Audit and Assurance Practice Exam

Which of the following is not an inherent risk relating to inventory?

1. Sales contracts may contain unusual terms

2. Revenue recognition is often complex

3. Inventory turnover rates are generally high

4. Excessive inventory may result from poor demand forecasting

The correct answer is: Inventory turnover rates are generally high

The choice that identifies inherent risk relates to the characteristics of the inventory and the factors that can affect its valuation and management. Inherent risks associated with inventory typically arise from the nature of the inventory, the way it is managed, and the external economic environment. High inventory turnover rates generally imply that inventory is being sold quickly and efficiently. This characteristic is usually viewed as a positive aspect of inventory management rather than an inherent risk. When turnover rates are high, it can signify that a company is adept at keeping its inventory levels in line with demand, which can reduce the risk of obsolescence and carrying costs. As a result, high turnover rates do not create inherent risk related to inventory valuation or accuracy. In contrast, the other choices present inherent risks. Unusual terms in sales contracts can complicate revenue recognition and introduce risks related to how revenue is recorded. The complexity of revenue recognition can also introduce risks, as improper recognition can misstate financial results. Lastly, excessive inventory resulting from poor demand forecasting directly creates a risk of carrying obsolete or excess stock, which can impact financial statements. Understanding these dynamics is crucial for auditors and management alike, as they must address the inherent risks associated with inventory transactions to ensure accurate reporting and effective inventory management.