Businesses and government agencies worldwide suffer hundreds of billions in lost or misused funds, diminished value, and irreversible damage to company reputation and customer trust. Making matters worse and no thanks to the economic downturnmany organizations have been forced to cut staff, freeze spending and skimp internal control and process assurance, which has left organizations more vulnerable to risk and fraud. The focus on fraud detection and prevention is shifting increasingly to internal audit departments.
It is usually the largest dollar value asset of retail businesses and a large portion of the asset value of manufacturing businesses. Most non-service businesses have at least some level of inventory or supplies on hand. The theft of physical assets is common.
One common target of these thefts is inventory items, as inventory items can numerous; can be of small value; may be readily accessible and removable; may not well protected; and may not be immediately missed, if missed at all. Although this paper describes the theft of inventory, the same type of fraud may be undertaken with other physical assets used in a business.
In these cases the same type of purchase order documents are manipulated. How is the fraud done? Stealing inventory items can be easy. Any lack of physical security contributes to the theft of inventory, by both employees and non-employees.
If items are openly available to any employee without authorization or requisition, inventory will be susceptible to theft. But these items need to be freely available to salespeople in most retail businesses.
Manufacturing businesses also need easy access to materials to work efficiently. Leaving inventory items unsecured during and after business hours provides the opportunity for theft.
After-hours access provides the opportunity for employees to not only take assets, but also the time to manipulate the business records to hide the loss without other people present. Physical security limits this opportunity.
If the employees cannot physically access and remove inventory items, avenues for losses from fraud are limited. Hiding the theft of inventory in the business records is the more difficult part of the fraud.
If the theft is a one time event, the employee may not attempt to hide the theft. Depending on the type of item stolen, they may leave the loss to be noticed at the next time stock-take believing that the loss will not be able to be traced back to them.
If the employee wishes to continue the thefts over a period of time, they will probably need to hide the losses. How the loss is hidden specifies which type of fraud has been committed.
Once inventory has been stolen, the loss should show up in the perpetual inventory records during the next stock-take. The records must be altered to hide the loss. Sales and purchases frauds rely on the theft of the items being hidden by the falsification of sales and purchases records through one of these methods:Financial Fraud.
Inventory fraud can be committed through financial statement manipulation. This includes timing schemes, expenses recorded as inventory, and valuation schemes.
This type of fraud is usually implemented by senior management and is motivated . Fraud prevention starts with a management team committed to a culture of honesty and integrity. They institute a formal code of conduct with a strong, unfailingly enforced policy on fraud.
An active training program ensures employees understand fraud, its impact on the company, and the seriousness with which management takes the matter.
Financial Fraud. Inventory fraud can be committed through financial statement manipulation. This includes timing schemes, expenses recorded as inventory, and valuation schemes. This type of fraud is usually implemented by senior management and is motivated by the need to attain some financial goal or benchmark.
Most fraud goes undetected. Of reported instances, the ACFE reports median losses equal to $, with the underlying behaviors in effect for 18 months before detection.
Beyond direct financial loss, fraud damages the company’s reputation. It may hinder its ability to attract and retain business partners, customers, and employees. The cost of ineffective inventory controls and internal fraud can have a significant impact on businesses' bottom line. U.S.
companies lost $ million on average to fraud in , according to PricewaterhouseCoopers' biannual survey of . The impact of inventory fraud can be expensive and affect an organization’s reports.
Inventory errors will not only affect the balance sheet but the income statement as well. Errors from theft or fraud within the physical inventory will misstate the costs of goods sold, gross profit, and net income.