A declining inventory turnover combined with an increasing gross margin rate suggests that the organization is not selling inventory as quickly as before, but still reporting higher profitability. This can indicate overstated inventory values, meaning that financial statements show higher inventory balances than what actually exists.
(A) Incorrect – The organization’s operating expenses are increasing.
Operating expenses do not directly affect inventory turnover, which measures how quickly inventory is sold.
Higher expenses could reduce net profit, but they would not explain a higher gross margin.
(B) Incorrect – The organization has adopted just-in-time (JIT) inventory.
JIT inventory systems increase inventory turnover by reducing excess stock.
Since turnover is declining, this suggests the opposite of JIT.
(C) Incorrect – The organization is experiencing inventory theft.
Inventory theft usually reduces inventory levels, potentially increasing inventory turnover due to lower stock.
Theft could lower gross margins if significant losses occur.
(D) Correct – The organization’s inventory is overstated.
Overstated inventory leads to lower COGS, artificially inflating gross margin.
If inventory levels are inflated, turnover appears lower because reported inventory is higher than actual sales justify.
IIA’s Global Internal Audit Standards – Financial Statement Audits and Fraud Risk
Covers risks related to inventory misstatements and financial fraud.
IFRS & GAAP Accounting Standards – Inventory Valuation
Defines how inventory overstatement impacts financial ratios.
Analysis of Answer Choices:IIA References and Internal Auditing Standards:
