During 2010, the Galina Shpakovskiy Drug Company experienced a significant incre

Question

During 2010, the Galina Shpakovskiy Drug Company experienced a significant increase
in the rate of gross profit on sales, compared with the rate it has averaged in recent years.
You are asked to determine the most likely reason for this improvement. Support your
answer.

The following data are from the records of the company:

2010 sales (at an average price of $40 a unit) were $1,800,000
2010 purchases (at an average cost of $24 a unit) were $960,000
The company uses the LIFO inventory method and has used it since 1985.

Explanation / Answer

Galina Shpakovskiy Drug Company experienced a significant increase in the rate of gross profit on sales because of several internal and external factor we discuss some factors in below lines.

Increasing gross profit on sales can mean two things for the company. First, the company has a favorable pricing power. When a firm raise price due to overwhelming demand, gross profit on sales will increase. Of course, this assumes that variable costs do not increase. Secondly, increasing gross profit on sales may mean that a firm is getting more efficient in production. When price per unit stays the same while the cost of variable unit drops, gross profit on sales will increase.

Some of the other reasons are:-

Ø Increase in the selling price of goods sold without any corresponding increase in the cost of goods sold.

Ø Decrease in cost of goods sold without corresponding decrease in selling price.

Ø Omission of purchase invoices from accounts.

Ø Under valuation of opening stock or overvaluation of closing stock.

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