Fraud and Inventory Loss

Hunting for misplaced “goods”

Fraud experts can help recover lost items
ReggieNovakIf your inventory numbers are not adding up during your year-end physical inventory, it may be time to uncover the source of the discrepancy and a fraud expert can help. Before assuming theft, a fraud expert determines whether the items were really stolen or were simply misplaced. In many cases, employees keep sloppy records or fail to follow proper procedures, resulting in “missing” inventory. For example, a company without a location assignment for each item, which can be an effective method of keeping tabs on overflow stock and returns, is likely to misplace inventory.

If there’s no innocent explanation for missing inventory, then the fraud expert looks for signs in the environment conducive to fraud. For example, a company with poor internal controls over purchasing, receiving and cash disbursements is at high risk of inventory theft. In addition, one person performing multiple duties within any one area of the Company can easily commit and conceal fraud.

If the expert believes inventory could have been stolen, he or she combs the records for clues. Anything that doesn’t follow established inventory procedures could be a red flag — such as odd journal entries posted to inventory, large gross margin decreases or sudden problems with out-of-stock inventory.

Exposing irregularities
Next, the expert works to prove the fraud. Inventory fraud may leave a paper (or electronic) trail, so forensic accountants typically review journal entries for unusual patterns. An entry recording a physical count adjustment made during a period when no count was taken obviously warrants investigation. The expert follows up by tracing unusual entries to supporting documents.

Vendor lists also may show suspicious patterns, such as post office box addresses substituting for street addresses, vendors with several addresses, and names closely resembling those of known vendors. Even if they’ve found no evidence of nonexistent vendors, fraud experts look at vendor invoices and purchase orders for anomalies such as unusually large invoices or alleged purchases that don’t involve delivery of goods.

Discrepancies between the amounts due per invoice, the purchase order and the amount actually paid warrant investigation. Finally, experts familiarize themselves with the cost, timing and purpose of routine purchases and flag any that deviate from the norm.

Catching the thief
Although a count performed by employees may disrupt normal business routines, it’s an effective way to learn exactly what merchandise may be missing — and could lead directly to the thief (unless the thief is involved in the physical inventory count!). Fraud experts sometimes recommend hiring an outside inventory firm to perform the count and value the inventory.
Whether employees or inventory specialists perform the job, a fraud expert carefully observes warehouse activity once employees realize a count is imminent. Thieves may attempt to shift inventory from another location to substitute for missing items they know will be discovered.

It’s important to confirm physical inventory as well.  Inventory at remote locations also can disappear, so fraud experts often will confirm quantities with the storage facility or go with the client to inspect them personally. Whenever possible, it’s best to perform a count in person rather than delegate the job to someone who may not be trustworthy. Unfortunately, sometimes it’s theft. But now you have the knowledge and evidence to address the issue appropriately.

The best advice is, “Don’t go it alone.” Contact Ciuni & Panichi, Inc. Certified Fraud Examiner, Reggie Novak, CPA, at 216-831-7171 or rnovak@cp-advisors.com.

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