Audit and Assurance Practice Exam

What might occur when inventory is sold if there is manipulation involved?

1. Cost of goods sold is accurately recorded

2. Inventory values are increased

3. Cost of goods sold is not recorded nor is inventory reduced

4. Sales revenue is overstated

The correct answer is: Cost of goods sold is not recorded nor is inventory reduced

When inventory is sold, manipulation can significantly distort financial reporting, particularly regarding how cost of goods sold and inventory are treated. If manipulation occurs, it is possible that the cost of goods sold might not be recorded, which would lead to the inventory not being reduced accordingly. This situation could arise in scenarios where a company seeks to present a more favorable financial position by avoiding the proper recognition of expenses related to the inventory that has been sold. Not recording the cost of goods sold leads to an inflated net income, as expenses are understated, which is often a goal of manipulative practices. Additionally, if the inventory isn't reduced as required in proper accounting, it misrepresents the actual asset levels of the company, inflating the inventory figure on the balance sheet. The other choices do not accurately represent the consequences of manipulation when inventory is sold. Accurate recording of cost of goods sold typically reflects proper accounting practices, while inflated inventory values and overstated sales revenue do not directly relate to the immediate impact of inventory manipulation tied to sales transactions. Thus, the choice that notes the failure to record the cost of goods sold and to reduce inventory accurately captures a potential outcome of manipulation in this context.