Inventory and Other Assets

Question 1

Both falsely increasing the perpetual inventory balance and failing to reconcile inventory records are ways a fraudster might conceal inventory shrinkage.
T/F

Answer 1

False
Falsely increasing the perpetual inventory record would only exacerbate the shrinkage problem. Instead, a fraudster seeking to conceal shrinkage would falsely decrease the perpetual inventory record to match the lower physical inventory count. In addition, failing to reconcile inventory records would likely cause more suspicion to arise.

One of the simplest methods for concealing shrinkage is to change the perpetual inventory record so that it will match the physical inventory count. This is also known as a forced reconciliation of the account. The perpetrator simply changes the numbers in the perpetual inventory to make them match the amount of inventory on hand. For example, the employee might credit (decrease) the perpetual inventory and debit (increase) the cost of sales account to lower the perpetual inventory numbers so that they match the actual inventory count. Instead of using correct entries to adjust the perpetual inventory, some employees simply delete or cover up the correct totals and enter new numbers.

Question 2

Sales and cost of goods sold almost always move in tandem, unless there have been changes in purchase prices, quantities purchased, or quality of products being purchased. T/F

Answer 2

True
Inventory fraud might be detected by using an analytical review because certain trends become immediately clear. For example, sales and cost of goods sold should move in tandem since they are directly related. However, if the cost of goods sold increases by a disproportionate amount relative to sales, and no changes occur in the purchase prices, quantities purchased, or quality of products purchased, the cause of the disproportionate increase in cost of goods sold might be one of two things: (1) ending inventory has been depleted by theft or (2) someone has been embezzling money through a false billing scheme.

Question 3

___________________ is the unaccounted for reduction in a company’s inventory that results from error or theft.

Answer 3

Inventory shrinkage is the unaccounted for reduction in the company’s inventory that results from error or theft. For instance, assume a computer retailer has 1,000 computers in stock. After work one day, an employee loads 10 computers into a truck and takes them home. Now the company only has 990 computers, but since there is no record that the employee took 10 computers, the inventory records still show 1,000 units on hand. The company has experienced inventory shrinkage in the amount of 10 computers.

Question 4

Of the following, who should conduct physical observations of a company’s inventory in order to most effectively prevent inventory theft?
A. Purchasing agents

B. Purchasing supervisor

C. A sales representative

D. Warehouse personnel

Answer 4

Sales rep
Someone independent of the purchasing or warehousing functions should conduct physical observation of inventory. For example, sales representatives usually communicate with customers and encourage them to buy the company’s products, but typically have no access to the physical inventory. The personnel conducting the physical observations also should be knowledgeable about the inventory.