can anyone explain why gross profit is highest for current rate method when fx is depreciating? i thought gross profit margin = (sales - COGS)/sales
If the fx rate is depreciating it is yielding less of the presentation currency over the period. Under current rate method inventory and thus cogs are valued at the ending period rate, when it would be the weakest over this period. The weaker ending rate would yield less in cogs than would have been the case if the stronger beginning period rate would have been used.
Small amendment to that…under current method you would use the average rate for the tear in translating cogs, not ending. However, the result is the same.
Oh i got your point, thanks AndrewWheeler!
Sales is translated using average under both Current rate and Temporal methods so that is same for both methods.
COGS is translated at average rate using current rate method while it is translated at historical rate under temporal method. That’s the difference. COGS is different.
Now, you stated that foreign currency was depreciating. When the foreign currency is depreciating, historical rate would be high and would result in a higher COGS. Average rate will be low and will result in a lower COGS.
Therefore, Gross profit will be lower under Temporal method (because the COGS is high and COGS is high because historical rate is high). Gross profit will be higher under current rate method (because COGS is lower and COGS is lower because average rate is lower than historical rate).
If the Foreign currency was appreciating, the results would reverse.
1 Like