Inventory Errors

Lesson

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Sometimes there are errors when it comes to inventory management.

Often, it's just an accident. Some bit of inventory might have been forgotten in a different warehouse or while in transit.

Maybe there's so much of it that managers just made estimates of what they had.

If only it were that easy. Did you know that some people will intentionally misstate their inventory levels to make their companies look better or worse than they really are?

That's called fraud.

Usually people commit fraud to make their businesses look more efficient than they are. They do this by making it reducing the amount of inventory that they claim to have used to make the profit they did in that quarter.

Question

Daniel Smith, owner of David Co., is worried that his reported inventory levels might be wrong, so he hired some expensive auditors to find out what really happened.

The firm's starting inventory was overestimated by $59.

What does this mean for the cost of goods sold (COGS) and net income values?

Answer

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👉 Answer:

The cost of goods sold is overstated
The net income is understated

👩‍🎓 Here are the steps to figure it out:

When the starting inventory levels are artificially high, that means that the firm will have used less inventory than is shown by the books.

When firms make thier costs look higher than they are, their costs look artificially high, and their net income (profits) look artificially loew.

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