Question: why would companies overstate inventory
Answer: There are a couple of reasons why a company might overstate inventory. They both relate to reducing expenses and therefore increasing the company’s profit.
If inventory is overstated, it means that cost of goods sold is understated. This could be a case of not writing down inventory that has lost value, or of simply not expensing out items of inventory that have already been sold.
Inventory can also be overstated by dumping business expenses into inventory. What better place to hide expenses that you don’t want to properly recognize in the current year.
And it’s pretty easy to manipulate inventory figures. There are a ton of individual transactions throughout the year, and the auditors can’t possibly test many of them. And inventory counting procedures at year end are easily circumvented to cover fraud. This is a financial statement line item with a very high risk of fraud.
No matter the motivation or the mechanics of how it’s carried out, overstated inventory quite simply causes a company’s profits to be overstated as well.
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