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The following is from the question:
The company does not undertake a full year end inventory count and instead undertakes monthly perpetual inventory counts each of which covers one twelfth of al lines in stores and the warehouses.
The following is written in the answer:
Inventory could be under or overstated if the perpetual inventory counts are not all completed such that some inventory lines are not counted in the year
If the perpetual inventory counts are not all completed such that some inventory lines are not counted in the year then inventory could be overstated.
So why is it written that inventory could be understated
It is not clear from your post but only your first statement is in the answer:
“Inventory could be under or overstated if the
perpetual inventory counts are not all completed, such that
some inventory lines are not counted in the year.”Basically if inventory records (which are the basis of valuing year-end inventory) are wrong, inventory will be misstated – we can’t specify without further information whether that is likely understatement or overstatement.
How could inventory be understated
If the perpetual inventory counts are not all completed such that some inventory lines are not counted in the year then how could inventory be understated
The purpose of a perpetual inventory system is to check the accuracy of the records (on which the y/e inventory will be included in the FS). If the program of checks isn’t completed we don’t know if they are accurate. In this system, the reason for all differences between physical and book quantities have to be investigated – and the book quantities adjusted if necessary.
Consider, for example, that they system is omitting to record goods returns from customers – the inventory will physically exist, but if not recorded, the records will be wrong – they will UNDERstate the actual quantities and therefore the valuation will be understated.
But it is not mentioned in the explanation of this audit risk that inventory records would be incomplete which will lead to understatement. Instead it is mentioned that inventory counts are incomplete
If all the counts are not done, there is an increased risk that the quantities in the records will be misstated.
If you don’t want to read our notes, you could read up on what it means to have a perpetual inventory system in ACCA’s study materials https://www.accaglobal.com/gb/en/student/your-study-options/studyhub.html
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