Simple inventory question

CFA Level II
#1

This might be almost too easy to some of you but unfortunately I couldn’t find a proper solution in the archives of AF.

According to the solution of Schweser question I just did:

“A warning sign of accounting manipulation is abnormal inventory growth as compared to sales growth. By overstating inventory, the cost of goods sold is lower, leading to higher profitability”

I always thought overstating inventory works via the balance sheet. How would increased inventory decrease the COGS? If the value of the inventory (per item) increases, the COGS would increase as well, no? In the question was no mention of FIFO, rising prices or currencies.

THANKS!

#2

COGS = Beginning Inventory - Ending Inventory + Purchases

Higher EI lower COGS

#3

Hi, most probably this question tests the following relationship:

COGS = Opening Inventory + Purchases - Closing inventory.

If a company overstates the level of closing inventory, e.g. by manipulating a stock-count, it would result in understated COGS and overstated profit.

However, it would have a knock-on effect on next period’s COGS (due to opening inventory being overstated).

#4

Ok, thanks, I get it now. I thought manipulation of inventory would affect all inventory the same way.

If you guys don’t mind, I would like to add a follow-up question regarding inventory:

How can LIFO be less suitable for the inventory turnover ratio? I thought FIFO = old prices for COGS and new prices for inventory balances wheres LIFO = old prices for inventory balances and new prices for COGS. So what difference does it make if I put old or new COGS above the average inventory?

According to Schweser the denominator in the inventory turnover ratio is historical but how can average inventory be historical?

Thanks again!