Businesses with a manufacturing component can be particularly vulnerable to non-cash schemes, such as inventory theft. In honor of World Chocolate Day, July 7, a real-life case of inventory theft at a chocolate manufacturer provides an in-depth look at inventory theft in manufacturing.
The case, initially described by the Idaho Society of Certified Public Accountants (ISCPA), involved a trusted, long-time employee stealing approximately $200,000.00 of inventory from a family-owned luxury chocolate manufacturer. While identifying details were removed from the story, it serves as an illustrative example of a complex inventory fraud scheme.
Inventory theft is classified as a non-cash fraud scheme—the second most common type of fraud, according to the Association of Certified Fraud Examiners’ (ACFE) Report to the Nations on Occupational Fraud and Abuse. Their report suggests that approximately 20% of all fraud schemes can be categorized as non-cash fraud.
The company’s owner and general manager – a member of the company’s founding family – relied heavily on the company’s purchasing and production manager, who was held in high regard after 30 years with the company.
Production of the company’s signature chocolate bars was divided between two teams: a warehouse team that received and processed raw materials and a production team that created and packaged the chocolate bars. The company’s production manager oversaw the entire process, including coordinating with the small team of delivery drivers.
As the only employee with access to the entire system, the production manager concocted a scheme in which he would misrepresent production totals in the inventory system and give unrecorded inventory to his co-conspirator, one of the delivery drivers. The driver would load the unrecorded chocolate bars into his truck alongside his scheduled deliveries and independently sell the misappropriated treats.
The scheme began to unravel when the company’s accounting manager was preparing her quarterly report and a production team member’s reported production for the day did not match the number recorded in the system. Over the next few days, the accounting manager confirmed consistent discrepancies between the actual and reported totals. When she reported her findings to the production manager, he assured her his entries were correct.
Suspecting a member of the production team was stealing the missing inventory before it could be counted by the production manager, she brought her concerns to the owner. The owner hired a fraud investigator who recommended the owner conduct a surprise inventory count before the delivery trucks left. When the count revealed untracked boxes in one of the trucks, the driver admitted to his role in the fraud scheme and described how the production manager would omit several boxes from his counts and the two would share the proceeds from their misappropriated inventory. Over the three-year duration of their scheme, the two stole an estimated $197,000.00 in chocolate bars.
While the co-conspirators were fired and had agreed to pay for the inventory they stole, the company was not able to recover the money.
Lessons in Preventing Inventory Fraud
- Separate supervisory duties to create layers of oversight throughout the manufacturing and shipping process.
- Compare the actual output to standard output (what the annual output should be, based on materials and labor). This production efficiency metric can indicate potentially stolen or missing inventory.
- Measure and review department-specific KPIs to quickly notice and pinpoint inconsistencies.
- Implement surprise inventory counts to deter potential fraudsters and catch fraud that has circumvented regular controls.
- “Smart” production machinery can directly report totals of materials consumed and units produced. These automatically generated totals can eliminate the vulnerabilities of manual reporting.
It takes active effort and controls to protect inventory, deter fraudsters, and reduce losses to fraud. In this case, the chocolate manufacturer received a $200,000.00 lesson on the danger of complacency.