There's More to Inventory Losses than Invoices!

by Chad Thompson

Inventory loss claims are often pegged as the easiest and most straightforward of all commercial claims. An inventory loss seems clear cut: the business had some inventory, a theft or damage occurred, and now some inventory is gone. Physical damage is easy to observe, as is evidence of forced entry. Thus, out of the gates, inventory losses are a matter of documenting what did happen. Compare this to income losses, where the focus is on what didn’t happen (the company didn’t have sales; the company didn’t pay certain expenses, etc). So by that measure, inventory loss claims do seem tame. However, when done correctly, just about any forensic accountant will tell you that inventory losses are indeed the most complex claims to corroborate.

I’ve been involved in hundreds of inventory loss claims. While each one was different in its own right, a common thread runs between most of them: Invoices! I’m always surprised at how some in the claims process treat invoices as the Holy Grail. The truth is, invoices play only a small role in substantiating the loss.

To prove and quantify an inventory loss, the following is required:

  1. Prove that the business acquired legal title to the inventory.
  2. Prove that the items were on hand and not sold, immediately prior to the theft.
  3. Prove the items were stolen, meaning they were not on the premises immediately after the theft.
  4. If 1 through 3 is proven, prove the items did not perish through “shrinkage” rather than theft.
  5. Prove the value of the inventory (ACV or replacement cost).

So we have five elements to prove an inventory loss. Where do the invoices come into play? Let’s take a look:

 

Element

Do invoices help?

Comments

Prove that the business acquired legal title to the inventory.

 

Yes.

(one for one, eh?)

Invoices will show the company purchased the items in question, or routinely makes purchases of similar items. Important also is that the invoice will show the delivery address. This becomes an issue for businesses with multiple locations.

Prove that the items were on hand and not sold, immediately prior to the theft.

No.

This will take a detailed analysis of accounting reports and ledgers for purchases and sales.

Prove the items were stolen, meaning they were not on the premises immediately after the theft.

No.

This will entail a post-loss physical inventory. Absent that, significant analytical procedures are needed of post-loss sales, purchases, turnover ratios or purchase ratios. A true accountant’s dream.

If the above is proven, prove the items did not perish through “shrinkage” rather than theft.

 

No.

This will take an analysis of prior book-to-physical adjustments, a study of industry standards, or a combination of both.

Prove the value of the inventory (ACV or replacement cost).

 

Yes (to some degree).

Depending on the age of the inventory, there may be notable price appreciation or depreciation since the original purchase, as in the case of  copper, silver or gold. If so, documentation other than original purchase invoices is needed. This will entail some or all of the following: more recent invoices, quotes, or industry pricing indexes.

There you have it. Out of the five elements, invoices help with one and a half. Yes, I gave the final one a “half.” The math tells us 1.5 out of 5 is 30%. In my books, that’s an “F” folks. To add more complexity to the five elements, assume there’s a coinsurance condition. Here, balance sheets, tax returns, and/or fixed asset ledgers are needed to determine the values at risk. So, invoices strike out again.

The bottom line is this: inventory claims are complex and require far more than invoices. Be prepared to roll up the proverbial sleeves and perform some analysis, or hire a forensic accountant. 

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