The bank loan officer reviewing the application would not have enough evidence to detect fraud. Carl Montague created and recorded false inventory to make it look like his auto parts store was doing well financially. Although the business was in the red, it would be challenging for the bank to detect the falsified information. The investors, employees, and Carl Montague could be affected most if the bank loan officer did not detect any fraud. After investing money, investors expect a return on investments. Consequently, they could suffer losses since Carl Montague's business is going bankrupt. In the same way, employees could be affected. When the loan was approved, and Montague expanded the auto parts store, employees were hired to help run it. The workers, therefore, could lose their jobs. The employees directly involved in fraudulent activities; presumably, the financial officers could face litigation and other monetary penalties. Montague, the founder, and owner of the auto store, could hurt himself should all the stakeholders and governing entities sue him for fraud. In addition to losing all the money he had made, he could also face monetary penalties and jail time.
There are several adjustments to the balance sheet that would affect the process of boosting earnings. An overstated inventory, for instance, shows more stock in the store that there is, which lowers the Cost of Goods Sold. The availability of more inventory thus translates into fewer COGS and more closing stock. The result of this is reduced gross profit. On the flip side, an understated inventory shows less stock in the store than the actual amount, which increases the COGS. The outcome of this is increased gross profit. In a nutshell, an upward adjustment on inventory translates to a decrease in the COGS resulting in more earnings, while a downward adjustment on the inventory leads to increased COGS, which in turn reduces earnings.
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