Chapter 8
Inventory Valuation
243
Who Commits Fraud andWhy?
Companies need to know the kinds of inventory fraud that can be perpetrated and understand who
would be most likely to commit fraud.
Inventory fraud from the top down
Various methods are used to pad a company’s inventory value. One method is to overstate the value
of items deemed obsolete, shop-worn or generally unsaleable.This would overstate the overall value
of inventory. Similarly, various overhead costs can be attributed to inventory.These figures can also
be manipulated in a way that affects the company’s bottom line. In addition, a manufacturer might
be tempted to overstate the completion of work-in-process inventories and, again, pad the value of
its inventory.
Generally speaking, these kinds of attempts to pad inventory numbers tend to come from the top.
Unlike determining fixed costs such as rent, determining inventory costs is a more subjective
exercise. Accountants and executives can abuse the subjectivity involved in some of these decisions
and errors can be rationalized as a matter of opinion.
Abuses can be avoided by establishing specific policies and guidelines for handling and valuing
inventory. Controls should be in place to ensure that these policies are being followed. Companies
can also have both internal and external auditors review the design and effectiveness of inventory
controls and detect any possible ethical breaches.
In the end, management is responsible for any errors arising from the way its financial situation is
reported.There is no excuse for manipulating the value of inventory. Any wrongful reporting should
be dealt with at the earliest opportunity.
Inventory fraud from the bottom up
Lower-level employees and thieves can also create havoc with inventory.Their motivation is often
associated with greed.
Inventory items are goods that have value and that people want to buy. That is why companies
purchase these items and eventually sell them. People who have routine access to such items, such
as employees, might be tempted to take them without paying for them. Alternatively, an employee
might take funds from the company, buy the inventory, then
resell it and pocket the profits. Even borrowing an item without
permission, such as a car on a sales lot, is theft, and needs to be
prevented.
There are red flags that help a company monitor and prevent
inventory shrinkage. One such red flag occurs when sales lag
inventory levels. In other words, the company is buying more
than it is selling. Some of that inventory is obviously not going
to the customer. Another potential inventory red flag occurs
Some forms of inventory fraud originate from
the executive level. Ethical guidelines are
needed that detect wrongdoing at any level
of the company.
