consequence of the unexpected rate change, is $170. This represents a 91% im-
provement over what would have been. Alternatively, the proposed reporting system,
in enabling management to trace all translation gains and losses on an individual
transactions basis, allows the firm to go back and retroactively correct the original
entry. This may prove cost effective to do if the exchange rate variance proves to be
unacceptably large as a result of a sudden price freeze or a maxi-devaluation.
Reporting cost of goods sold is based on the same concepts that we have enu-
merated with respect to expenses in general. However, since costs are passed through
inventories, it is more complicated to go back and make retroactive corrections to re-
ported expenses when future exchange rates are projected incorrectly.
The importance of having accurate numbers in the case of cost of sales cannot be
overemphasized. It is critical in determining a firm’s “drop dead rate,” that is, the
lowest price a firm is willing to quote a client before turning down the business. This
is especially important if a firm has excess capacity or must match competitors’
prices. Traditional methods of reporting cost of goods sold can result in tremendous
distortions.
27.5 GROSS MARGINS. Let us now examine the distortions traditional reporting
practices have on gross margins. In the following example, assume that our Turkish
affiliate purchases an item of inventory for TL1,000,000 and sells it for TL2,000,000
in the same month. The traditional reporting model would report a gross margin of
50% determined as follows:
Sales TL2,000,000/130 $15,385
Cost of Goods Sold TL1,000,000/130 _______7,692
Gross Margin ______________$ 7,693
Gross Margin % 50.0%In the first scenario, assume that the inventory is purchased on the last day of the
month on account with payment due in 30 days. The item is sold the same day for
cash. While traditional reporting would continue to report a gross margin percentage
of 50%, the proposed accounting treatment reveals that the gross margin on the sale
is really 61.5%:
Sales TL2,000,000/130 $15,385
Cost of Goods Sold TL1,000,000/169 _______5,917
Gross Margin ______________$ 9,468
Gross Margin % 61.5%27.5 GROSS MARGINS 27 • 11Invoice on Month 1, Day 30; Payment Term 30 Days
Traditional Proposed
Measure Measure Diff. %At 169 Forecast 7,692 5,917 –1,775 –23.1
At 174 Actual 7,692 5,747 –1,945 –25.3
Exhibit 27.5. Effect of Rate Changes on Operating Expenses.