Padded inventories;

              Bulletin HASKINS & SELLS 69
Padded Inventories
NOT long since the daily papers con­tained
reference to a report filed in
the Federal Court by the receivers for a
silk concern in which, according to the
newspapers, it set forth that "the inventory
of the corporation was overstated by a
sum in excess of $1,250,000, and that the
overstatement was concealed from the
accountants and appraisers by the creation
of false records for the purpose of deceiving
the bankers."
Newspaper reports are not needed to
recall other instances where inventories
have been used for purposes of deception,
to conceal losses, inflate profits, and
generally produce favorable results. Dur­ing
the past three or four years conditions
have been ripe for this sort of thing, due
to the marked fluctuations in price levels
and the readjustments occasioned by
economic influences.
The subject of inventories is one which
all accountants who are thoughtful and
sensitive to the risk involved need to
approach with some fear and trembling.
Granting, however, that the accountant
takes his professional life in his hands, so
to speak, when he approaches a situation
in which inventories are involved, there is
still no reason, apparently, why he should
not make use of such common sense as he
has without relying solely on the somewhat
perfunctory technique usually employed
in verification procedure.
The story of inventory requirements
from an accounting point of view is old
and worn, but, perhaps, like the oft-told
tale, it becomes so commonplace that it is
accepted as a matter of course and forth­with
disregarded. The word inventory
implies the physical existence of materials
or goods. This existence, obviously, is pre­requisite
to value. Further, the term
definitely means a counting, listing and
valuing of goods. The verification of an
inventory then involves several questions:
(1) becoming satisfied as to the existence
of the goods; (2) that they were accu­rately
counted and listed; (3) that the
prices used in valuation were proper; and
(4) that the mathematical computations
necessary to arrive at a total were correct.
On the first point evidence is frequently
impossible beyond the attestation of per­sons
who took or supervised the physical
count, except in those somewhat rare in­stances
where the accountants were in
charge of such work. Too frequently no
physical inventory is taken and the quan­tities
are drawn from the book records.
There is here, of course, an added question
as to whether or not the balances on the
stock records reasonably represent the
goods in existence.
As to the counting and listing the ac­countant
is likewise dependent on the
word of others, except as he may have the
opportunity to test the schedule from
original memoranda made in the case of a
physical inventory when the count was
taken. Prices used in valuation, however,
are usually at his disposal, and it is in this
particular, usually, that he may render
most intelligent service. The basis of
valuation is too well established to call for
much question. Cost or market, which-