Manufacturers: How Vulnerable Are You to Fraud?

Fraud is a significant problem for all businesses, but the manufacturing industry is particularly vulnerable. According to the Association of Certified Fraud Examiners (ACFE), manufacturing is among the industries with the highest number of reported fraud cases.

The most recent edition of ACFE’s biennial survey — Occupational Fraud 2022: A Report to the Nations — reveals that manufacturing had the third most occupational fraud cases, with an average loss of more than $1.7 million per case and a median loss of $177,000. (While these numbers may signify a higher incidence of fraud, ACFE notes that they may also indicate that the industry employs more certified fraud examiners than others.)

In addition to occupational fraud, the nature of the business exposes manufacturers to external fraud threats, including warranty claims fraud and product quality fraud. In light of these threats, manufacturers should conduct a risk assessment and implement anti-fraud controls designed to reduce fraud losses and detect fraud more quickly.

Occupational Fraud

According to ACFE, occupational fraud generally falls into one of three categories:

1. Asset misappropriation occurs when employees steal or misuse the company’s resources. Examples include theft of company cash, inventory or equipment; false billing schemes; and inflated expense reports.
2. Corruption happens when employees “misuse their influence in a business transaction in a way that violates their duty to the employer in order to gain a direct or indirect benefit.” This may include bribery, extortion and conflicts of interest.
3. Financial statement fraud arises when employees intentionally create a material misstatement or omission in the company’s financial statements.

For manufacturers, the most common fraud schemes in ACFE’s survey were corruption (59%), billing schemes (for example, submitting invoices for fictious goods or services) (26%) and noncash misappropriation (for example, theft of inventory or equipment) (23%).

The Report to the Nations identifies anti-fraud controls that can help companies minimize their fraud losses and detect fraud more quickly. The most effective controls include:

• Proactive data monitoring and analysis,
• Surprise audits,
• Anonymous hotlines (tips from employees or others are the most common way frauds are detected), and
• Job rotation/ mandatory vacations

Other important controls include formal fraud risk assessments, anti-fraud policies, fraud training for employees, codes of conduct and dedicated fraud departments or teams.

Given the high incidence of noncash misappropriation in the industry, manufacturers should implement inventory-focused anti-fraud controls. These may include cycle counting (to compare physical inventory to inventory records), strong warehouse organization and recordkeeping. Also important are robust procedures and controls related to picking, packing, receiving and stocking of inventory. Technology — such as bar code scanning, GPS and RFID tracking — can also be invaluable.

Warranty Claims Fraud

For manufacturers that offer warranties, warranty fraud is a significant risk. For example, customers or service centers may submit false or duplicate claims, disguise non-covered repairs as covered ones, or backdate claims that otherwise would fall outside the warranty period. Manually checking warranty claims is costly and time-consuming and often ineffective. A better approach is to use data analytics to automate the process and quickly spot anomalies or suspicious patterns of warranty claims that call for further investigation.

Product Quality Fraud

Manufacturers that purchase component parts from vendors or subcontract portions of the production process may be exposed to product quality fraud. For example, vendors or subcontractors may purchase poor-quality materials. Another example is they may falsify records or test results to meet regulatory standards or your quality control standards. To avoid these issues, manufacturers should conduct thorough due diligence on these third parties and implement rigorous quality control measures throughout their supply chains.

Assess Your Risk

Every manufacturer is different, and fraud risks can change over time. So it’s a good idea to conduct periodic risk assessments to identify the areas where you’re most vulnerable. Armed with that information, you can design a fraud risk management program that’s tailored to your company’s needs.

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