An unfortunate fact of the business world is that some companies use their inventory systems to commit fraud. Although this can involve the deliberate theft of inventory, it is even easier to artificially inflate or deflate a company’s reported profits without laying a hand on the inventory. This can be done through the alteration of costing records, bills of material, the item master file, and the contents of overhead cost pools, as well as by changing the costing methodology used. In this post, we explore who usually commits inventory fraud, the various types of inventory-related fraud that can be perpetrated, and how it can be prevented (This post can be combined with the inventory control systems I have posted for better picture of how fraud is caused and can be prevented).

Advertisement

Warning!:

  1. This post is not going to talk about inventory theft, you know how and what to do with inventory theft. It is rather about inventory fraud in many ways and form that clever (yet, naughty and bad management people) may override to cheat the other board member or stakeholders.
  2. This is not about some law speeches, it is not about fraud concept and theories. It is about real techniques for real problem on real inventory cases that you can copy and duplicate for your own cases.

 

Next, we are going to discuss these inventory common fraudulences and each techniques you can apply for each. But, you know, due to the traffic increase. I will breakdown this topic to become some post series maybe three or four post. There shouldn’t be a problem. You only need to follow the link (I am going to provide it on every bottom of the post) will lead you to the related topic may worth reading for you. So read on…………

 

Who Commits Inventory Fraud?

Inventory-related fraud is usually instigated at the management level. The reason is that when managers are compensated based on the profitability of the company as a whole or of their individual business units, they have an incentive to stretch reported results. The problem is exacerbated when a disproportionately large part of a manager’s potential income is based on “stretch” profitability goals that can only be achieved through inordinately great efforts. The reverse situation may also be true for privately held companies that are more concerned with the avoidance of taxes; these organizations may reward their managers based on their ability to improve cash flow while holding down the amount of reported profitability. In either situation, the level of fraud initially committed is relatively minor—perhaps a slight adjustment to income that results in a small change in income, but enough to reach a performance goal. However, that small step into the realm of fraudulent behavior makes it easier to make a larger adjustment in the next reporting period, and so on.

Soon, a manager is incorporating fraudulent actions into his or her daily activities and develops a range of activities that will result in skewed financial results. The simplest detection approach is to create a trend line of all major cost categories, inventory levels, and cost allocation pools, and simply trace the levels of the items from as far back as possible, right up to the present day. Because these costs rarely change, either in total or in proportion to each other, variations will reveal the presence of a tampering manager. The level of work required to keep track of this information is minimal, so even a reduced accounting staff or one whose activities are being deliberately forced in other directions should still be able to find the time for such rudimentary analysis. The real problem is that, once detected, the very people who should be acting on the information to prevent fraud may be the ones creating it. If so, consider forwarding the information to the corporate audit committee for further action.