This document outlines areas that should be covered in an internal audit of a manufacturing company. It discusses 12 key areas: purchases, sales, creditors, debtors, subcontracting, inventory, export incentives, price escalation, cash management, payroll, labor contractors, and a review of management information systems and internal controls. The goal is to evaluate financial records, internal processes, and risks to help management ensure efficiency, effectiveness and compliance.

1. Internal Audit
How to perform Internal Audit of
Manufacturing companies

2. Index
1. Definition
2. Internal Audit: A Statutory requirement
3. Auditing Standard
4. Areas of Audit
5. Each area explained
6. Conclusion

3. Definition
• Frequent or ongoing audit conducted by a firm's
own or independent auditors appointed by the
company to
1. Monitor operating results
2. Verify Financial Records
3. Evaluate Internal Controls
4. Assist Management in increasing efficiency and
effectiveness of business operations
5. To detect Fraud

4. Internal Audit: A Statutory Requirement
• As per Companies Audit Report Order (CARO)
2003 every statutory auditor has to comment
on the companies having
o Paid Up Capital – Rs.50 Lakhs and
o Average Annual Turnover – Rs 5 Crores
o Listed Companies irrespective of above limits

5. Auditing Standard
• ICAI is the statutory body to make auditing
standards. Standard on internal audit is not
yet been published although ICAI is shortly
coming up with it. Exposure draft on the same
can be read on www.icai.org

6. Areas of Audit of Manufacturing Companies.
Purchases
Sales
Creditors Price Escalation
Debtors Cash Management
Payroll
Sub Contracting
Labour Contractors
Inventory – Scrap Review of MIS and
Export Incentives Internal Controls

7. 1. Purchases
To check whether quotations are received from various suppliers.
To check whether Comparative Statements are prepared for each
Purchase Order.
Match the Purchase Orders with the Purchase Requisitions in
respect of quantities.
Receipt of materials is recorded through Material Receipt Note
(MRN) against all Purchase Orders.
To check whether bills are passed after adequate inspection.
Quantity and Rates match with the PO
Check of bills are properly accounted in the books

8. 2. Sales
Scrutiny of contract with the client and ensure that design, supply and
erection phases are properly billed.
Provision of Guarantees/advances
Review Project Status
Check the Billing Break Up as per Contract & Ensure the same is
followed
Collection/ Receivables/ Retention
Taxes & Duties reimbursement from the client
Taxes & Duties in case of Direct Dispatches
All Materials dispatched is billed
Sales Returns
Compare budgeted profit with actual profit.

9. 3.Creditors Review
1. Scrutinize debit balances in creditor's ledger, to
determine the following:
Excess payment
Bill not booked
Advance made but material not received
Whether new advance given to the same party
from which earlier supplies are pending since a
long time.

10. 4. Debtors Review
Check age wise listing of the debtors
Filter out debtors aging more than the credit period
Investigate into the reasons of delay in payments
Ensure the adequacy of the debt recovery measures and recommend
ways to eliminate the inefficiency
Reconcile the debtors as per the branch/site and as per the Head Office.
Accentuate on frequent visits by HO officials/auditors to site/branch in
order to sort out the differences in the amount of debtors and keep a
track on the debt recovery controls.

11. 5. Sub Contracting
Matching bills to Work Order and receipt of material.
Check whether Excise/CENVAT implications
Quotations are invited for new jobs / new contracts.
Material Accounting Report / PO wise Material Accounting Report is
checked with issue and receipt details for reasonableness.
Perform material reconciliation to ensure whether correct credit has
been given for expensive material for e.g. Stainless Steel.
Perform material reconciliation to ensure that input/output ratio's exist
and are reasonable.

12. 6.Inventory - Scrap
• Procedure for selection of party e.g. alternative quotations, tenders etc.
• Whether advance earnest money deposit is given before clearance of material.
• Whether scrap cleared is correct type & weighed before clearance.
• Whether scrap is sold by the subcontractor & proceeds/debit notes received
by the company.
• Whether scrap retained by subcontractor is forwarded to company.
• Whether excise duty has been correctly paid.
• Scrap invoices raised are in accordance with contract rates.

