By D.M. Studler
Complex production processes, varied
accounting methods and the sheer volume of items make it difficult to measure
inventory accurately. As a result, many
companies experience inventory shrinkage, or a discrepancy between recorded
inventory and actual inventory.
One common reason behind inventory
shortages is miscalculating the amount of
inventory used. For example, an ice cream
shop might think it can dip 100 cones in
a can of chocolate, but it actually got 95
cones out of the last can and 85 from the
one before that. Unless the shop keeps
historical data on its chocolate usage, its
inventory count likely won’t be accurate.
Data entry and human errors, includ-
ing coding items incorrectly, paying a
vendor invoice twice or overshipments to
customers account for many other short-
ages. A thorough review of a company’s
books and its physical inventory will of-
ten uncover the problem.
While inventory discrepancies are often the result of honest mistakes, fraudulent schemes also abound. One common
scheme involves “ghost inventory,” where
an employee pays for fictitious orders that
are never delivered. Other schemes involve falsifying physical inventory quantities, including consigned inventory in
total values, and failing to write down
Before investigating a claim, ask the
company to explain its recording methods
so you can note anything unusual. Some
companies use a periodic system where
they record inventory changes at the end
of an accounting period, while others use
a perpetual system, recording changes
continuously. Watch for any abnormal in-
ventory shrinkage or a pattern of shrink-
age in one department or location.
Other red flags to look for include
slowing inventory turnover, inventory
increasing faster than sales, and shipping
costs decreasing compared with inventory volume. Changes to gross profit margins, or the gross profit divided by sales
are another reason for suspicion – an unusually high figure could indicate overstated inventory, while a low margin may
indicate inventory theft. Unusual book-keeping entries, such as round figures or
credits in the purchases section, can also
signal that something is amiss.
When working with companies to resolve their loss claims, encourage them
to improve their reporting. Inventory
management software, which tracks average turnover, top-selling items and other
critical information, can help businesses
get a handle on their books.
Reducing inventory is another way to
minimize claims as well as cut inventory-related costs. Many companies realize savings by adopting Just-In-Time inventory
management practices, where they order
materials as needed instead of hanging
onto them for months. Tighter controls
are another important deterrent against
inventory losses. Companies should ensure that the person recording a transaction isn’t same person who processes it and
limit asset access to necessary employees.
Whether a company’s loss claim is
the result of a pilfering employee or just
sloppy data entry, understanding how the
organization’s inventory works and ensuring it is recorded accurately can help
avoid similar issues in the future.
D.M. Studler is the founding member
and managing officer of SDC CPAs
LLC, a global investigation and
forensic accounting firm. Contact her
Is it fraud? Alternate causes
for inventory loss claims
While fraud may be your first thought when a business files an inventory loss claim, it isn’t always the culprit behind missing items.