A&D Accuracy and Inventory Accountability are the Keystones to a Successful Compliance Inspection

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Contents

ATF’s Inspection Priorities Should Define Your Success and Risk Determinations / 3Conducting Your Internal Inventory – A Recommended Methodology / 4A Note on Virtual Locations / 6Conducting Your Internal Inventory – Common Pitfalls / 10

DisclaimerBy using this material, you agree that Orchid Advisors shall not be liable for any damages whatsoever. Orchid Advisors makes no representation as to the completeness nor legal interpretation of the content in its licensed materials. This should be used as an operational guide to enhance awareness and do not replace your responsibility for reading and complying with the law.

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ATF’s Inspection Priorities Should Define Your Success and Risk DeterminationsA licensee’s Book of Acquisitions and Dispositions is a foundation element for your next compliance inspection and is a focus of the ATF’s attention. Generally speaking, the ATF’s goals with respect to a compliance inspections include:

1. Ensuring the licensee is maintaining accurate required forms (e.g., Form 4473; Form 3; Form 4; Form 5; Form 9; Theft, Loss or Missing Inventory Reports; Re-ports of Multiple Sale, etc.);

2. Ensuring the licensee is maintaining an accurate Book of Acquisitions and Dispo-sitions;

3. Maintaining the traceability of certain firearms, including where they were ac-quired from and to whom they were disposed;

4. Disposition reports (including reports of multiple sale) which may lead to the discovery of illegal firearms diversion and trafficking;

5. And other objectives depending on the nature of the FFL and scope of the in-spection.

Inspect Yourself Like the ATF Will Inspect You – Understand Their Goals to Define Success and Risk

There is no better way to ensure the demonstrable accuracy of a licensee’s records during a compliance inspection than a complete bi-directional match between on-hand inventory and the A&D Book, and supporting documentation (when required) for dis-posed firearms.

As you can see, some of the top focus of the ATF during an inspection center on infor-mation that is initially contained in three major sources: (a) Inventory on-hand; (b) A&D

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Records; and (c) supporting documentation and required forms. For Title I firearms (and even to a degree Title II firearms), the ATF relies on a starting point from which to conduct their inspection. This starting point is the licensee’s A&D Book. The accuracy of these records will make or break the success of the inspection with respect to verifi-cation of inventory and supporting required forms, as this information will be validated against information contained in the A&D Book. A&D accuracy is so critical to the ATF’s conduct of the annual inspection that a first step of nearly every compliance inspection will be for the assigned IOI to conduct a bi-directional inventory of the licensee’s books and physical inventory. Although IOIs may conduct the process slightly differently, in practice, the process is as follows:

1. All physical firearms on the licensed premises and any off-site storage are com-pared to the A&D Book to ensure that all physical inventory is acquired; and

2. All open entries in the A&D Book are compared to physical inventory to verify there is a physical firearm for each open entry to ensure that no inventory is lost, stolen or unaccounted for.

Even after the inventory portion of the annual compliance inspection is complete, the A&D Book will still play a central role in the remainder of the inspection, as closed en-tries (dispositions) will be reviewed against other required forms (Form 4473, Reports of Multiple Sale, Form 3/4/5/9 for NFA dispositions or Missing Inventory/Theft Loss reports.)

By conducting regular bi-directional inventories prior to a compliance inspection, a licensee can ensure the accuracy of their A&D Records, ensure the accountability and accuracy of their inventory and verify the accuracy and presence of required forms.

Conducting Your Internal Inventory – A Recommended Methodology

General Concept of Operations

Bi-directionality (book to physical and physical to book) is the most important element in both an annual compliance inspection and regular in-house audits of a licensee’s in-ventory. The sophistication of your internal process and the tools and technology used in support will vary greatly depending on a licensee’s volume of inventory and transac-tions. However, the methodology will remain the same, regardless of whether you are a small family-run gun shop or a major firearms manufacturer or distributor.

1. Every serialized asset on or offsite attributed to the Federal Firearms License is included in the inventory. In the case of a manufacturer, include firearms that were manufactured by the licensee or any third party.

2. In-bound receipts and out-bound shipments are frozen approximately one day prior to the inventory.

3. Any transaction that would otherwise impact the A&D Book or the physical count is frozen prior to the inventory. This includes but is not limited to: Serialization, Scrap, Out-bound transfers, In-bound transfers, Change in Form, Loans, Tempo-rary Assignments, etc.

