May/June 2006

Whether it is a power outage resulting in thousands of pounds of perishable food being spoiled or a sprinkler malfunction that causes water damage to clothing, manufacturers and retailers face unpredictable damages to stock and contents at any time.  In these types of challenging situations with seemingly immeasurable losses, it is imperative to involve a forensic accountant immediately after the damage or destruction occurs.

“It is ideal for the insurance company to involve a forensic accountant as soon as possible and is in the best interest of both the insurer and the insured,” said Dave Elmore, partner in Matson Driscoll & Damico’s Washington D.C. office.  “Initially, a forensic accountant will research the industry and type of inventory involved and then assist in the on-site count.”

If the insured and their representatives prefer to conduct the count themselves, the forensic accountant will then perform test counts on a statistical sample of the items to verify the work.

The length of time needed to perform a physical inventory largely depends on the size of the stock.  More important to the valuation process is determining whether the stock is in-sight or out-of-sight.  In-sight stock is product that is tangible and countable versus out-of-sight stock which has been completely destroyed and is therefore uncountable.

“Often times the stock and contents are completely destroyed, rendering a count impossible, so the insured must provide financial records to determine the damaged amount,” said Elmore.  “A forensic accountant brings the proper experience, knowledge and investigative accounting skills to perform an in-depth analysis that helps determine the actual value.”

When a total loss occurs, the forensic accountant will also examine the observed physical inventory prior to the loss.  This examination is followed by a thorough analysis of all in and out inventory transactions such as sales records, manufacturing reports and transfers-out leading up to the date of loss, rolling forward the inventory to the date of loss.

If it is a situation where a flood has damaged lumber or the smoke from a fire has made stocks of fabric unusable, the investigative analysis will involve the count numbers of damaged materials, past invoices, replacement costs and normal selling price to find an accurate loss amount.  When the stock is to be measured at “selling price”, it is important to look closely at the unincurred selling expenses as credit card fees, commissions and other expenses involved in making the final sale of the product will not be incurred by the insured.  These unincurred selling expenses must be identified and deducted from the loss.

“Other factors a forensic accountant will consider when determining inventory value include tests for obsolete and slow-moving inventory,” said Elmore.  “These valuations may be more involved because the inventory may not be available for replacement or the demand for the items has decreased.”

One of the most challenging and complex stock and contents scenarios can be a work-in-progress (WIP) situation.  WIP cases involve damage or destruction to a product during the manufacturing phase.

For example, when an explosion occurs in an automobile plant that causes damage to products mid-way through assembly, a forensic accountant must evaluate several different expenditures.  These include labor costs, materials and other additions that were made since the product was in its raw material form.  However, costs that were not already invested in the WIP product must be left out of the valuation.

A forensic accountant can provide the expertise needed to determine at what point in the production timeline costs should be included or excluded from the final calculation.

“Stock and contents losses can be very time-sensitive and multifaceted.  It’s important to have forensic accountants working hand-in-hand with the adjusters and other critical parties to determine the most accurate calculation of loss,” said Elmore.