency ef-
fects. By substituting different exchange rates in the profit plan statements, ranges of
currency exposure can be established which, in turn, permit hedging decisions to be
made. On the operational side, all levels of management can arrive at conclusions as
to future actions to be taken on the basis of what volume or price variances reveal.
For example, a negative price variance may cause management to probe into the pos-
sibility and effects of raising unit prices; a negative cost rate variance may suggest a
need for better inventory controls or a change in suppliers.
The recommended basic methodology is not affected by any revision of the tech-
niques for translating local currency statements. The examples show that the basic
operational variances are the same, regardless of whether the parent company’s or the
subsidiary (local) company’s currency is selected as functional currency; only the
variance attributable to changes in currency relationships differs in line with the
translation technique employed. The portion of the analysis which deals with the op-
erational events that occurred in the country in which LC Company was located will
not be affected, regardless of which currency is selected as functional.
25.8 PROFIT PLANNING CONTROLS 25 • 21