Signs of Inventory Fraud

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18 Nov Signs of Inventory Fraud

Is your inventory being stolen by dishonest employees or customers? Inventory is a prime target for fraud schemes, second only to cash. It does not always involve the physical theft of items. Here are early warning signs that your inventory has been targeted.

Know your risk profile

Some companies are more at risk for inventory fraud than others. Obviously, service companies with minimal inventory on hand bear little risk of inventory embezzlement; instead, it is more common among retailers, manufacturers, and contractors. In general, higher-value inventory items, such as electronics or jewelry, tend to be more attractive to thieves.

Sometimes, however, the inventory account is just a convenient place to hide financial misstatement ploys, such as skimming or bogus sales. Thousands of journal entries are typically made to the inventory account, and it is closed out to cost of sales each year. So, thieves with access to the accounting systems may bury their scams in the inventory account. Then, victim-organizations may write off discrepancies between the computerized perpetual inventory records and physical inventory counts as external pilferage, obsolescence, or errors — when, in fact, it is due to intentional manipulation of the accounting systems.

Monitor inventory metrics

If your year-end inventory counts are not adding up, do not just write off the discrepancy as a cost of doing business; investigate why. You can shed light on the situation by computing various inventory ratios, including:

  • Days in inventory (average inventory divided by annual cost of sales times 365 days)
  • Gross margin (sales minus cost of sales) as a percentage of sales
  • Inventory as a percentage of total assets
  • Returns as a percentage of annual sales
  • Shipping costs as a percentage of sales

These metrics should be consistent over time and comparable to industry benchmarks. Sudden changes require immediate action.

Catch fraud early

The median duration — from inception to detection of a fraud scam — is 18 months, according to the 2016 Report to the Nations on Occupational Fraud and Abuse by the Association of Certified Fraud Examiners. Many victims are unaware that inventory balances are inaccurate until they have accrued substantial losses. Diligent managers know the signs of inventory fraud and can identify anomalies early. Contact us for help investigating a suspected inventory scam.

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