Is Your Inventory Missing — Or Stolen?
For many businesses, such as retailers, manufacturers, and contractors, strict inventory control is central to operations. If you don’t track inventory accurately, you cannot effectively produce goods, meet customer demand, and realize profits. During your year-end inventory count, you unexpectedly find that stock levels are lower than anticipated. Have you miscounted or have the items been misplaced? Or has someone stolen inventory? A professional fraud expert can help you get to the bottom of such discrepancies.
Assuming an Innocent Explanation
Before assuming theft, experts investigate whether missing inventory items were really stolen. Employees might have kept sloppy records or failed to follow proper procedures, resulting in “missing” inventory. For example, a company without a location assignment for each item, an effective method of tracking overflow stock, and a well-run returns system can easily misplace inventory.
If there is no innocent explanation for inventory shrink, the expert next looks for signs that the environment is conducive to fraud. These might include:
Poor internal controls for purchasing, receiving and cash disbursement,
Reliance on one worker to perform multiple inventory duties, and
Weak management oversight of the inventory function.
If the expert believes inventory could have been stolen, records will generally be combed for evidence. Anything that does not follow established inventory procedures — such as large gross margin decreases — could be a red flag.
Finding Fraud Evidence Where Red Flags Fly
Inventory fraud may leave a paper or electronic trail, so fraud experts typically review journal entries for unusual patterns. An entry recording a physical count adjustment made during a period when no count was taken warrants investigation. An expert might then trace unusual entries to supporting documents.
Vendor lists also could show suspicious patterns, such as post office box addresses substituting for street addresses, vendors with several addresses, and names closely resembling (but different from) those of established vendors. Even if they find no evidence of fake vendors, fraud experts usually look at vendor invoices and purchase orders for anomalies such as unusually large invoices or alleged purchases that do not involve delivery of goods. They also familiarize themselves with the cost, timing, and purpose of routine purchases and flag any that deviate from the norm.
Confirming Physical Inventory
It is important to confirm physical inventory as well. A fraud expert sometimes recommends hiring an outside firm to perform a count and value inventory to minimize risk that the fraud perpetrator will be on the team.
Whether employees or inventory specialists perform the job, fraud experts carefully observe 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.
Automating Your Inventory
To help prevent inventory shrink by employees and other parties, automate your inventory control. If you do not already use it, know that the technology is relatively affordable (even for small businesses), and that it costs much less than potential fraud losses.
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Disclaimer of Liability
Our firm provides the information in this article for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisors. Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this blog are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability and fitness for a particular purpose.
