Inventory is usually the largest dollar-value asset of retail businesses and a large portion of the asset value of manufacturing businesses. Even service businesses have some assets or supplies, and this inventory may be stolen.
The theft of physical assets occurs in about 16% of all occupational frauds, and the losses can be significant. The most common assets stolen are inventory items, as they can be numerous, of high value, easily accessible and removable, not well protected, and may not be immediately missed, if at all.
A lack of physical security may make stealing inventory easy. But in most retail businesses inventory items need to be freely available to salespeople in order for them to do their jobs, and manufacturing businesses need easy and efficient access to materials. If items are openly available to any employee without authorization or requisition, inventory will be susceptible to theft.
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. 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 difficult part of any inventory fraud. If the theft is a one-time event or if the record keeping process is not strictly enforced, the employee may not even attempt to hide the theft. Depending on the type of item stolen and the type of business, they may leave the loss to be noticed at the next stock-take. But if the employee wishes to continue the thefts over a period of time, they will need to hide the losses. How the loss is hidden determines which type of fraud has been committed.
Generally inventory frauds are grouped into:
(i) Inventory Record Frauds; and
(ii) Sales and Purchases Frauds
Inventory Record Frauds
Inventory record frauds involve hiding the theft by directly manipulating the perpetual inventory records. These frauds can be hidden through:
- False Write-offs
- False Stock-takes
- Falsified Perpetual Records
- False Receiving Documentation
False Write-offs
This fraud is done by writing off stolen inventory as scrap or similar, causing an alteration to the inventory records so that they coincide with actual inventory levels. A stock count should then show the 'correct' number of items and the loss will not be noticed. The benefit is that the cover up is permanent - once an item is written off, it is written off for good.
This fraud generally requires access to the inventory records (see below) or the power to authorise the write-off. If the employee does not have that authority, they still may be able to falsify a write-off authorization and have the entry made in the perpetual records, or convince the person with that authority that the item was scrapped.
Businesses may have systems for reworking or reusing items, returning them to suppliers or selling them for scrap value. Without these systems being enforced, anyone with the authority to write off inventory, or able to convince that someone else to write it off, will be able to misappropriate inventory and hide it.
False Stock-takes
The stock-take process compares stock counts to perpetual inventory records. It matches what is there with what should be there. An alternative to falsifying perpetual records (what should be there) is falsifying the stock count (what is there). The physical count is simply adjusted during the stock-take process to match the level of stock in the perpetual records.
This is one of the simplest methods of hiding losses of stock, but can only be done if the employee performs the count or has access to the count sheets before they are compared to the perpetual records.
But adjusting stock counts is only a temporary fix. The perpetual records are not adjusted to the actual level of inventory. The next stock count will also have to be falsified, but that next stock-take may be up to 24 months after the theft occurred and the trail to the employee would then be cold. If stock takes are only an annual event, hiding the loss once will usually protect the employee, even though the loss may eventually be noticed.
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