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Inventory Management Audit:

Lessons Learned from the
City of Palo Alto

Presented by:
City of Palo Alto - Office of the City Auditor
October 14, 2014
Mimi Nguyen, Senior Performance Auditor

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Moderator
R. Kinney Poynter
Executive Director
NASACT
Opening Remarks
Speaker
Mimi Nguyen
Senior Performance Auditor
City of Palo Alto (CA)

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Introduction
Audit Objective:
To determine if the City has adequate controls to ensure:
Accuracy and completeness of inventory records
Accountability for inventory transactions
Safeguarding of inventory
Audit Scope:
Inventory - supplies and materials not placed into
operation
Municipal Services Center (MSC)
Regional Water Quality Control Plant (RWQCP)


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Background
How did the inventory audit appear on the radar?
2011 Risk Assessment of the Citys Utilities identified the
lack of an asset management policy and procedure
2012 Contract Oversight Audit of Office Supplies identified
that about 75% of inventory in the Citys warehouse was
related to Utilities
2012 Finance staff raised concerns regarding bypass of
process, poor communication, and potential waste
2013 Audit Workplan included the Utilities Asset
Management Audit, which later changed to Inventory
Management Audit

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Audit Planning
The GAO-02-447G: Executive Guide - Best Practices in
Achieving Consistent, Accurate Physical Counts of Inventory
and Related Property (March 2002) helped identify the risks.
What are the risks?
1) Not knowing the quantity, location, condition, and value
of assets
2) Assets not safeguarded from physical deterioration, theft,
or loss
3) Unnecessary storage and maintenance costs or asset
purchase
4) Unable to determine costs of government programs using
assets

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Audit Planning
What were our preliminary questions?
A. What is inventory?
B. Who (which department) is responsible for inventory?
C. How is the inventory recorded physically and financially?
D. What are the existing, required inventory controls?
E. How complete are the inventory records?
F. Are inventory records accurate?
G. Is there accountability for all inventory transactions?
H. Do we have the right amount of inventory?
I. Is inventory safeguarded?

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Audit Planning
A. What is inventory?
Citys policies and procedures did not clearly define
inventory
Audit definition Supplies and materials that have not
been placed into operation
B. Who (which department) is responsible?
Administrative Services Department responsible for
warehouses and storage facilities
Each department responsible for safeguarding City
assets
However, in practice, no agreement regarding who is
responsible for what


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Audit Planning
C. How is inventory recorded?
City of Palo Alto CAFR -
Materials and supplies are held for consumption
and are valued at average cost. . . Under the
consumption method, inventories are recorded as
expenditures at the time inventory items are used,
rather than purchased.
CAFR indicated $3.6 million in inventory as of June
30, 2013
Different inventory management systems used
Undocumented inventory identified

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Audit Planning
D. What are the existing inventory controls?
City adopted SAP for its inventory management:
Tracking valuated and non-valuated stock
Inventory counting
Reporting and analysis tools to detect:
Slow-moving or dead stock
Inventory turnover
Reservations and tracking movements
Generation of purchase requisitions based on stock
levels
Valuation of inventory
Implementation mirrored a pre-2003, legacy system
Policies and procedures did not cover key control elements
Lack of performance measures

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Methodology
E. How complete are the inventory records?
Interviewed staff
Surveyed surrounding areas for unmarked items
Toured Citys storage areas
Counted and valuated inventory NOT managed in SAP
Warehouses outlined in red and yellow represent areas where materials
or supplies were stored and not managed in SAP.

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Lessons Learned
E. How complete are the inventory records?
Redefining staffs understanding of inventory
Lack of commitment to the Citys adopted SAP system
for inventory management and control
Narrowing scope to what matters, but not losing sight
of the big picture

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FINDING 1: Not all inventory was managed
using the SAP inventory system
At least $4.2 million in inventory, more than half of the
Citys inventory, was not subject to consistent or
adequate inventory management controls.


The lack of reliable and complete inventory data may
impair the Citys ability to know the quantity, location,
condition, and value of its inventory.