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4. All counts must be performed on a bi-directional basis. 5. Serial number counts or logs must be matched to physical firearm counts. In

other words, verify that you have logged 100 serial numbers and have physically counted 100 firearms and vice versa.

6. If applicable, ensure that at least one employee from each area or department is onsite and available to open locked areas during the inventory process.

7. If your location secures firearms in multiple locations within your licensed premises (e.g., display cases, safes, secure cages, on-site warehouse, WIP areas, etc.), ensure that all firearms are returned to their assigned location prior to the start of the inventory.

8. With limited exception (e.g. areas which holds long-standing or static goods), no firearm should be marked with a tag that has a human readable serial number. Ideally, the licensee will rely upon 1D or 2D barcoded tags in conjunction with the number physically engraved, cast or stamped in the firearm’s receiver or frame. This ensures that the inventory process verifies the actual serial number marked on the metal of the firearm.

9. Depending on the licensee’s technical capabilities and the firearm markings, consider requiring dual entry requirements to ensure accurate data entry that uses one of the following methods:

a. Human readable off firearm + human readable off firearm (dual blind, first entry is masked)

b. Human readable on firearm + 1D paper barcode scan c. Human readable on firearm + 2D metal barcode scan d. Optical character recognition of human readable on firearm + 2D

metal barcode scan10. All serial numbers must be taken from the metal on the firearm (and not a paper

tag) unless it falls into one of these categories and your technical capabilities permit:

Pallet Tagging and Pre-Metal-to-Label Matching Pallet Tagging, License Plating or Handling Units describe a process where a licensee’s back-end inventory control software will allow the pre-loading of multiple serial num-bers into a single electronic record. This record is then physically defined either as an alphanumeric code, 3 of 9 barcode, data-matrix, QR code or both. When the Pallet Tag number is entered or scanned, it will conduct an electronic lookup of all serial numbers assigned to the code and log each serial number as “counted”. If a licensee’s tech-nology permits, using pallet tagging can be a valuable time saver during the inventory process. Bear in mind, however, that bi-directionality and all other inventory taking controls must be used when establishing pallet tags and your inventory process should still require a physical count and bi-directional match to ensure a match of physical count vs. serial number count.

Inventory subject to this methodology during prior inventories that has not moved only needs to be re-matched on an annual basis. In other words, frozen inventory in an ar-chive or other static location does not require re-matching every quarter.

1. In cases where box serial numbers will be used during inventory, pre-inventory gun-to-box matching has been performed.

2. In cases where box serial numbers will be used during inventory, pre-inventory

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gun-to-box matching is confirmed by “QC stickers” applied to the box.3. Pre-inventory gun-to-box matching has been independently validated.4. Large groupings of static goods may receive a “License Plate” “Pallet Tags” or

“Handling Unit” designation for ease of scanning, if electronic scanning technol-ogy is to be used. However, the license plating or pallet tagging process must uti-lize technology-enabled internal controls embedded in the License Plate / Pallet Tag software.

Palletized, Sealed Finished Goods

Inventory just packaged prior to the inventory (as a finished good) and subject to suffi-cient controls to ensure metal-to-label serial number match do not require re-matching. A manufacturer or wholesaler who flushes its finished goods inventory to its logistics provider or customers daily, will often experience low volume in this area.

1. In the rare event that palletized and sealed finished goods have not yet been shipped and disposed, the auditor may scan the Pallet Tag barcode which holds all of the serial numbers for every item on the Pallet.

2. The Pallet Tag / License plating process uses technology-enabled internal controls embedded in the License Plate / Pallet Tag software as follows:

a. Pallet tag initiated by entering a box pre-count b. Boxes are scanned into the system (or dual-blind-hand key) c. The number of serial numbers scanned (or hand-keyed) must equal the

number of the pre-count or the system will not generate a pallet label d. Labeling is done with one-piece flow and all pallets are shrink-wrapped and stored in a locked room to prevent disruption.

Individual Firearms Not Palletized or Pallet Tagged

Inventory of Firearms Not Palletized or Pallet Tagged is conducted using the same pro-cesses outlined in the General Concept of Operations sub-section, above. Ideally, these firearms would be allocated to smaller virtual locations, as no preliminary verification or validation has occurred and the risks associated with scanning or manually entering in-dividual serial numbers without the pre-verification that comes along with Palletization or Pallet Tagging has not been conducted.

