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Fraud Watch: Beware of Shrinking Inventory

Marcia Collins
Jul 1, 2008

This is the third of a four-part series discussing areas of your business you can examine to determine whether fraud is taking place.  Part one covers using your computer to help detect fraud, part two discusses holes in your accounting software and part four discusses how to keep your finger on the pulse of your company.

Times are tough, and you may find an otherwise beloved employee stooping to a new level of desperation. If you sense that your inventory is shrinking, you may be the victim of one of the fastest growing areas of occupational fraud.

With the popularity of online auction sites like eBay, perpetrators can sell stolen goods from the comfort of their home or workstation, without a trip to the pawn shop. In fact, the Internet has opened a new frontier of opportunity for the fraudster. Inventory items that were once considered safe from theft because they could not be easily converted to cash – items like bricks, machine parts and motors – can now be sold to the highest bidder even before the item is removed from the property.

Here are a few steps you should take to protect your inventory:

Restrict Access

Proper inventory control begins with access restriction. Only the employees that need access to the inventory area to perform their job duties should be allowed in inventory storage areas. In order to limit access:

• Keep inventory out of the main work and traffic areas of the building. If the inventory warehouse is off the beaten path, only employees that work in the area should be there. No excuses, no exceptions.
• Secure the inventory at its entrance and exit points. Use any combination of locked doors, electronic key card readers, surveillance cameras and security personnel. Even if the inventory is kept away from the main areas of the building, the motivated fraudster will still find an excuse to enter these areas – so security is important.
• Conduct occasional surprise inspections of personal items at the end of the work day as allowed by company personnel policies or union contracts, especially if your inventory consists of small, expensive items. Lunch boxes, purses and computer bags are ideal for transporting stolen inventory off the premises. Use this method sparingly, though, to maintain positive employee morale and labor relations.

Maintain Accurate Accounts

The second critical area of inventory control is accuracy. An inventory area that is famous for being disorganized is easy prey for the employee fraudster - after all, management usually chalks any inventory shortage up to another error by the "guys in the back."

The key components of inventory accuracy are:

• Accurate counts when items are received into inventory. Count the items and make sure what you receive matches the packing list. Then ask an employee who is familiar with inventory components to enter the items received into the perpetual inventory system. If you don't enter the inventory into the perpetual inventory system correctly when it arrives, the perpetual inventory will truly be "garbage in, garbage out."
• Accurate counts when items are relieved from inventory for release into production or shipment to a customer. The items pulled from inventory should be counted at least twice by two different employees. The description of the items being shipped should match the packing slip or sales order to determine that the correct items are being shipped.

Identify Inventory Properly

The final critical area of inventory control is the proper identification of obsolete and scrap inventory. There have been countless fraud schemes centered on the "disposal" of "obsolete and scrap" inventory that is later pulled from the trash by the fraudster.

Proper procedures for the disposal of obsolete and scrap inventory should include:

• Review and approval of all items identified for disposal. This should be handled by a member of management who is familiar with the various components of the inventory, as well as one who is independent of the inventory yet familiar with the financial impact of the disposal. This ensures that all aspects of the disposal have been reviewed and considered.
• Recount and review all items at the time of actual disposal to determine that only those items are being disposed. There are countless stories of good and valuable inventory items being mixed in with scrapped and obsolete items at the time of disposal.
• Analyze all items to determine if they could be sold for scrap value before being thrown away. There are some items that have more value in their recoverable components then they do as whole and salable items. For example, any item that has been in inventory for more than 18 months and contains copper or platinum is probably worth more as scrap then as a complete item sitting on the shelf awaiting sale.

By implementing the above key components of inventory control, you can better safeguard your inventory from employee theft. Remember that no system is completely foolproof, but by improving your company's inventory controls, you can make the fraudster's job a lot more difficult.

This article was originally published in The Rea Report, Summer 2008 issue.

Note: This content is accurate as of the published date above and is subject to change. Please seek professional advice before acting on any matter contained in this article.

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