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  • Writer's picturePhil Villegas

Biting the Hand That Feeds You: Real Cases from Fixed Operations - Insight Vol. 32

AXM - Biting the Hand That Feeds You
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Integrity is doing the right thing when no one is looking.  It is our belief that most individuals conduct themselves with integrity. Nevertheless, our experiences as auditors have shown that this is not always the case. We have encountered employees who are well-compensated, long-serving, highly esteemed, and trusted, yet they exploit their positions for financial gain to the detriment of the dealerships they represent.

To avoid overly academic language, such behavior often reflects the elements of the well-known fraud triangle: pressure, opportunity, and rationalization. I remember my mother saying, "Never bite the hand that feeds you." At that time, she meant that misbehavior would result in no chocolate chip cookies for me. Now, the phrase extends to harming an employer who provides the means for a decent livelihood and sustenance.

We have witnessed embezzlements in the millions of dollars, deeply hidden below the surface of healthy monthly financial statements and escaping the most thorough financial statement audits.  But most often, instead of a single large transaction, fraudsters usually get their perceived share of the dealership’s profits in “death by a thousand cuts” where inappropriate activities in relatively small dollar amounts steadily perpetuate over time equating to a surprising sum of money all the while keeping the trust of the dealer and earning a good living.  If an employee is prepared to exploit their employer for personal gain through transactions that occur under the leadership team's scrutiny, one can only imagine the extent of undetected misconduct. Misconduct can transpire at various points within a dealership. Let us examine some real-life instances of employees harming the very source of their livelihood.

The present value of tomorrow’s gross profit in today’s commission – The affected dealership implemented a commission structure for service advisors and parts counter staff that increased the commission rate on parts and labor gross profit as monthly gross profit targets were met. Upon reaching a new tier of gross profit, the commission rate would rise. Although pay plans ought to encourage appropriate behavior, in this instance, it incentivized the premature recording of gross profit. Investigations revealed that repair orders were frequently initiated on the last day of the month, late in the day, with an abnormally high number of labor hours recorded and an excessive amount of parts charged for a single day's work. It was observed that the department's total gross profit was sufficient to reach a new bonus level for that month. The vehicle listed on the repair order was indeed in the shop, and the requested work was documented; however, the labor had not been completed, nor had the parts been installed. This overstatement of gross profit elevated the bonus percentages for the month. The higher commission percentage would otherwise not apply. Several employees benefited from this practice of prematurely recording revenue and gross profit.

Do service policy unto yourself as you do to others - Department managers usually go unquestioned by their subordinates when giving instructions. In this instance, a service manager's relative had repairs done on a vehicle, including the replacement of a part that had been installed about a year prior. Initially, it was thought that the removed part was defective and could be returned to the original vendor under warranty, thereby incurring no cost to the customer. However, upon examination by the vendor, it was determined that the part failed due to the driver's negligence rather than a defect in the part itself. Consequently, the cost of replacing the part was deemed the responsibility of the customer who brought the vehicle for repair. When informed that the part was not covered by warranty, the service manager knowingly authorized the expense of the failed part to be charged to the service policy, instead of collecting the amount from his relative. The service manager's decision went unchallenged as he was the one who approved any charges to the policy.

Excess flagged hours with no red flag – In this instance, a technician who should have been paid for 4.1 hours was mistakenly compensated for 41 hours. With a pay rate of $35 per hour, the technician received an overpayment of 36.9 hours, resulting in an additional labor cost of $1,292 for the dealership. The repair order was recorded at a loss, and notably, the error went unnoticed by the booker, service advisor, service manager, and accounting office. This transaction did not appear in any exception report. Given the high volume of operations at the dealership, such anomalies could easily go undetected. While technicians typically alert management if their pay is short by even an hour, in this case, the technician knowingly accepted the extra pay without mentioning the error. The technician's pay was not adjusted until the mistake was uncovered during an internal audit.

Free parts for the creative counterperson – An employee in the parts department recorded several transactions that resulted in no sales. These transactions showed no total amount due but indicated movement of parts into and out of inventory. The counter ticket was billed to a customer named "Cash," and the parts charged on the ticket appeared unrelated to the parts credited back on the same ticket. Upon further investigation, it was discovered that some parts were billed on repair orders but not installed by the technician.  The parts were returned to the parts department and the parts employee would use the value of returned parts to offset the selling price of parts he was taking for personal use, rather than crediting the manufacturer or customer who was billed for the parts in the first place. Interestingly, the parts counterperson tried to maintain accurate on-hand quantities of his personal parts acquisitions, rather than simply removing his parts from the shelf and allowing the parts variance to occur. These transactions were easily overlooked as they netted zero dollars, and no one was looking for the credits associated with the returned parts.  Additionally, the serious implications of warranty fraud are evident when the returned parts which were originally billed under factory warranty were neither installed nor removed from the repair order, exacerbating the dealership’s risk considerably.

Shop supplies - or are they? – Many dealerships maintain an ongoing shop supplies ticket for items billed to technicians throughout the month, which is then charged to the shop supplies expense at the end of the month. These tickets usually include items such as brake cleaner, wheel weights, nuts and bolts, among others. Interestingly, most Service Managers closely monitor the shop supplies expense. However, in this case, the credits from shop charges and environmental fees collected on repair orders were so substantial that the account typically had a credit balance at the end of the month, causing the shop supplies ticket to be overlooked amidst the credits that absorbed it. Items that were not supplies were often billed to the ticket as a catch-all, and the individual transactions where the parts were handed to a technician were lost. In some instances, we observed that parts damaged by a technician needed to be billed somewhere. However, Pirelli P-Zero tires, wheel sets and running boards are not exactly shop supplies and are not likely to be damaged by a technician or given away as a goodwill measure. It was unclear who received the parts and why the dealership absorbed their cost as shop supplies expense. Parts employees pointed to service as the culprit, while the service department pointed to parts.

I can give you a discount, but not at my expense – Most dealerships have compensation plans for service advisors based on gross profit. These plans certainly incentivize selling more labor hours per repair order and more parts, while discouraging discounting practices. However, there are instances when a customer needs to be given a discount. We have discovered that normal discounting practices are often bypassed, and commissionable gross profit is preserved through creative measures. These include removing sales tax on taxable sales, eliminating environmental fees or shop charges, or crediting the customer for a non-existent or expired coupon, which is then charged to advertising expense when the repair order is closed. Each of these methods maintains 100% of the gross profit and, consequently, the service advisor's commission. While shop charges and environmental fees are income sources, the advisor typically does not receive commission on these items, making them an easy concession when a customer requests a discount. Moreover, the advisor may not comprehend the implications of removing sales tax. The dollar amount might be minimal on a per-transaction basis, but in the hands of a sales tax auditor, any detected sales tax deficiency is extrapolated and applied to taxable sales for the period being audited, potentially leading to a substantial sales tax assessment, penalties, and interest.

Integrity is a fundamental value that is essential for the smooth functioning of any dealership. It is disheartening to know that despite most individuals conducting themselves with integrity, there are still some who exploit their positions for personal gain. The article highlights the importance of monitoring even the smallest transactions that can potentially lead to greater misconduct.  Employees are biting the hand that feeds them as I write this article.  Don’t wait for a finger to go missing to realize it is happening in your store.  

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