13. 7.Export Incentives
• Correct selection between advance license, duty drawback and DEPB.
• All dutyfree eligible imports under advance license have been fully made.
• Whether all exports made against a particular advance license are properly allocated
thereto.
• All advance licenses are properly redeemed after completion of export
• Review of penalties for not completing export obligation
• Whether AIR (All Industry Rate) for exported item has been claimed as drawback
• Where drawback is claimed on a brand application basis,
• whether all imported items have been properly considered.
• Whether combination of claims i.e part advance license, part duty drawback have
taken place.
• Whether all eligible DEPB claims have been lodged.
• Review of Exim Policy & Procedures together with SION and products eligible for DEPB.
• Whether all export / trading House benefits have been claimed
• Whether deemed export claims have been properly lodged.
• Whether any product exported has any input which is deemed to be imported and
hence eligible for duty drawback Whether incentives for services have been claimed.

14. 8.Price Escalation
• Objective:- To ensure that price escalations are claimed in all eligible sales
components and are claimed correctly.
• Read all contract provisions in general, and in particular for price escalation, to
determine the plan of action.
• Check ceiling on price escalation claimable, in respect of various project price
components and total claims made during the review period.
• Examine the formula provided in the contract, has been applied correctly.
• Check whether the base and current indices for various types of raw material have
been derived from the sources specified in contract and used in the formula
correctly.
• Examine various dates i.e. scheduled date and execution date of work done, used are
correct.
• Check currency conversion factors, in case project price is expressed in foreign
currency.
• Check arithmetical accuracy of calculation of value billed, adjusted price payable by
customer and net adjustment amount (escalation amount).
• Check whether escalation claims are made in respect of billing done, upto the date of
claim/s.
• Review status of claims lodged with the customer with respect to acceptance and
payment of the same.

15. 9.Cash Management
• Identify all the Bank CC Accounts, Current accounts & EEFC Accounts of the company
• Analyze the Daily Bank Balances at the end of the day to find out the monthly unutilized
balance
• Prepare a frequency Distribution Table of daily balances
• Check whether the balances at banks are lying idle over a period of time.
• Find out if there are any loans taken by the company
• Analyze the need for taking loans, if surplus bank balances are in existence.
• Check other investments of the company e.g Fixed deposits. Term Deposits and analyze
the cost benefit of Interest paid on loans vis a vis interest received on FDs

16. 10.Payroll
• Ensure that gross pay paid is in accordance with contract of
employment.
• Payments are made for time spent in the office/factory.
• Payroll calculations are correct.
• Statutory deductions and other deductions are properly
made and paid over to the concerned authorities.
• Payments to contractors are verified in respect of actual
attendance in company premises.

17. 11. Labour Contractors
• Read all the provisions of the contract agreement in respect of maximum number of
laborers required, payment terms etc.
• Check attendance record maintained by the contractor with that of time office.
• Check whether requisition slips for casual labour (i.e extra labour) are authorised.
• Surprise Check the physical attendance of laborers in the company with that of
attendance record at time office.
• Check whether wages/overtime wages/other allowances are paid as per agreement
• Check whether any other deductions like canteen, leave etc. are made as per the
provisions of the contract
• Check whether statutory deductions like PF,ESI etc are properly made and paid by
the contractor & the Company
• Check whether other reimbursements like Service tax/PF/ESI are paid after
producing sufficient documentary evidence.
• Check whether billing for regular and casual labourers are done properly and as per
the agreement.

18. 12.Review of MIS & Internal Controls
 Study the internal control manual of the company
 Check if these controls are followed by all department
 If not then identify the reasons
 Find out loopholes and risks in the system
 Recommend ways to eliminate the loopholes and mitigate the risks
 Draw Flow Charts of the Business process flow
 Draw a flow chart of the inter department document flow
 Study the flow and recommend improvements
 Specifically look for delays in the document flow in any particular
department and find ways to pace up the flow.
 Identify bottlenecks in the business process flow and categorize in the
order of importance and recommend ways to eliminate them to result in
optimum utilization of resources and increased production capacity

19. Conclusion
• These are few of the important areas of internal
audit in any manufacturing company. There can be
many other areas of audit such as Risk Management,
SOX Audit, Indirect Taxes, Direct Taxes etc which I
shall upload very soon.
• There can be no standard audit programme for all
the manufacturing companies but I have tried to put
most common areas to be scrutinized.
• Hope this would be useful for all the readers
concerned with the internal audit