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An electrical store and a cake shop both have the same mark up on cost. However, the gross profit
margin of the electrical store is significantly higher than that of the cakeshop. Which of the following
is a possible reason for this?
A) The cake shop has a higher turnover
of inventory than the electrical store.
B) The electrical store takes advantage
of trade-discounts for bulk buying.
C) The cake shop has a higher level of wastage of inventory than the electrical store.
D) The cake shop’s revenue is increasing, while that of the electrical store is decreasing.
The correct answer is C. Dear tutor, could you please explane all options (A,B,C,D)? I didn’t understand why A,B,D are incorrect and why C is correct. Thanks in advanceSuppose the mark-up on cost is 25%. So if the cost is $100 then the selling price is $125, and the gross profit margin is 25/125 = 20%.
Selling more or less will not change the % – they will still make a margin of 20% is the markup is 25%, so A and D are not correct.
The cost per unit is already after any trade discount, and so B is not correct.
For C, suppose they buy goods for $110 but they waste $10 and only sell $100 of them. With a mark-up of 25% they will have sales of $125. However the cost is $110 and so the profit is 15 and the margin is 15/110. which is lower than 20%.
Why wasted inventory is included Cost? I supposed wasted inventory or stolen inventory is included other expenses as they don’t sell
Although it is better practice to show the closing inventory at cost and then to record any waste or loss as an expense after the gross profit, the closing inventory is often instead just shown at the lower figure which does then affect the gross profit.
In this question, given that the other choices are not correct for the reasons that I have given, the correct answer has to be C (which means that they are recording the closing inventory at the lower figure).
Dear tutor, i didn’t understand your explanations. ?n your example 15/110 is mark up not gross margin, however It is said that gross margin is higher relating to question. So both mark up and gross margin lower than electrical shop bcoz of wasted inventory? How is calculated gross margin and mark up relating to your example? Thanks in advance
The cake shop has higher wastage which means that the value of the closing inventory will be lower.
A lower closing inventory will mean that the cost of sales (opening inventory + purchases – closing inventory) will be higher. Higher cost of sales means lower profit and therefore a lower margin.
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