Because inventory fraud is often more difficult to prevent and detect than other asset thefts, fraud examiners need to understand the mechanics of inventory accounting and the signs of overstated inventory schemes.
The metal bands were a dead giveaway to the "Asset-Based Lender" (ABL) auditors. Computers are never shipped on pallets secured by metal bands. ABL's quick check of the boxes revealed nothing but air instead of the $4 million in inventory that helped collateralize the customer's $7 million working capital loan.
ABL's customer, a mid-size retailer of computer hardware, had attempted to dupe the auditors. Our CPA firm's job was to discover the truth and, of course, find the cash.
We discovered that the hardware company was losing money by selling its products at near break-even and the financial statements were fictitious.
Eventually, our examination would find some of the proceeds anchored off Ft. Lauderdale in the form of a 110-foot yacht, complete with a full-time crew. Yes, the company owner was enjoying the high life at the lender's expense.
Inventory fraud is a significant problem for many businesses. This fraud is often more difficult to prevent and detect than other asset thefts because of a large volume of items in inventory, the number of employees with access to assets, complicated processes involved in production, and the many entries and complex systems used to account for the inventory and the production process.
A Lesson in Inventory Accounting
The fraud examiner needs to understand how inventory is accounted for and valued in an organization before attempting to spot or investigate an overstated inventory scheme.
Generally Accepted Accounting Principles (GAAP) define inventories as:
Those items of tangible personal property, which are held for sale in the ordinary course of business, are in the process of production for such sale, or are to be currently consumed in the production of goods or services to be available for sale.