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Understanding Inventory Fraud: Part 2


Protecting your company’s inventory involves more than just guarding against physical theft. While setting up controls to prevent traditional inventory theft is important, it’s just as crucial to monitor and implement controls for your company’s inventory record-keeping. If your company is a retailer, manufacturer, or other inventory-based business, taking steps to prevent fraudulent inventory accounting is a must.


Why It Happens

This type of fraud commonly hides inventory theft, but covering up an inventory disparity isn’t the only motive for this crime. Dishonest management or accounting staff may manipulate inventory records in order to disguise or fund another scheme, such as reporting fictitious sales, skimming funds, tax fraud, or overstating earnings to deceive lenders or stakeholders.


How It Happens

The way a dishonest employee commits inventory fraud depends on the scheme being committed and the individual’s access to the inventory system. Common methods include:

  • Falsifying inventory counts or inflating values
  • Failing to report new inventory
  • Completing phony write-offs
  • Failing to write off inventory when needed
  • Changing existing entries


Looking into possible fraud in your inventory system isn’t as straightforward as investigating regular theft. A midsize company may see thousands of entries in its perpetual inventory system each year, and these transactions sometimes include subjective estimates that make it harder to detect fraud than in other types of accounting. Also, when numerous employees are involved in the reporting process, whether directly or indirectly, it can be difficult to pinpoint the source of suspicious activity.  


Strengthening Controls

Middle-market executives can follow these steps to boost transparency, accountability, and accuracy in their company’s inventory management:

  • Require secondary authorization for entries with insufficient information
  • Use a third-party service for periodic inventory counts
  • Maintain a strict authorization policy for write-offs and other inventory updates
  • Create a clearer separation of duties to increase accountability
  • Regularly match your COGS to sales data, your shipments to sales invoices, and supplier deliveries to inventory counts


Investigating Possible Fraud

Routine changes, such as overhead allocations, inventory value adjustments, and write-offs of lost, damaged, or obsolete inventory, make it hard to distinguish ordinary fluctuations from deliberate manipulation. Because investigating inventory fraud is a complex process, consider hiring a forensic accountant to review and verify inventory documentation and collect the evidence needed to put a stop to this crime.

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The information contained herein is for general informational purposes only and does not constitute tax, legal, or business advice.