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Are your profits sneaking out the back door? Reducing your exposure to inventory fraud requires controls that combine effective results and minimum expense Next to misappropriation of cash, inventory theft is the most common type of employee embezzlement. A devious employee has a seemingly infinite variety of methods at his or her disposal to steal from your company’s inventory. Before we consider possible safeguards to minimize or eliminate the possibility of inventory theft, let’s look at some of embezzlers’ more popular methods. How inventory disappears. The simplest and most common method is to conceal inventory in personal belongings and simply walk out with it. Another common practice is to inflate outgoing orders and then enter into "profit sharing" arrangements with your delivery drivers or those of your customers. A third method is less obvious or significant on a single theft but can add up to a sizeable sum over time: the on-premises consumption of inventory (e.g., food, beverages, tobacco products, etc.). Inventory fraud can also result from the diversion of inventory intended for delivery to your company. Your crooked employee arranges for merchandise to be picked up by one of your drivers, siphoning off a portion of that merchandise before it arrives, and sharing the proceeds with the driver. Third-party pilferage. Companies that store inventory off-site or that contract out their intermediate processing make themselves vulnerable to fraud in ways that don’t threaten a company that keeps everything on-site. The misuse of customers’ inventory is not uncommon among suppliers that hold inventory on behalf of your company – inventory for which you have paid in full and that is stocked by the supplier for future delivery. On occasion, when auditors have tried to inspect the inventory on the supplier’s premises, they found that the supplier "borrowed" a portion of it for shipment to another customer, with the intent of replacing the missing stock before your delivery date. Since you’ve already paid for that inventory, your supplier is in fact misappropriating your property inventory for its own benefit. Another type of inventory misuse can be found where contractors short-ship a product before they return it to you for further processing. Typically, the control procedures after the merchandise has been purchased and enters the production cycle are not as tight as at their initial entry point or ultimate departure point from the company. Therefore, if the inventory isn’t properly tracked through the system (including out to and back from contractors), you probably can’t monitor shrinkages and shortages. What can you do? Having discussed some of the ways that thieving employees can help themselves to your property, we can look at internal controls that can help you reduce the threat of inventory fraud and the accompanying financial loss. Assess level of risk. The first issue to resolve is the level of risk associated with a particular type of inventory. That is, you must determine how valuable your inventory is to the average employee. Is it readily usable or saleable? Can it be taken without anyone noticing? If you sell front-end loaders, the answer is probably "no"; if you sell consumer goods, it’s a sure-fire "yes." Choose the right controls. After you establish the level of risk, you can then assess the extent to which you need to implement and enforce inventory controls. By carefully selecting controls that provide the most effective results with minimum expense, you can reduce your exposure to inventory fraud. But remember: Where collusion exists among several employees in responsible positions, it is extremely difficult to detect and prevent carefully conceived and executed fraud. With regard to inventory, all controls must be backed-up by carefully planned and performed physical inventory counts on a regular basis to determine whether inventory shortages are occurring. If they are, special investigative procedures may be necessary to determine where the leak is occurring and who the culprits are. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |
