CFA Practice Question

There are 334 practice questions for this study session.

CFA Practice Question

Which of the following statements about the gross profit margin is true in a period of an appreciating local currency and the use of the current rate method?

A. The current rate method results in a lower gross profit margin than the temporal method.
B. The current rate method results in a higher gross profit margin than the temporal method.
C. Cannot determine the effect of translation method on the gross profit margin.

The key to this answer is the fact that the temporal method remeasures inventories at historical exchange rates, while the current rate method uses current exchange rates. Appreciating local currency means that the \$US equivalent is lower. As a result, ending inventories are translated at a lower \$US equivalent under the current rate method, resulting in higher COGS and lower gross profit.

User Comment
katybo I thought the following: all current method translates all inc statement using average rate and temporal method uses functional currency, and because it apreciates cogs are lower in this case and gross profit margin higher than all?
prabhur08 The answer is correct. Here is my explanation: An alternate explanation could be: for the temporal method, depreciation is lower (based on historical) therefore profit margin is higher. Similarly for the current method, depreciation is higher (based on average or current) therefore the profit margin is lower.
ptyson "Appreciating local currency means that the \$US equivalent is lower"

not true is it? Appreciating local currency surely means \$US equivalent is HIGHER!

hence, COGS will be lower (as cogs = beg + purch - end) - if end is higher, cogs will be lower.

Therefore, if cogs is lower, then Gross Profit Margin will be higher (GPM = [sales - COGS] / sales)

smaller COGS -> larger top part of that equation and higher GPM.

therefore, surely B is correct
ptyson also, check what they say in question 3 to verify that their statement i've highlighted is incorrect...
ptyson checked the book - COGS itself is measured using the totals from local currency, not the individual constituents as i indicated above, so scrap what i said.

COGS itself is just like sales, etc, in current method, and is translated to usd at the current exchange rate.

in temporal method, it's calculated in the foreign currency, and converted to usd using historical exchange rate.

sorry for any misunderstanding i may have caused!
StJohnDale No prob Ptyson , thanks for following up with the last explanation.
daverco A weakening dollar means you're translating foreign currency that is worth more => revenue upside. Since you're translating more expensive currency, your costs and expenses will be higher as well.
While A is thus correct, inventory I think should be higher (because it is worth more in USD given the appreciated foreign currency).