In the steel industry, scrap and returns are often treated as operational byproducts. But to audit managers, they represent high-risk areas of financial leakage and misstatement. Without tight internal controls, scrap losses, over-reported returns, and misclassified material can distort both margins and inventory valuation.
As scrap prices fluctuate and customers become more particular about specifications, the financial implications of these activities have grown. Smart audit teams are shifting their focus from simply verifying scrap weights to building robust, traceable workflows that ensure every pound is accounted for—and properly valued.
Why Scrap and Returns Are a Growing Audit Concern
Unlike other inventory categories, scrap and returns sit at the crossroads of operations, sales, and finance. Each has its own risk profile:
Scrap: Generated from cutting, slitting, and processing steel. It should be weighed, classified, and either sold or credited against job cost. But when tracking is loose, valuable material can disappear or be misvalued.
Customer Returns: Steel returned due to defects, wrong specs, or over-shipments must be assessed for condition, reclassified, and often written down. If not managed well, this creates overstatement of inventory or hidden COGS distortions.
Audit managers are increasingly asking: where is the proof that this scrap was generated, sold, or reallocated appropriately? And what’s the financial treatment for those returned coils sitting in the yard?
Control Weaknesses That Raise Audit Flags
Lack of Scrap Segregation
When scrap is not physically separated by grade or source, it’s impossible to trace its origin or ensure correct value.
Co-mingled bins from different jobs may hide over-scrapping, incorrect processing, or even misappropriation.
Inconsistent Scrap Valuation
Steel scrap may be booked at market rates, historical averages, or a flat internal rate. Without policy alignment, scrap revenues or offsets to job costs are inconsistent.
Rapidly shifting scrap markets make this even more volatile—what was worth $180/ton last month could fetch $240/ton now.
Return Approvals Lacking Documentation
Returned material without clear RMA (Return Merchandise Authorization) trails creates audit uncertainty. Was it really defective? Was the credit justified?
In some cases, credit memos exceed the value of returned material due to miscoding or sales team discretion.
Returns That Don’t Trigger Inventory Review
Returned material should prompt a full review: Is it resaleable? Should it be downgraded to secondary? Was it correctly reversed from revenue?
Many distributors simply receive the material and re-stock it at full value—creating an inflated inventory figure.
Scrap Sales Without Matching Revenue
When scrap is sold to local yards or recyclers without clear invoicing or weight documentation, the offsetting revenue often goes untracked or gets miscoded as miscellaneous income.
What Audit Managers Look for During Review
Scrap Weight Reconciliation
They trace job travelers and production logs to expected scrap generation rates (e.g., percentage loss in slitting). Discrepancies signal potential issues—over-claiming scrap to hide poor yield or simply poor tracking.
Sample reconciliation: A job expected to yield 2,000 lbs of scrap based on cut plan shows only 1,300 lbs recorded. Where is the missing 700 lbs?
Review of Scrap Sales Invoices
Auditors ensure scrap sale invoices match weighbridge tickets, pricing aligns with market, and proceeds are coded to correct GL accounts.
Any cash sales or missing supporting documents are immediate red flags.
Returned Goods Authorization (RGA) Testing
A sample of return transactions is selected to verify existence of:
Customer complaint or return request
Physical material inspection record
Credit memo approval from finance
They also test whether sales reversal entries and inventory reclassifications are properly matched in ERP.
Write-Down Policy for Returned Material
Audit teams assess whether returned material—especially over 30 days old or outside original specs—has been marked down appropriately.
If resaleability is low or secondary market pricing applies, inventory should reflect impairment.
Review of Scrap Revenue Trends
Significant swings in monthly scrap sales prompt inquiry. Are volumes changing, or is scrap price movement being improperly captured?
How Audit Managers Help Build Better Controls
Establish Scrap Yield Standards
Create process-based scrap generation benchmarks (e.g., 5% for slitting, 2% for shearing). Use these to monitor actual scrap output by job and flag outliers.
Segregate and Barcode Scrap
Physically separate scrap by type (e.g., clean offcuts, dirty scrap, mixed grade) and assign barcode tags linking to job number. This allows traceability back to original inventory.
Require Dual Approval for Returns
Implement a mandatory two-step return process: sales initiates the RGA, operations inspects and confirms condition, and finance approves credit memo after inventory update.
Scrap Valuation at Market Rates
Tie monthly scrap values to external indices (e.g., AMM or Fastmarkets). Use these to update inventory adjustments and job cost offsets regularly.
Conduct Periodic Scrap Audits
Random audits of scrap bins vs. system-logged scrap help validate accuracy and deter diversion. Record results and adjust procedures based on findings.
Tag and Age Returned Material
Returned steel should be clearly tagged with date, condition, and reusability notes. Apply aging rules to determine when it moves from active to impaired inventory.
Bottom Line: Control the Residuals, Protect the Margins
Scrap and returns are often treated as afterthoughts in the steel business—but for audit managers, they’re litmus tests for internal discipline. When scrap is underreported or returns are overvalued, financial statements become less trustworthy and margins erode silently.
Strong internal controls not only help ensure audit compliance—they protect against real economic loss. In an industry where yield, grade, and timing matter, managing what’s left behind is just as important as managing what ships out.
