Question

Post a response on the discussion board.

If appropriate, include personal experience in your response.
Inventory accounting is a good place for fraudulent behavior. Think about the accounting principles and practices related to inventory and list one way that fraudulent behavior might take place. Be very specific.
Create one way to reduce the risk of this fraudulent behavior in the business.

Answer 1

Inventory is the term used for goods or merchandise that a company manufacturers or trades for its business. Accounting for Inventory hence becomes an important issue as it is an asset for the business and therefore Business Valuation may be dependent on appropriate valuation of Business Inventory.

Generally, Inventory is valued at Cost or Fair Market Value, whichever is lower. Generally Accepted Accounting Principles(GAAP) and IFRS or various Accounting Standards confirm the above view.

For trading firms, inventory valuation is relatively easier as there is no value addition. Whereas for Manufacturing Firms, valuation for Work in Progress and Finished Goods Inventory may be a difficult task as it involves use of Costing Principles and approximations.

Financial Impact of Inventory Valuation:

a. Impact on Statement of Profit and Loss - Since, opening and closing inventory values affect the Cost of Goods Sold, hence there is direct impact on the Income Statement causing variation in Profit/Loss for the period.

b. Impact on Balance Sheet - Value of closing Inventory affects the total value of Working Capital & Net Assets.

FRAUDULENT PRACTICE OF INVENTORY VALUATION:

One of the most followed way of affecting the financial position is Manupulation of Closing Inventory:

- Overstating Closing Stock may cause lower profits to be recorded. This would imply deferment of Current year Income to next years.

-Understating Closing Stock may cause higher profits to be recorded. This would imply disclosing higher profits than actually booked.

STEP TO REDUCE RISK OF FRAUD:

One such step may be "Physical Verification" of Closing Stock and assigning values after physical verification so as to Record the same at Actual Figures rather than manupulated ones. Management, along with Auditor shall carry on Physical Verification on year end or a date close to the year end and reconcile the same.