Question

No area of accounting provides more opportunities for subjectivity and creative accounting than the valuation of inventory. This is illustrated by the report Fraudulent Financial Reporting: 1987–1997 – An Analysis of U.S. Public Companies prepared by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Discuss why the accurate valuation of inventory is so crucial if the financial statements are to show a true and fair view.

Answer 1

An accurate valuation of inventory is so crucial because the reported amount of inventory will affect the cost of goods sold, gross profit, and net income on the income statement. It will affect the amount of current assets, total assets, working capital and stockholders' or owner's equity reported on the balance sheet. An inaccurate valuation of the inventory an incorrect will result two income statements to be incorrect. The main cause is that ending inventory of one accounting period will automatically become the beginning inventory in the subsequent accounting period thus will impact the two income statements to be inaccurate. If the computed value of the inventory is inaccurate it will represent a wrong financial position on the date of the balance sheet. Furthermore inventory actually is a vital portion of the company's working capital thus it is important to value it correctly to ensure that the current ratio and liquid ratios can be computed accurately. These ratios are significant to check for the liquidity of a company.