Internal Audit Tales – The Case of the Winningest Warehouse Supervisor

By Ralph Villanueva CISA CISM CIA CFE

Introduction

As you have noticed by now, the Thanksgiving feel good mood has stayed with me – because I still am very much in the mood to continue sharing my internal audit experiences and insights. I guarantee that these insights will help you add value to your organization – and even earn that much coveted promotion or raise. So without further ado, here’s another interesting real – life personal story from my internal auditing days.

The Case of the Winningest Warehouse Supervisor

Once more, allow me to take you back in time to my favorite decade, you guessed it right – the 90’s. To paint a mental image of 1990, imagine listening to MC Hammer’s “Can’t Touch This” on the radio, raving about Demi Moore, Patrick Swayze and Whoopi Goldberg in the movie Ghost and watching on CNN then Iraqi president Saddam Hussein take over Kuwait.

I was working as an internal auditor for a publicly listed food manufacturing company in 1990 in Manila, Philippines. One of my responsibilities was to conduct an operations audit of the company’s liquid milk processing plant in Laguna province, which was about an hour’s drive south of Manila. I did the usual audit processes – talk with the stakeholders, set the audit objectives, use the internal control questionnaire to identify possible risk areas, prepare the audit plan, went over the related documents, reports, policies and procedures – and went to work.

There were a few audit findings here and there, but nothing with substantial financial or operational impact. Then I remembered what I heard from one of the warehouse workers – that the warehouse supervisor is very generous with his subordinates because he always wins in the local numbers lottery, known as “jueteng”. They always have parties with San Miguel beer (beer is more expensive than locally brewed rum or gin) and lots of various sumptuous pork – based dishes such as charcoal grilled pork barbecue, crispy “pata” (deep fried pork shank), “chicharon bulaklak” (deep fried pork innards) and “chicharones” (fried pork skin).

For those who are not familiar with this lottery, the mechanics of this game goes this way: a bettor picks two out of thirty-seven numbers, gives his bet to a “cobrador” (Filipino word for a person collecting bets) and then waits for the result on the same day. The “cobrador” will give the winner his winnings on the same day, and the winnings could be substantial. Since the “cobrador” is part of the community, everyone trusts him with their money and their bets. The person who runs the entire operation is known as the “jueteng” lord, because this very lucrative multimillion peso enterprise constitutes illegal gambling under Philippine law (Peso is the Philippine currency; currently equivalent to 56 Philippine Pesos for every US$1).

That piqued my interest. I went back to my audit of finished goods warehouse internal controls. Nothing seems amiss. All inventory counts tied up with warehouse records. Receiving documents for pallets of canned condensed and evaporated liquid milk from production, as well as bill of ladings for outbound shipments were duly signed and approved. Even the records of the security guards who works as a final and independent checker of goods loaded to the wholesale customers’ cargo trucks (most security guard services then and now are employed by independent third party security agencies) tallied with all related documents and records.

Back then, live closed circuit TV cameras were not as common as they are now. Hence, there is no way to confirm my suspicion that dozens of cases of unrecorded canned milk products could have been loaded into the cargo trucks every day with the connivance of the security guards, to be sold by the truck drivers to other wholesalers and then the proceeds split between them, the warehouse supervisor and the security guards. So if theft is committed, how is it covered up?

So I decided to go back to analyzing the entire manufacturing cycle and the corresponding process owners at each stage. I thought like a fraudster. I learned that a certain sample of each manufacturing batch (a few pallets per batch, which contains dozens of cases each) are set aside for observation for a certain period of time. These are called “control” cases, because they are under the Quality Control Department or QC. If a certain batch had an unusual quantity of spoiled cans, or liquid milk cans which became bloated after a certain number of days due to massive bacteria growth, then that entire batch could be defective and had to be recalled from the wholesalers.

I also learned that there are no records for the eventual disposal of these “control cases”. Moreover, the QC warehouse is run by the same warehouse supervisor who manages the finished goods warehouse. The QC employees merely check on the “control” cases at prescribed intervals to see which cans and which batches wee bloated and therefore subject to recall. To top it all, the returns received by the company are in a returns warehouse which is also controlled by the same warehouse supervisor.

I surmised that any theft in the finished goods warehouse is covered up by products from the QC warehouse. Although the product returns in the returns warehouse are accounted for upon receiving those from the wholesalers (returns have to be replaced by products from the finished goods warehouse), there is no accounting for the returned products that go to disposal. Hence the returns can also be used to cover up any shortages during inventory counts.

There seems to be a separation of duties issue here, so I decided to recommend the following:

• The QC warehouse should be under the QC manager, and the movement of “control cases” from the QC warehouse to the disposal area has to be recorded and attested by the same manager as well,
• The returns warehouse should be run by a separate returns warehouse supervisor and all movement of returned products especially to disposal should be accounted for, and
• All inventory records and documents from both QC and returns warehouses are reviewed by the plant accountant and the plant general manager.

Instantly, the “winningest” warehouse supervisor stopped winning from his “jueteng” bets. At the same time, there was a reasonable reduction in the number of returned products due to spoilage. However, there was a noticeable reduction in warehouse employee morale, because they have suddenly stopped partying.

Takeaways

• It pays to broaden your audit scope, especially when there is a suspicion of fraud,
• Looking at the audit universe at the macro level can yield surprising audit findings. Had I confined my audit to finished goods warehouse operations, I would have missed the segregation of duties issues, and
• Always think like a fraudster to prevent or at least mitigate fraud in your company.

Tune in for more true life internal audit tales from yours truly. I will help you live up to the Institute of Internal Auditor’s definition of internal audit – “independent objective assurance and consulting activity designed to add value and improve an organization’s operations”, and hopefully help you earn that promotion or raise because your organization or your client realizes the immense value of your work and your intellect.

Ralph Villanueva is currently an IT security and compliance professional for a global vacation ownership company, and has relevant professional certifications earned from over ten years protecting his stakeholders from IT security and compliance risks. In his previous professional life, he was an internal auditor for a decade, earned relevant certifications as well, and has protected his employers from fraud and financial risks due to weak internal controls and weaker company leaders. He also recovered tens of thousands of dollars through his audits. Though he is happy where he is right now, he is nevertheless waiting for the day when he can fuse these two magnificent professions into something that can generate enormous value to whoever makes it happen. Think Taylor Swift’s Eras and Beyoncé’s Renaissance tours, Oppenheimer and Barbie, Predator and Alien, Godzilla and King Kong, Freddy and Jason or Batman and Superman (sorry Robin). Yes, these are extreme analogies, but I’m sure you get the message. ? Ralph Villanueva. All rights reserved.