APICS - TPA - February 1998 - Letters to Editor

February 1998 • Volume 8 • Number 2

Letters to the Editor

The article on fraud by Michael Pierce in the December 1997 issue was outstanding. Articles like this help us become broader and more professional.

I have a couple of additional points to contribute, from my own experience.

Fake Sales: I know of a software company, now defunct, where salespersons would fake invoices to potential customers, put the distribution diskettes and manuals in the trunks of their cars, and let them sit there over the end of the fiscal year. This counted as a sale. Then they would return the materials and have credit memos issued against the invoices, which took effect in the new year. The potential customers knew nothing about this chicanery. I think the fake sales also got commissioned. I suspect this happens a lot, and not just in the software industry.

Excess and Obsolete Denial: In my consulting practice, I often run across manufacturing companies that avoid writing off excess and obsolete inventory. Modern, commercial, MRP-based software usually has a feature to report on excess and obsolete inventory. Obsolete is defined as inventory not needed to fulfill the current master production schedule. In effect, this is inventory that your most recent MRP run doesn't ask for at all. Excess is inventory that will be left over after the designated days of coverage. If you are shooting for 12 inventory turns, then anything left over after 22 days is excess.

The most flagrant example I ever ran into was a client that had accumulated enough obsolete inventory to wipe out the previous seven years of profit. And the bosses at corporate refused to allow any write off.

Capitalizing Expenses: This is a favorite for growing companies. For example, software companies sometimes can capitalize software engineering. But this is dangerous because the ever-growing capitalized amount requires amortization. As soon as a sales downturn occurs, the amortization cost becomes a burden that could eliminate profit.

I worked for a short time for a small manufacturing company making agricultural spraying equipment. This company got its starting capital on the local over-the-counter market in the days when you could sell anything if you had a prospectus. Because sales were weak they capitalized their design engineering department, thereby making the monthly financials look good. But the checkbook finally gave out and the company went bust.

Another company I know of was having a bad year in sales, and their union contract made it hard to lay off workers. So they simply manufactured a couple million dollars of subassemblies for inventory at the end of the fiscal year. The effect was to capitalize labor and overhead, delaying the expenses into the following year.

Cost-of-Goods-Sold Buffer: It is easy to juggle the material component of cost-of-goods-sold in order to show the desired bottom-line profit. This is especially easy for a company with a poor cost accounting system. I think the accountants call this "plugging." You start with the profit you want, and plug in the dollar amount for material to make the numbers come out.

What to Do?
As true professionals, what should we do when we observe these frauds, or worse yet are called on to participate in them? This is a clear ethical dilemma. Do we refuse to go along, or blow the whistle? This often is "career limiting." Or do we conveniently shrug it off and go along?

Pierce, in his article, uses the term "fraud" loosely. Some acts are merely reprehensible, but others are criminal. We could use another article or two on the definition of fraud and its legal implications.

John N. Petroff, CFPIM, CIRM
Executive Consultant

Lionheart Publishing, Inc.
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