Question

What are the consequences of having an overvalues inventory that does not physically exist?

Answer 1

when companies do any malpractices in managing the physical presence of inventories with the motive of profit-making and these practices have been known of companies shipping goods to a customer early or having goods in the transit so that they are not physically present at any premises.

case-Mckesson and Robin (1938) US- created fictitious inventory in Canada

Income statement effects. A miscalculated inventory balance would lead to an error in the calculation of the cost of goods sold and, therefore, an error in the calculation of gross profit and net income. Left unchanged, the error has the opposite effect on cost of goods sold, gross profit, and net income in the following accounting period because the first accounting period's ending inventory is the second period's beginning inventory. The total cost of goods sold, gross profit, and net income for the two periods will be correct, but the allocation of these amounts between periods will be incorrect. Since financial statement users depend upon accurate statements, care must be taken to ensure that the inventory balance at the end of each accounting period is correct. The chart below identifies the effect that an incorrect inventory balance has on the income statement.

	Impact of Error on
Error in Inventory	Cost of Goods Sold	Gross Profit	Net Income
Ending Inventory
Understated	Overstated	Understated	Understated
Overstated	Understated	Overstated	Overstated
Beginning Inventory
Understated	Understated	Overstated	Overstated
Overstated	Overstated	Understated	Understated

Balance sheet effects. An incorrect inventory balance causes the reported value of assets and owner's equity on the balance sheet to be wrong. This error does not affect the balance sheet in the following accounting period, assuming the company accurately determines the inventory balance for that period.

	Impact of Error on
Error in Inventory	Assets =	Liabilities +	Owner's Equity
Understated	Understated	No Effect	Understated
Overstated	Overstated	No Effect	Overstated