Audit and Assurance Practice Exam

What outcome is expected for gross margin when a company improves efficiency significantly?

1. Gross margin would remain constant

2. Gross margin is expected to decrease

3. Gross margin is expected to fluctuate

4. Gross margin is expected to increase

The correct answer is: Gross margin is expected to decrease

When a company significantly improves its efficiency, the expected outcome for gross margin is an increase. This is because enhancements in efficiency typically lead to lower production costs or reduced overhead, allowing the company to either maintain pricing while reducing costs or improve profit margins by potentially raising prices if the product's value proposition is enhanced. Increased efficiency can result from better resource management, improved processes, or technological advancements, all contributing to lower costs associated with producing goods or services. Since gross margin is calculated as sales revenue minus cost of goods sold (COGS), a decrease in COGS due to improved efficiency would directly increase gross margin. While gross margin can fluctuate due to various market factors, when efficiency is improved, it more consistently leads to an increase in gross margin. Thus, the correct interpretation of the question is that significant improvements in efficiency are positively correlated with gross margin trends.