Definition
Gross profit margin is gross profit divided by revenue, expressed as a percentage. Gross profit is revenue minus cost of sales. Margin is not the same as markup, which divides gross profit by cost. What goes into cost of sales, such as freight, depreciation or warehouse labor, varies by entity, so margins are only comparable when classification is consistent.
Why it matters in an audit or review
Margin is one of the first relationships an auditor tests because errors in revenue, cost of sales or inventory all move it. A margin that rises with no pricing or mix explanation can indicate premature revenue, unrecorded costs or overstated ending inventory. A fall may signal unreported discounts, returns or inventory write-downs. AU-C 240 expects the team to consider unusual relationships when identifying fraud risk.
Example
Illustrative: revenue of $5,000,000 and cost of sales of $3,400,000 give gross profit of $1,600,000 and a margin of 32.0%. If the prior year was 35.0%, the team asks whether the drop reflects price cuts, mix or cost errors.
Common mistakes
- Confusing margin with markup.
- Comparing margins after a change in cost classification.
Sources
- AICPA, AU-C Section 520, Analytical Procedures
- AICPA, AU-C Section 240, Consideration of Fraud in a Financial Statement Audit
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error