A client's revenue has risen by 10% while its cost of sales is unchanged, so the gross margin has risen from 30% to approximately 36.4%. The business has not changed its pricing or suppliers. Which risk is this most likely to indicate?

Correct answer: A) Purchases may be incomplete, or closing inventory may be overstated

Explanation

Check the margin: if last year's revenue was 100 and cost of sales 70 (30% margin), this year's revenue is 110 with cost of sales still 70, so gross profit is 40 and the margin is 40 / 110 = 36.4% (rounded to one decimal place). With unchanged prices and suppliers, cost of sales should rise roughly in line with revenue, so an unchanged cost of sales may mean purchases have been omitted or closing inventory overstated, both of which reduce cost of sales and inflate the margin. Understated revenue or understated inventory would lower the margin, and administrative expenses do not affect gross margin.