A Note on Virtual LocationsIn order to drive accuracy to the highest levels, subdivide your facility into virtual locations (i.e. Receiving, Vaults, and Displays) and into smaller logical areas. This is a virtual exercise and doesn’t require the actual movement of product. The objective for creating these subdivisions is to aid in the count / scan process and to reduce the likeli-hood of completing the inventory while accidentally failing to record some of the assets. The following are hypothetical examples that demonstrate our point.

Example 1: You count 2,000 firearms and determine that 22 are missing. Likely, you will have to re-count all 2,000 to determine if you simply failed to scan them or if they are truly missing.

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Example 2: You divide 2,000 firearms into subgroups by firearm type (Receivers, Shot-guns, Rifles, Revolvers, etc.) and into piles no greater than 500. You determine that 16 revolvers are missing. Rather than re-count all 2,000, you can focus on the one pile of revolvers.

Conducting Your Internal Inventory – Preparation, Planning and ExecutionPreparation for each inventory should begin 14 to 30 days prior to the event. The Licensee should identify an inventory project manager, and a project plan is developed by the overall inventory project manager that includes the following key attributes.

Example: Sample Project Plan with Key Dates

Finalize Team Assignments by Location; Identify Logistical Constraints (30-60 Days Prior)

1. Divide factory into virtual locations and assign team lead (virtual locations are defined later in the document).

2. Identify inventory dates. Inventory should be scheduled during a time your facility can be “offline” for the duration of the inventory and reconciliation period. Do not schedule your inventory during expected “rush periods”, such as just prior to month or quarter end, when you cannot dedicate sufficient time and resources to the inventory process.

3. Ensure sufficient Wi-Fi access in all areas of your facility where firearms are locat-ed if electronic tools are to be used.

Serial Number Inventory Preparation (14-30 Days Prior)

1. Contact supplier facilities and inform them to stop any shipments to the licensed premises as of date “X” (to limit logistics movement).

2. Identify auditor teams (two-person teams are recommended to dual-verify count and serial numbers).

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3. Schedule and hold all-auditor training session training or refresher training.4. Conduct any pre-inventory box-to-gun matching and independent validation.5. Lock-down static areas with shrink wrap and door locks (to ensure lack of move-

ment prior to the inventory date).6. Apply Pallet Tags and License Plates to static areas only; Shrink wrap and vali-

date as discussed previously. 7. Identify reconciliation room or inventory command and control center.8. Obtain any additional technology required for execution (laptops, scanners).9. Gather any additional materials needed, such as: a. Labels or Stickers to Confirm Completed or Counted Areas b. Paper for Pre-Count Sheets c. Paper for Error Reporting Flags

Pallet Tagging and pre-validation are the most time consuming aspects of this phase, and sufficient time and resources should be dedicated to this portion of the evolution. However, there is a near 1-for-1 trade-off on the day of the inventory – for every hour spent pre-validating and pallet tagging, the execution of the inventory (and the ultimate disruption to your logistical operations) will be shortened by one hour.

Organize Facility (1-2 days Prior)

1. Freeze production, serialization, scrap or change in form;2. Process any open scrap (Dispositions);3. Process any open shipments (Dispositions);4. Process any open receipts (Acquisitions);5. Freeze shipping;6. Freeze receiving;7. Freeze A&D Book (e.g., no changes are to be written to the A&D book); 8. Download the frozen A&D Book (if records are kept electronically) the night be-

fore and upload to any technology used to conduct the inventory.

Execute (Day of Inventory)

1. Convene entire team for pre-inventory meeting. A kickoff meeting will be held the morning of the event. All count / scan personnel are required to attend, as well as the reconciliation team and managers or team leaders. During that meeting, all participants will be provided the naming convention for the inventory or a shared drive location for upload of inventory records. All teams are provided with pre-count validation sheets, a tool that is used for visual verification and cross-audit to the software scan and count (i.e., a second check). After the meeting, the groups will disburse and the inventory will commence. (Note that some static areas may have already been assigned pre-count sheets and pre-counted during inventory preparation).

2. Begin inventory. Count, scan, and reconciliation activities are performed as follows.

a. Pre-count firearms by virtual location (physical count of firearms) b. Scan by virtual location (verification of serial numbers) c. Close and report each virtual location (data aggregation) 3. After the close of each virtual location, the area leads or scan teams must visit

the reconciliation room and report.

