During an analytical review of the financial statements, which red flag might indicate inventory theft?

• A. The percentage change in sales was significantly higher than the percentage change in cost of goods sold.
• B. The percentage change in cost of goods sold was significantly higher than the percentage change in sales.
• C. Sales and cost of goods sold moved together.
• D. None of the above possible outcomes would indicate inventory theft.

Answer: (B)

Analytical procedures look for unusual relationships between related items. A red flag for inventory theft shows up when costs tied to producing or purchasing goods rise much faster than revenue. If cost of goods sold climbs disproportionately compared with sales, it suggests costs are increasing without a matching increase in sales—a pattern that can occur when inventory is stolen or lost and the lost value is absorbed into COGS or reflected as a higher ending-inventory write-down. In that scenario, gross margin erodes because more of the cost is being recognized per dollar of sales than would be expected from normal operations.

If sales and COGS move together, or if sales outpace COGS in growth, the relationship doesn’t point to theft, and “none of the above” isn’t supported.