Li Chen has calculated profitability ratios using data extracted from his client’s pre-audit trial balance. He also has the values for the same ratios for the preceding two years (using audited figures). The data for the gross profit and profit margins are as follows:

Li is a little confused because the profit margin shows declining profitability but the gross profit margin has improved in the current year and is higher in 2018 than in the previous two years.

Required

(a) Make a list of possible explanations for the pattern observed in the gross profit and profit margins.

(b) Which of your explanations suggest additional audit work should be planned? For each, explain the accounts and/or transactions that would need special attention in the audit.

Gross profit margin Profit margin 2018 0.40 0.09 2017 0.30 0.15 2016 0.35 0.18