Inventory in transit is an area that is customarily ignored by control system designers, because they tend to think only in terms of on-site inventory. However, this can be a major problem area if the terms of inbound or outbound shipment specify that the company retains ownership of the goods either before or after its arrival at or departure from the company premises. Thus, the key control issues include identification of the ownership of any in-transit inventories, mitigation of ownership risk, and inclusion of owned in-transit items in inventory valuations. The following controls address these issues:
Record inter-company inventory transfers in a central inventory database. If a company shifts inventory from one subsidiary to another, it is possible that the inventory will not be properly relieved from the shipping entity or added by the receiving entity, either of which can cause unit record error. In addition, the receiving entity may record the inventory at a different cost than the shipping entity. Both problems can be resolved by recording inventory transfers in a central inventory database that is used by both subsidiaries. However, these central databases are expensive to purchase and maintain, and also require reliable online access by multiple locations.
Audit both sides of all inter-company transfer transactions. As just noted, both sides of an inter-company inventory transfer can incorrectly record the transaction, resulting in incorrect consolidated financial results. One way to detect these issues after the fact is to regularly schedule an internal audit review of both the shipping and receiving transactions associated with a sample of inter-company transfers. These reviews should result in recommendations to alter the recording system to eliminate errors.
Require a customer signature on every bill-and-hold document. If a company builds products but does not ship them, it can still claim revenue under the assumption that customers have authorized the company to store the units on their behalf. This approach can lead to significant abuse of revenue recognition, so a good control is to require all customers to sign a bill and hold transaction approval document. This document states that customers have authorized the off-site storage and accept ownership of the goods.
Audit shipment terms. Certain types of shipment terms will require that a company shipping goods must retain inventory on its books for some period after the goods have physically left the company, or that a receiving company record inventory on its books before its arrival at the receiving dock. Although in practice most companies will record inventory only when it is physically present, this is technically incorrect under certain shipment terms. Consequently, a company should perform a periodic audit of shipment terms used to see if any deliveries require different inventory treatment.
Policy to prevent in-transit ownership. The easiest form of in transit inventory to control is when a third party owns it until it arrives at the company’s receiving dock. To do so, have senior management approve a policy preventing any other type of shipping arrangement, and communicate this policy to the staff through a policy and procedures manual, as well as through periodic refresher training.
Verify existence of insurance coverage for owned in-transit goods. If a company legally has title to in-transit goods, there is a risk that damage to those goods while in transit will result in losses to the company. Thus, the internal audit program should include an annual review of the existence and adequacy of insurance coverage for owned in-transit goods. A more passive control is to also include this requirement in a procedure listing all insurance requirements to be covered as part of the annual insurance renewal process.
Enforce rapid completion of financials. A common problem is pressure on the accounting staff to delay the month-end cutoff date, thereby allowing the shipping department to pack a few more deliveries into the reporting period to increase revenues. This is an ongoing battle that never really goes away. An excellent control over the issue is to get management so used to receiving financial statements within one day of month-end that they tacitly approve of a stringent cutoff in order to obtain the financials as fast as possible.
Compare shipping log dates to shipper documentation. A good way to detect an extended period-end cutoff is to compare the shipment date recorded in the corporate shipping log to any shipper documentation on which the shipper records the actual date on which it accepted the goods for delivery. If the shipping staff knows this audit will be conducted, they will be less inclined to stuff more shipments into the reporting period with an extended cutoff.
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