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4. The reconciliation team will confirm that all areas have been closed in the sys-tem; data files are complete and error-free and perform an independent review prior to closing an area.

5. Once all virtual locations for the factory are complete, the bi-directional book-to-physical report will be run.

6. A preliminary analysis of off-book or discrepancies will be conducted to ensure they aren’t the result of human, system error, etc. For example:

a. A scanner failed to include a pallet located in the corner; b. The same serial number was scanned twice (note: they will also show on the

duplicates report);7. Continue reconciliation as needed/warranted and then report, seek direction from

ATF, etc.

The following is a general list of inventory roles and responsibilities for a medium to large-scale licensee:

Conducting Your Internal Inventory – Reconciliation and Reporting

Once the facility has completed scanning, physical operations remain frozen. No seri-alized activities may restart in the facility until the reconciliation is either complete or down to such a level where operation would not affect its results. Activities not directly impacting non-serialized components may resume.

The reconciliation team lead will download three reports from the Serial Number Inven-tory Tool and hold an immediate meeting with the Value Stream Managers to review:

1. Potential on-book, not scanned;2. Potential off-book, not in A&D;3. Error reports (i.e., duplicate serial number scan or incorrect scan/data

entry errors).

Every single serial number on these reports should be forwarded to a team lead or man-ager for immediate review and reporting back to the Reconciliation Room. Physical proof must be provided and retained to clear a number from the list.

Tasks Responsible Part Options

Overall Inventory Owner Compliance or Operations Manager

IT Hardware (scanners, laptops, printers) Information Technology

Count / Scan Teams Assigned by each virtual location and found in the virtual location table. The individuals who count and scan are manufacturing personnel that work in the factory every day.

Aggregation of Results Compliance (must be an independent group)

Independent Validation Third party to validate work by factory and compliance

Reporting of Results FFL Responsible Person

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Example 1: A firearm was scrapped and for some reason was not disposed, a photo-graph of the cut firearm must be provided.

Example 2: A firearm was shipped and for some reason was not disposed, a con-firmation of acquisition by a subsequent FFL or customer must be provided, along with a photograph of the serial number.

Example 3: A firearm (or pallet of firearms) was not scanned during inventory but are accounted for. A photograph of the firearm must be provided, or the firearms may be scanned or inventoried according to your inventory procedures and an addi-tional data file or amended data file is sent to the Reconciliation Room.

Once the reconciliation has been completed to the fullest extent, the following will take place.

1. A Theft / Loss report will be filed within 48 hours for any firearms not located during the inventory, as required.

2. Acquisition of any off-book firearms is made in the Book of Acquisitions and Dis-positions, as required.

3. All root causes are tracked and assigned to an employee to improve internal con-trols and to eliminate the weakness. Trends are identified and shared back to the operations team. Doing so will bring down future risk of violations.

Conducting Your Internal Inventory – Common PitfallsWith sufficient planning, experience and training, it is possible to conduct a full inven-tory and reconciliation in less than one day. One major manufacturer has repeatedly demonstrated an ability to inventory upwards of 65,000 serial numbers and fully recon-cile the results in less than 12 hours, and in certain cases, within 8 hours. Minimizing the time taken to complete and reconcile your inventory will minimize production or operational downtime. Below are some observed pitfalls which would prevent you from achieving a speedy and accurate internal inventory:

Valuing Speed Over Accuracy – Taking Shortcuts and Not Adhering to Processes

While any business is not making money if it is not “doing its business”, you have already committed to the cost (in terms of time, manpower and technology) to conduct your inventory. If you take shortcuts in the process by abbreviating your planning and organization phases, not spending sufficient time preparing for the inventory or failing to enforce procedures that minimize errors in the inventory process, you will compound your losses – you will end up with time lost to conduct the inventory, inaccurate (and therefore nearly meaningless) inventory data, and the further added expense that it takes to plan and execute a second (hopefully correct) inventory. Additionally, sloppy inventory practices can result in making disclosures to the ATF which may not have been necessary if a thorough and complete inventory been conducted.

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Insufficient Planning, Training or Organization

The amount of time spent planning inventory, training auditors and organizing your facility for inventory should be, in terms of man hours spent, should be at least 2-1 over the amount of time you expect to conduct your inventory. Planning and process docu-mentation can be re-used in subsequent inventories to reduce the time commitment for later inventories and will present a well-polished image to the ATF when you receive your compliance inspection.

