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ACCA Applied Knowledge · Financial Accounting · Ratios

Kestrel Ltd reports the following for the year ended 31 December: revenue $800,000; cost of sales $520,000; operating expenses $160,000. Last year the gross margin was 35% and the operating profit margin was 15%. Which statement correctly interprets the change in profitability?

Gross profit is $280,000 (35%) and operating profit is $120,000 (15%), identical to last year's margins. Profitability is therefore unchanged.

  1. AGross margin has fallen to 32.5% and operating margin has fallen to 15%, so cost control on overheads has offset weaker gross profitability
  2. BGross margin has fallen to 35% and operating margin has fallen to 12.5%, so overheads have increased sharply
  3. CGross margin has fallen to 32.5% and operating margin has fallen to 12.5%, so the decline is mainly due to higher cost of sales rather than overheadsCorrect
  4. DGross margin has risen to 65% and operating margin has risen to 20%, so profitability has improved

Explanation

Gross profit = 800,000 - 520,000 = 280,000, a margin of 35%. Operating profit = 280,000 - 160,000 = 120,000, a margin of 15%. Both are unchanged from last year, so none of the stated changes occurs...

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