Fraud Schemes: Inventory (#245)
/In this podcast episode, we discuss fraud schemes relating to inventory. Key points made are noted below.
Theft of Inventory at Receiving
The intent behind inventory fraud is to steal the goods and then sell them, though a person might want to keep stolen inventory for his personal use. One approach to stealing inventory is right at the receiving dock. It usually doesn’t make much sense for a receiving person to steal a box right there at the dock, walk it out to the parking lot, and dump it in the trunk of his car. That’s not entirely subtle. A more discrete way to do it is to come to an agreement with the delivery person who’s bringing goods to the receiving dock. Have that person park somewhere out of the way and extract the goods in private, and then deliver the rest of the goods in the normal manner. The receiving person signs off on the full amount stated on the packing slip, so the company pays for the full amount. The delivery driver and the receiving clerk then split the proceeds from the sale of the inventory.
This scheme falls apart when the warehouse staff keeps finding shortages in the received goods that they’re putting away in the warehouse. To find out what’s going on, they can trace missing inventory back to the person who signed for the goods. However, if the receiving clerk is clever, he’ll forge the signatures of other people in the department on the receiving documents, which muddies the water.
Quality Assurance Collusion
Another possibility is when a warehouse clerk colludes with someone in the quality assurance department. The quality assurance guy can designate inventory as not meeting quality standards, so it has to be scrapped – even though it’s actually good product. The warehouse person then intercepts the inventory and records it as having been scrapped. This approach can result in some pretty significant losses. It’s especially possible when there really are quality problems, so some stolen goods can be slipped in with all of the other quality issues being reported.
Finding this kind of theft calls from some trend analysis. See if there’s been a spike in the amount of scrapped inventory lately. And as usual, see if most of the scrap designations can be traced back to one person.
Accounting Department Collusion
Another form of collusion is for someone in the accounting department to create credit memos for supposedly returned goods from customers. The accomplice in the warehouse then writes off the supposedly returned goods as being damaged, and steals them. This approach will cause a spike in the amount of returned goods, which would hopefully trigger an investigation by the product design staff, to see what’s wrong with the product. Another indicator is that the credit memos will appear in the customer receivable records, which might prompt some questions from the customers.
Order Entry Clerk Collusion
Another collusion scheme is for an order entry clerk to enter a fake sales order into the system that triggers a shipment to an address where the inventory can be redirected. If a billing clerk is in on the scam, no invoice is ever logged into the accounting system, so there’s no record of a sale. Of course, the shipment is still listed in the system, so a reconciliation of shipments to billings would spot the missing invoice. So all of these are collusion schemes.
Theft from the Warehouse
It’s also possible to simply steal inventory items right off the shelf in the warehouse. A warehouse person can cover his tracks by writing off these items as being damaged and thrown out, or just inventory counting errors. This is really easy, and it’s tough to spot, especially if the warehouse staff is careful, and only steals a few items at a time. This doesn’t mean that detection is impossible. You could track who is entering write-down transactions in the inventory database, though – again – a warehouse person could log in as several different people to record the transactions. Another option is to put video recording equipment in the warehouse, though that can get somewhat expensive.
And along the same lines, even more opportunities are available if the company has overflow inventory that’s stored in trailers near the warehouse. In this case, an employee can break the lock and make off with the inventory, without bothering to hide the theft with some paperwork shuffling. Since the inventory was taken from a location outside the building, the theft could be blamed on an outsider.
Scrap Payment Theft
But that’s not all. Some inventory really is scrapped, and it’s thrown into a bin, which is picked up periodically by a scrap dealer. The dealer may pay cash on the spot, in which case anyone – but probably someone in authority – intercepts the cash, so it never appears in the accounting records. This is really easy to do, since scrap is maybe the least controlled asset in a company.
You can get rid of this problem by having the scrap dealer only pay with a check, which it sends to a bank lockbox. Doing so keeps the cash off the premises. Another option is to set up a pickup schedule for the scrap dealer, so you know when to expect a payment. And yet another option is to track the amount of these payments on a trend line, to see if the total amount is declining, or there are gaps in the payments.
Indicators of Inventory Fraud
So, what are some of the signs that inventory fraud is occurring? One item is that inventory count variances are always unfavorable – which means that you’re always writing off inventory as the result of a count. With normal inventory counts, there’s more likely to be a mix – a few items are written up, and a few are written down.
Another sign is that inventory-related documents keep disappearing. There may be missing packing slips, or shipping receipts, or physical count sheets. If so, employees are stealing the documents to hide their thefts.
Yet another sign is that the signatures or initials on inventory-related documents are completely illegible. Now, some people just write that way, especially when they’re in a hurry. But when lots of documents have illegible scrawls on them, it’s possible that one person is fudging the signatures of multiple people.
And here’s another one. Employees in the warehouse are always bringing baggage into the building. Sure, it could be their lunch, but what if there’s enough room in there to jam in some inventory?