Down for the Count: Detecting Inventory Fraud

As with any type of employee scam, inventory fraud can lead to losses that can go undetected for long stretches of time. Many industries, such as manufacturing and retail are particularly vulnerable to such fraud because of risks that are inherent in the way they do business. Dealing with high-value raw materials and finished products creates greater danger for manufacturers, for example.

Common Fraud Techniques

It’s not just sticky fingers that companies need to worry about with their inventory. Several other fraud techniques are also common and potentially more costly.

In retail

1. Fake sales. The employee on the cash register fails to ring up an item for an accomplice or rings it up at a lower price.
2. Returned goods. The register worker rings up an item at a lower price and subsequently processes a return for the accomplice at the full price.
3. Requisition fraud. A manager inflates customer demand for an item and pilfers the excess items ordered. Or the manager submits an invoice for inventory that wasn’t really ordered, diverting the payment to a fictitious business.

In manufacturing

1. Physical theft. Workers directly steal finished goods, work in progress (WIP) or raw materials.
2. Record manipulation. Fraudsters alter inventory counts or create fake purchase orders to conceal theft.
3. Misrepresentation. Employees intentionally overstate or understate inventory levels on financial reports.
4. Diversion. Workers redirect inventory to a different location or recipient, for personal gain.

Take Stock and Get Help

A variety of ill-advised practices can invite inventory fraud. For example, granting too many employees access to inventory can literally leave the door open to theft. Fraudsters can also take advantage of inadequate recordkeeping systems and a company’s failure to track every item with location assignments. In addition, weak purchasing, receiving and disbursement controls make it easy for perpetrators to cover their tracks.

Who can help detect these weak spots? A fraud expert. In examining a company’s financial records, he or she can look for unusual journal entries posted for inventory, such as an entry making a physical count adjustment during a time when no inventory count had been conducted.

A fraud expert will also scan the books for large adjustments after physical inventory counts, significant drops in gross margins and repeated issues with out-of-stock inventory. Moreover, he or she may check for invoices or purchase orders with no corresponding record of delivery, as well as discrepancies among the amounts due according to the invoice, the purchase order and the payment record.

An inventory fraud investigation goes beyond the company’s books and financial statements, too. An expert might find hints of inventory fraud in documents such as vendor lists — revealing vendors that are using post office boxes or multiple addresses, which are possible signs the business is paying a fictitious vendor.

Shrink Your Fraud Risks

Some amount of fraud is virtually inevitable in any organization. But you can take practical steps to reduce your losses — for example, by establishing a formal fraud prevention policy and implementing an anonymous tip line. To jumpstart your efforts, Armanino can review your current controls and provide insights and expertise to improve them. Learn more about how our fraud prevention team can help you assess your risks and build an effective program to prevent and deter fraud.