Running Operations Immediately Prior to Start of, or During, Inventory

Like the allure of taking shortcuts in inventory preparation or execution, it can be tempt-ing to run operations right up until the start of inventory, or even during the inventory itself. With planning and experience, some licensees have demonstrated an ability to do just this, but only after conducting numerous wall-to-wall inventories first in order to fully understand the limitations on the inventory taking technology and improving the inventory processes and technology to accommodate certain operations. If you are con-ducting your first internal inventory, or utilizing new inventory processes, stick to your project plan and give yourself a full 24-hour stand-down prior to the start of inventory to ensure all manufacturing or distribution sub-processes are complete, system or invento-ry updates have run and your A&D Book is current and fully up to date. Insufficient Time Allocated to Inventory or Reconciliation Process

Give yourself sufficient time to conduct your inventory and reconciliation. In cases where licensees are conducting their first serial number inventory, the reconciliation process can take as long as the inventory itself (or longer!). Be honest with yourself in determining the number of hours the inventory process will take, with respect to the number of items to count and validate, your assessment of the integrity of your records, and available personnel and technology to assist with the process. A general rule of thumb is with a good process but no pallet tags, you should allocate 25 seconds for each serial number for the count.

Insufficient Training of Audit Personnel on Processes and Procedures

Inventory day is not the day to be training your auditors on processes or technology. It is not compatible with “on the job training.” Ensure that all auditors, counters, reconcilers and validators understand their roles, responsibilities and how to execute them. Creating Virtual Locations Which Contain Too Many Firearms

The time penalty for having multiple virtual locations is much lower than the potential time penalty for virtual locations containing too many firearms. Remember: If your virtual location contains 2,000 firearms and you determine that 1 is missing, you will have to re-count all 2,000 in that virtual location to determine if you simply failed to scan it or if it are truly missing. If your virtual location only contain 200 firearms and one is missing 1 firearm, you will still have to count, but the time spent re-counting will be reduced by a factor of ten. It is recommended that you keep your virtual locations to fewer than 500 firearms.

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Combining Other Business Functions with the Serial Number Inventory

It may be tempting to combine other business functions which negatively impact operations with your Serial Number Inventory. Financial inventories, maintenance stand-downs, common vacation periods or other activities may be combined with serial number inventory, but ensure that you will have sufficient resources and time dedicated to each activity.

Conclusion and Final Thoughts

To sum up: 1. Evaluate yourself to the same standards the ATF will evaluate you; 2. Preparation is key; and 3. Allocate sufficient time to both the count and reconciliation portions of

your inventory.

You do not need extravagant software or technology to execute an inventory with a high degree of confidence. Commercially-available software, such as those available from Or-chid Advisors (Serial Number Inventory Tool), Microsoft (Excel or Access), Apple (Num-bers) or public domain software such as OpenOffice can be leveraged to provide basic inventory and reconciliation functionality. In fact, during your compliance inspection, the ATF will often ask for a printed copy of the bound book and conduct your inspec-tion with little more than a copy of your book, a pen, and a highlighter. Technology can make the process faster and easier, but planning, adherence to controls and not taking shortcuts is what will drive accuracy.

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About Orchid Advisors Orchid Advisors assists firearms manufacturers, distributors and retailers in achieving compliance and operational excellence through education, technology, software and consulting solutions that reduce risk, cut costs, and provide expert guidance to make our client’s business more successful and efficient.

Our unique methodology provides process, technology and internal control solutions that achieve all three objectives at once. Our consultants derive their expertise from years served in Fortune 500, Federal Government, Global Business Consulting and Legal environments. Orchid Advisors is the only compliance consulting firm endorsed by the NSSF.

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About NASGWThe National Association of Sporting Goods Wholesalers (NASGW) is com-prised of wholesalers, manufacturers, independent sales reps, media and service providers – both national and international – all of whom are primarily focused on shooting sports equipment and accessories. As a trade associa-tion representing the business interests of its members, NASGW’s mission is to bring shooting sports buyers and sellers together. NASGW also serves as a liaison with other sporting goods associations, including the National Shoot-ing Sports Foundation (NSSF), Congressional Sportsmen’s Foundation (CSF) and the National Rifle Association (NRA). NASGW is also a member of the National Association of Wholesaler-Distributors (NAW). For more information about the NASGW, visit the association’s website at www.nasgw.org.