Fraud Detection and Deterrence in the Manufacturing Sector

Key Takeaways:

1. Fraud risks in manufacturing are significant and multifaceted, with corruption, billing schemes, and misappropriation of noncash assets being the most common and costly threats to organizations.
2. Prevention and early detection are critical, as most fraud cases stem from weak internal controls or management override. Employee education, internal audits, and management oversight are the most effective defenses.
3. A proactive and consistent fraud response strengthens organizational resilience, making sure that potential issues are investigated objectively, and that disciplinary actions reinforce a culture of accountability.

Every industry is subject to fraud risk, and the manufacturing sector is no exception. Compared to other industries, manufacturing organizations face heightened risks that require particular attention. Areas of concern include corruption (especially in global supply chains), billing schemes, and misappropriation of raw materials and finished goods. Below, we examine key fraud schemes that present a higher risk in manufacturing and provide some preventative and detective actions to help reduce that risk.

According to the Occupational Fraud 2024: A Report to the Nations from the Association of Certified Fraud Examiners (ACFE), the median fraud loss in the manufacturing sector is $267,000, with an average loss of $1,816,000. The top three schemes in the manufacturing industry are corruption (55%), misappropriation of noncash assets (29%), and billing schemes (27%). Notably, the ACFE report indicates 35% of cases involve both asset misappropriation and corruption. Therefore, it’s important for organizations to understand that the two largest schemes present in this industry may occur simultaneously. More than half of all frauds examined in the report occurred from either a lack of internal controls or an override of existing controls.

Common Fraud Schemes

Here are just a few schemes manufacturing entities must maneuver.

Corruption and Bribery

A manufacturer that sources materials or distributes products globally is exposed to increased corruption risk throughout their supply chains.

Misappropriation or Theft of Noncash Assets

Manufacturing organizations often have significant raw materials and inventory on hand, which have considerable value. While these noncash assets may be harder for the fraudster to convert to cash, they still carry substantial value and are often not subject to as many controls as cash.

Billing Schemes

Due to the high volume of vendor transactions and payments for materials and services related to manufacturing, there is an increased risk of billing fraud.

Reducing Fraud Risk

The best way to minimize loss due to fraud is to prevent it in the first place—or at the very least, detect it quickly. According to ACFE, the most effective methods of detecting fraud in order of occurrence are:

1. Tips
2. Internal audit procedures
3. Management review

The following strategies can help manufacturers reduce fraud risk and strengthen these defenses.

Employee Education and Reporting

Having open discussions about fraud empowers employees to recognize and report suspicious behavior. Tips have been the most frequent method of identifying fraud across multiple editions of the ACFE’s report. Part of building a culture of fraud prevention is providing safe reporting mechanisms, such as hotlines, which help foster a culture of accountability.

Surprise Inventory Audits

Conducting unannounced physical inventory counts of noncash assets, raw materials and finished goods can make sure that your inventory records are accurate and signal that management is watching.

Process Audits

Regular compliance audits help businesses verify employees adhere to internal policies and procedures while reinforcing a culture of integrity and displaying management’s focus on compliance. Areas to review during a process audit include vendor selection and approval, credit memo authorization, and contractor review.

Management Review and Data Monitoring

Effective management oversight reduces both the duration and cost of fraud incidents. In manufacturing, monitoring inventory write-offs, turnover ratios, profit margins, and scrap loss can reveal potential signs of fraud. While many sales functions have increased activity at the end of reporting periods, it is important that management conduct a review of those end-of-period sales to confirm they were not subsequently written off through receivable write-offs or credit memos to revenue.

Annual Fraud Risk Assessments

Fraud prevention starts with knowing what your risks are. Incorporating a fraud risk assessment into the annual risk assessments allows organizations to identify vulnerabilities and align controls accordingly. Any large risks without adequate controls should be analyzed further.

Periodic Vendor Master File Cleanup

Periodic analysis of the vendor master file can help identify and prevent a fraudulent disbursement from happening. Inactivating unused or duplicate vendors can reduce opportunities for unauthorized payments.

Vendor Disbursement and Credit Review

Analyzing disbursements and credits can identify anomalies such as payments just under approval thresholds, even-dollar payments, duplicate payments, or missing purchase orders.

Fraud Response

Even with strong controls, fraud can still occur. The most common misstep is to dismiss an allegation or red flag. The initial evaluation of a potential fraud should involve personnel independent of the implicated area. If the organization determines future inquiry is required, engaging an internal or external independent party maintains objectivity and thoroughness. Lastly, applying consistent disciplinary action reinforces the serious nature of fraud.

Manufacturing organizations are not immune to fraud and have some specific vulnerabilities due to the nature of their operations. By taking a proactive stance—through prevention, detection, and consistent response—companies can reduce the impact of fraud. EisnerAmper offers experience and a depth of resources to help prevent, investigate, and analyze fraud vulnerabilities in the manufacturing sector. Contact us below to discuss how we can assist.