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ACCA Applied Knowledge · Management Accounting · Performance measurement - application

A company's gross profit margin has stayed constant, but its operating profit margin has fallen sharply compared with last year. Which is the most likely explanation?

The most likely explanation is that operating expenses have risen as a proportion of revenue. Gross margin captures only sales and cost of sales, so if it is unchanged, the fall in operating margin must arise from costs below gross profit such as administration or distribution.

  1. ASelling prices have fallen relative to direct costs
  2. BDirect material costs have risen faster than selling prices
  3. COperating expenses have increased as a proportion of revenueCorrect
  4. DClosing inventory has been overvalued

Explanation

Gross margin only reflects revenue and cost of sales. If it is unchanged while operating margin falls, the difference must come from costs below gross profit, i.e. operating expenses rising relative to revenue. Price or material cost changes would alter the gross margin, and inventory overvaluation would raise gross profit.

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