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Scenario:
It has been discovered that the soil relating to a batch of plants with a cost price of $0.1 m is contaminated, meaning that the plants may not be able to be sold. Tests are currently being carried out to determine whether the contamination can be remedied.
Audit Risk identified:
Inventory valuation:
Inventory of $ 0.1 m has been noted as being damaged due to containing contaminated soil. In addition, the inventory holding period has increased from 28 days to 54 days meaning the company is retaining inventory longer than the prior year.
If the contaminated soil can’t be remedied and the damaged inventory of $ 0.1 m is not written down to its net realizable value, inventory will be overstated, and cost of sales will be understated.
Here I don’t understand how cost of sales will be understated. I think, closing inventory will be overstated because it would also be including the damaged inventory and hence cost of sales would be understated.
Is it the right train of thought?
Welcome to my forum!
Though I don’t understand what you don’t understand as you seem to concur that closing inventory would be overstated (because damaged inventory should be written down to NRV) and that means that cost of sales would be understated (because cogs = opening inventory + purchases – closing inventory).
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