Certified Internal Auditor (CIA) Practice Test

What could explain a significant increase in gross margin with no changes in products or methods?

1. Increase in similar product competitors

2. Decrease in suppliers for manufacturing material

3. Overstatement of year-end inventory

4. Understatement of year-end accounts receivable

The correct answer is: Overstatement of year-end inventory

A significant increase in gross margin without any changes in products or methods could occur due to an overstatement of year-end inventory. Gross margin is calculated by subtracting the cost of goods sold (COGS) from total revenue. If a company inaccurately reports its year-end inventory as being higher than it actually is, it would result in a lower COGS. This, in turn, inflates the gross margin because gross margin is affected by the costs allocated to inventory. In practice, when inventory is overstated, it means that the expenses related to purchased goods have been understated on the financial statements. Consequently, this leads to an artificially high gross margin that does not reflect the true economic situation of the company. The other choices relate to external factors or different accounting areas that, while they could influence various aspects of financial performance, do not directly explain the specific scenario of an inflated gross margin without alterations in product or service offerings.