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F. Are inventory records accurate?
Assess inventory management controls
Understand SAP inventory data
Compare inventory system records to financial inventory
Determine a sampling strategy
Execute sampling strategy to determine accuracy
Methodology
Grouping Sample
Size
Total Population
Count
Sample
$
Total Population
$
Group 1: $0 to $2,000 44 1,658 $43,957 $740,448
Group 2: $2,001 to $10,000 54 237 $250,662 $933,092
Group 3: More than $10,000 42 42 $1,121,702 $1,121,702
MSC Location Subtotal: 140 1,937 $1,416,321 $2,795,242
Group 1: $0 to $2,000 17 2,499 $13,217 $349,068
Group 2: $2,001 to $10,000 17 80 $72,998 $306,865
Group 3: More than $10,000 7 10 $124,635 $173,821
RWQCP Location Subtotal: 41 2,589 $210,850 $829,753
GRAND TOTAL: 181 4,526 $1,627,171 $3,624,995

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Lessons Learned
F. Are inventory records accurate?
Staff claimed over 99% accuracy not supported
Different approaches to assess inventory accuracy
Different control systems and deficiencies by location

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FINDING 2: Accuracy of recorded inventory
Inventory records were inaccurate for 20 of 182
materials in our sample, indicating an 89 percent
accuracy rate overall for the $3.6 million in recorded
inventory.

Inaccurate inventory records may result in financial
misstatement and operational inefficiencies, including
the inability to meet demand and maintain appropriate
stocking levels.

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G. Is there accountability for transactions?
Identify high risk transactions:
Inventory issued without SAP reservations
Use of a generic user account
Identify incompatible duties not segregated:
Reserving and issuing goods
Recording inventory and making adjustments
Methodology

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Lessons Learned
G. Is there accountability for transactions?
Generic user accounts defeat transparency and
accountability
Storekeepers reserving and issuing items, and
adjusting inventory after the fact
Goods issued without reservations, as unplanned
goods issue

Initial FO is the Storekeeper

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FINDING 3: Accountability for inventory
transactions
From January 1, 2007, through April 19, 2013:
About $1.0 million in inventory issued without
reservations to evidence need and authorization
About $8.5 million in inventory (58% of total
inventory issued) processed using a generic user
account accessed using a shared password
Staff performed incompatible duties in managing
and processing inventory

Controls ensuring accountability and transparency of
inventory transactions reduce the risk of fraud and
abuse and help ensure materials are appropriately and
timely procured and made available.

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H. Do we have the right amount of inventory?
Identified reasonable inventory turnover benchmarks
Identified and ran inventory analytic reports in SAP
Assessed SAP configuration to determine ordering
strategy

Methodology

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Lessons Learned
H. Do we have the right amount of inventory?
Staff not aware of SAP inventory reports and analytics
Staff not aware of SAP materials requirement
planning (MRP) system configuration
Lack of oversight, costly decisions

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FINDING 4: Unused or infrequently used
inventory
More than 50 percent of the Citys 4,383 stock
materials, or about $2.5 million in inventory, had not
turned over in a one-year period

Inventory turnover decreased from 87 percent in FY
2007 to 64 percent in FY 2013

Inventory that does not move may indicate a waste of
resources including:
1) Unnecessary inventory purchases
2) Obsolete inventory
3) Wasted storage space

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I. How is inventory safeguarded?
Interviewed staff
Reviewed security system access records
Compared card holders with employee list
Reviewed card access system capabilities
Methodology

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Lessons Learned
H. How is inventory safeguarded?
6 employees worked at warehouse; 71 cards provided
access (including generic and shared cards)
Ineffective camera surveillance system
Inadequate fleet access control system
Open ceiling tiles to a secured area Low fence with open crawl space

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FINDING 5: The City should improve physical
security over its inventory
A large number of cards granted access to the MSC
and the MSC Warehouse, including cards without
adequate identifying information

Other security concerns were noted that may apply to
other City facilities

Physical security controls are required to safeguard
and protect the Citys inventory and sensitive and
strategic sites.



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Other Lessons Learned
Resources
1,630 hours to complete (over 10 months)
Reporting
Layered reporting style
Written in a direct way, less is more
Pictures and graphs tell the story
Vetted report drafts with stakeholders prior to issuing
Effective presentation slides, focused discussion
General
Connecting the dots of the workflow process
Keep it layman and relatable to facilitate discussion
Imbedded in culture, getting to the root cause

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Where are we now?

Management developed an Implementation Plan,
taking a citywide, holistic approach
Other areas of concern are being addressed, not
only what was explicitly identified in the audit report
Having a vested interest in it and understanding
Whats in it for me?
Not just a check off the audit recommendation list;
new level of expectations

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Moderator
R. Kinney Poynter
Executive Director
NASACT
Questions?
Speaker
Mimi Nguyen
Senior Performance Auditor
City of Palo Alto (CA)

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For Additional Information, Contact:
houman.boussina@cityofpaloalto.org
mimi.nguyen@cityofpaloalto.org

Audit reports can be found at the City of Palo Altos website:
http://www.cityofpaloalto.org/gov/depts/aud/reports/performance.asp