LO5-3 Show how fraud can be avoided through inventory control.

Because of its size, the cost of goods sold normally has a significant impact on the amount of net income that is reported on the income statement. Since the reported balance in the inventory account has a direct effect on the amount of cost of goods sold, inventory manipulation is a target for unscrupulous managers seeking to control the amount of reported earnings. These statements are

True or False

True

If the amount of ending inventory is overstated, the amount of

Multiple Choice

• net income will be understated.

• liabilities will be overstated.

• cost of goods sold will be understated.

  Correct

• cash flow from operating activities will be overstated.

cost of goods sold will be understated.

If the amount of ending inventory is overstated, the amount of

Multiple Choice

• net income will be overstated.

• total assets will be overstated.

• retained earnings will be overstated.

• All of the answers are correct.

All of the answers are correct.

Assume that the amount of ending inventory is overstated in Year 1. Further, assume the overstatement in Year 1 is not discovered and the ending inventory in Year 2 is reported accurately. Under these circumstances,

Multiple Choice

• cost of goods sold in Year 2 will be understated.

• total assets in Year 2 will be understated.

• the Year 2 ending balance in retained earnings will be accurate.

  Correct

• none of the answers are correct.

the Year 2 ending balance in retained earnings will be accurate.

To avoid the risk of fraud associated with inventory manipulation

Multiple Choice

• the company Chief Executive Officer (CEO) should supervise the counting of inventory.

• the employee in charge of counting inventory should be different from the employee in charge of recording inventory transactions.

  Correct

• companies should not sell inventory.

• all inventory must be counted by government regulators.

the employee in charge of counting inventory should be different from the employee in charge of recording inventory transactions.