Fraud in the Parts Department; Is Your Dealership protected?

Cases of fraud, such as the one described above, take a financial and emotional toll on a business but can be used as a learning opportunity for other business owners to determine if their current processes and controls could prevent and detect fraud. Take a moment to consider the following as it relates to your dealership:

• Parts pad to General Ledger (GL) reconciliation – In the above example of fraud, the stolen parts were never included in the DMS inventory-on-hand, but payments were made to the manufacturer and would have been recorded in the GL parts inventory account. This would have created a growing variance between the parts pad and the GL. A parts pad to GL reconciliation should be prepared each month by the accounting team to determine that any variances between the parts pad and GL are known and expected. Any unknown and unexpected reconciling items should be researched fully.
• Parts inventory cycle counts and year-end physical inventory counts – These are key internal controls in the parts department. They also help with making sure your operation runs smoothly.

Cycle counts are when a part is selected from the parts pad, traced to its location in the parts department, counted, and compared to the number of units reported in the parts pad. The idea is that each part in the parts department is counted during the year and adjustments are made, as necessary.

Additionally, a best practice is to engage a third party on an annual basis to perform a physical parts count. Like cycle counts, having a physical count completed would ensure the parts pad is accurate based on the inventory-on-hand.

Neither of these internal controls would have necessarily caught the scheme above, but they are still an important internal control to consider. They can be done in conjunction with the monthly and yearly general ledger to parts pad reconciliation.

• Segregation of duties – The segregation of duties involves the assignment of responsibility in such a manner that more than one employee is involved in the processing of a transaction. If an employee’s duties include the ordering of parts, receiving parts, and controlling communications with the factory and the accounting department, the risk of intentional or unintentional errors increases. A review of your dealership’s processes and internal controls, including the adequacy of segregation of duties in all departments, is key to protecting all dealership assets.
• Review of expenses – A dealership’s accounting department should always include in its month-end procedures a detailed review of monthly expenses to ensure expenses are in line with expectations and free of unusual trends. If your dealership does not prepare a detailed budget, including expenses, and perform a monthly budget-to-actual analysis, your dealership is missing a valuable tool to monitor the dealership’s performance and take note of fluctuations outside of expectations.
• Auditing vendor statements – Before bills are paid, vendor invoices and statements should be reviewed, compared to supporting documentation, and approved. Comparing the FedEx charges to supporting sales documents and sales proceeds could have led to identifying these fraudulent actions. Parts receiving procedures and a purchase order system can help detect these schemes as well.
• Review of Key Performance Indicators (KPIs) – If the OEM continued to bill the dealership and the dealership continued to pay for these expensive parts without ever selling and relieving inventory, an ever-increasing parts inventory GL balance would exist. Paying attention to KPIs like frozen capital, days supply in inventory, and performing inventory flux analysis, could help to identify anomalies in the dealership’s financial statements.

Unfortunately, like death and taxes, fraud in the business world is a certainty and can occur where it is least expected. Business owners should expect there will always be employees who are motivated enough, able to rationalize, and can identify opportunities to commit fraud. Review your insurance policies and understand how instances of this type of fraud are covered and whether your coverage is adequate. Investing in the design, implementation, and monitoring of internal controls is also a small price to pay to protect your dealership from the financial and emotional costs of fraud. Contact an ARB Auto Dealership Services Team member if you would like to discuss this further.

Author: Laura Everett, CPA