Inventory Fraud: Stop It Before It Starts

Occupational fraud costs businesses around the globe trillions of dollars each and every year, eating away organizations’ overall revenue. Inventory fraud, specifically, is a big contributor to this.

But inventory fraud can lead to more than just financial losses. It can also create corporate compliance issues under the Sarbanes-Oxley Act (SOX) and other laws, regulations and accounting standards. 

Larceny and other schemes

The most common form of inventory fraud is theft, which fraudsters perpetrate through several methods. Primary among them is larceny, which involves the removal of inventory from the business’s premises for personal use. It can be difficult to detect, because co-workers privy to another employee’s pilfering often are reluctant to “tattle.” They might not want to seem to side with management against “one of the gang,” or they could fear management retribution for whistleblowing.

Other inventory theft schemes include:

Fake sales. In this case, an employee fails to ring up an item “purchased” by an accomplice, or the employee rings up the item at less than the actual price.

Employee discount abuse. Typically this means employees allow friends to use their employee discount when buying smaller-ticket items such as clothing. Employee discount abuse, however, can prove much costlier. Workers might sell pricey items, such as electronics, to an accomplice in bulk. And if the items subsequently are sold on the street, the business may suffer another loss — loss of customers who have found what they need at a lower price.

Returned goods. An employee might ring up an item for the accomplice at less than the ticketed price. The accomplice later returns the item for a refund without a receipt and receives a full refund for the amount shown on the ticket.

Requisition fraud. Here, employees overstate the inventory demand and then pilfer the excess items to sell or use in a side business. Employees also might help themselves to “scrap,” whether in the form of excess construction materials or last year’s cell phone model.

Falsifying shipments. Employees who work in a company’s shipping and receiving department easily can falsify incoming shipments by underreporting the number of units received and keeping the excess. They may conceal the theft by altering the receiver’s copy of shipping documents, leaving the actual number shipped on the shipper’s copy. In a similar scheme, employees mark up the number on the documents associated with outgoing shipments, ship the actual number ordered and keep the extra goods.

“Temporary” fraud. This may not even appear to be fraud at first glance. Temporary fraud occurs when an employee removes or borrows inventory and uses it temporarily. For example, an employee might take a company laptop home to run his eBay store. These transgressions may not seem fraudulent, but any use of inventory diminishes the items’ value.

Stop it cold 

Businesses can take several steps to discover ongoing inventory fraud and prevent it in the future. Every company needs an express fraud policy that clearly states that pilferage is not acceptable. The policy must be broadly disseminated throughout the company and prominently displayed to encourage employees to monitor one another.

Workers often are aware of nefarious activities, so businesses should establish anonymous tip lines for employees that will also be open to third parties such as vendors and customers. Businesses might also consider incentive programs, such as awarding bonuses to recognize minimal inventory shrinkage.

In addition, internal and external auditors should be employed to ensure inventory activity is all above-board. Auditors can perform statistical analyses of financial data and reconcile amounts recorded as having transferred in and out of inventory with the actual physical inventory. Companies must give auditors the authority to thoroughly investigate any discrepancies — including those involving upper executives. Finally, audits should be conducted throughout the year, rather than only at the end of financial periods.

On the alert

With today’s increased corporate governance responsibilities, businesses need to be on the alert, both to minimize financial losses and to avoid potential liability in shareholder suits or other types of litigation or enforcement. A forensic accounting expert can help your clients cut inventory fraud.

SOX and fraud

From erroneous financial statements to internal controls and mitigation, fraud is no stranger to SOX-related activities. With an effective SOX program implemented in your organization, sound compliance and continued monitoring can help mitigate fraud risk. Learn more about the impact of the Sarbanes-Oxley Act in Weaver’s SOX Insights document.