Question

What is Phantom Inventory?

Why, from your perspective, is inventory so easy to inflate without auditor detection?

Answer 1

Phantom Inventory is an inventory which is reported but doesn't exist. It is the thing that happens when unending stock—the quantity of things in the front and back of the store—is more prominent than on-rack availibility.

Phantom Inventory is especially testing in light of the fact that your stock administration framework says the items are available, yet the racks are vacant. You can't fix what you don't know is even an issue. There are a few potential reasons for phantom stock, including:

Shrinkage – Shrinkage happens when an item is lost because of worker robbery, shoplifting, or another obscure explanation.

Worker mistakes – Store partners may make a blunder when entering information, handling returns, or picking stock to satisfy an online request.  

The difficulties related with Phantom Inventory increases with scale.

It is relatively easy to inflate the inventory without auditor detection due to the following reasons-

1. The obvious way to increase inventory asset value is to create various records for items that do not exist: unsupported journal entries, inflated inventory count sheets, bogus shipping and receiving reports and fake purchase orders. Since it can be difficult for the auditor to spot such phony documents, he or she normally uses other means to substantiate the existence and value of inventory.
2. Observation of physical inventory. The most reliable way to validate inventory quantity is to count it in its entirety. Even when this is done, little mistakes can allow inventory fraud to go undetected:Management representatives follow the auditor and record the test counts. Thereafter, the client can add phony inventory to the items not tested. This will falsely increase the total inventory values. Auditors announce when and where they will conduct their test counts. For companies with multiple inventory locations, this advance warning permits management to conceal shortages at locations which auditors will not visit. Sometimes auditors do not take the extra step of examining packed boxes. To inflate inventory, management stacks empty boxes in the warehouse.
3. The auditor relies heavily on observing the client’s inventory. Therefore, it’s quite important for the auditor to take and document test counts. Regrettably, some cases of inventory fraud occur when the client alters the auditor’s working papers after hours. Auditors must maintain adequate security over audit evidence. For instance, say the client receives a large shipment of merchandise five days before the end of the accounting period and picks up all copies of the receiving reports and invoices and secretes them during the audit. Then, during the physical inventory count, employees count the merchandise, which the auditor then tests.