Why is gross profit margin higher under the temporal method in an appreciating local currency. Can someone explain please.
Gross profit = (Sales - COGS) / Sales Temporal is used if the parents currency is your functional currency. So current is converting sales from a stable currency to one that is appreciating, therefore sales will be a smaller number. There Gross profit is smaller. I’m probably going to fail level 2 so you might want confirmation from someone else
COGS is translated at the avg. rate (or what when inventory was purchased) over the year for both methods. Therefore: GP = 10 - 5 / 10 = 50% But if you’re doing current and the currency your translating to has appreciated now sales won’t be worth as much. ex: GP = 7 - 5 / 7 = 29%
denominator =sales is calc at the avg rate. numerator = sales - cogs (calc @ hist which should be lower if the currency is appreciating) avg(appreciation or rate)-historical(lower appreciation or rate)/ avg( appreciation) the numerator will be higher/ avg denominator.
I thought COGS would be avg. rate? You don’t buy all you’re inventory for the year on January 1st.
Sales are calculated at Avg rate in both the methods so no impact related to sales. BUT COGS is calculated at Avg rate in Current method and Historical Rate in Temporal. With appreciating local currency, cogs calculated with historical rate will be lower compared to the avg rate. lower cost will give higher margins.
thanks guys!