manufacturing company audit practice.pptx

Manufacturing Industry
audit techniques

4. Manufacturing sector Audit
techniques
4.1 The concept of industry sector
audit
4.2 Understanding the Production
process
4.3 Pre-Audit Analysis
4.4 Specific Auditing Techniques
4.5 Industrial input-output analysis
4.6 manufacturing industries
attributes and issues

The concept…
• this training material contain
audit techniques, common and
unique manufacturing industry
issues, business practices,
industry terminology and other
information to assist tax auditors
in performing examinations.

4.2 Understanding the Production
process
• It is very important to know what
type of manufacturer is the
taxpayer and which cost method
does the taxpayer use. This will
help in determining which
interview questions to ask and in
understanding how the production
process relates to the flow of
documents.

4.2 Understanding…
Types of Manufacturers
.Customer order basis
.Market base Production
.Combination
There are cases where, a taxpayer
may engage in manufacturing and
wholesale business

4.2 Understanding…
• Attention should be noted when
reviewing sales accounts and
selecting accounts of interest for
cost of goods sold, expenses and
assets

4.2.2 Costing Methods for
manufacturing industry
• Calculating the cost of a product
is a cost accounting function that
answers financial accounting’s
inventory-valuation needs and
management accounting’s
decision-making needs (such as
deciding how to price products
and choosing which products to
promote).

4.2.2 Costing Methods…
Manufacturers use one of three
methods for costing
• Job Order Costing
• Process Costing
• Operation Costing

Three Common Features of Cost
Accounting & Cost Management
a)Calculating the cost of products,
services, and other cost objects
b) Obtaining information for
planning & control, and
performance evaluation
c) Analyzing the relevant
information for making decisions

Audit scope, criteria and approach
Audit scope The scope
statement clearly describes
the areas, processes,
activities, or systems that will
be the subject of the audit
and to which the conclusions
will apply

• Audit Criteria Audit criteria are
reasonable and attainable
performance and control against
which compliance, the adequacy
of systems and practices, and the
economy. e.g. generally recognized
industry norms, accepted good
practice, and the taxpayer prior
audit result/compliance level.

• Approach The purpose of
articulating the audit approach is
to ensure that sufficient,
appropriate audit evidence is
collected to enable the drawing of
a conclusion with respect to each
of the audit objectives.

4.3 Pre-Audit Analysis
• The first part of an audit plan is the
pre-audit analysis. This is where
you identify “significant issues”
and determine the potential scope
of the audit. The term “significant”
is dependent on the auditor’s
perception of the tax declaration
as a whole, and the items that
make up the tax declaration.

4.3 Pre-Audit Analysis…
Items to consider when
determining whether an item is
significant include:
• Comparative size of the item;
• Absolute size of the item;
• Inherent character of the item;

• Relationship to / with other items
on the declaration;
• Is the reported income sufficient
to support the taxpayer’s financial
activities;
• Is the profit normal for this type of
business;
• Etc.

Preparing for and planning the audit
are extremely important to ensure
that the audit is completed as
efficiently and effectively as
possible.

Pre-audit planning should include
the following:
• Identification of potential
issues/tax declaration analysis
• Prior year audit finding & industry
information
• Comparative year financial
statements analysis

• Ratio analysis.
• Understand the Accounting
System/Internal Controls
Team leaders should ensure that
auditors are familiar with the
information on case assigned for
audit and that auditors prepare and
use an Audit Plan for each audit.

• 4.3.1 Identification of Potential
Issues/Tax Return Analysis
Every audit should begin with a
thorough analysis of the tax
declaration.
. 4.3.2 Prior Audit: Review the
history to see if there is a prior
audit on the taxpayer. (page No.9)

4.3.3 Comparative Years Analysis
• Changes in amounts from year to
year
• Direction of amount changes
• Types of costs listed.
• Are accounts consistent from year
to year?
• In addition observe if there are any
unusual types of accounts. Are the
appropriate types of costs listed?

4.3.3 Comparative…
• Observe patterns and note
material changes (that is,
direction of an amount change,
account change, material amount
changes, and account
relationships).

4.3.4 Ratio Analysis-
a) Perform preliminary analytical
procedures:
• Auditors perform preliminary
analytical procedures to better
understand the taxpayer’s
business and to assess business
risk.

There are five types of analytical procedures:
• There are five types of analytical
procedures:
• Those ratios that compare client
and industry data,
• Ratios that compare client data
with similar prior period data,

Analytical procedures…
with client-determined expected
results;
with auditor-determined expected
results, and
with expected results using
nonfinancial data.

b) The Objectives of the Financial Analysis
Process
• Prior to embarking on any financial
analysis, the tax auditor should
clarify purpose and context, and
clearly understand the following:
• What is the purpose of the
analysis? What questions will this
analysis answer?
• What level of detail will be needed
to accomplish this purpose?

Financial Analysis…
• What data are available for the
analysis?
• What are the factors or
relationships that will influence
the analysis?
• What are the analytical limitations,
and will these limitations
potentially impair the analysis?

c) Industry norms (cross -
sectional analysis)
• Many ratios are industry specific,
and not all ratios are important to
all industries. Companies may
have several different lines of
business. This will cause
aggregate financial ratios to be
distorted.

c) Industry norms…
• It is better to examine industry -
specific ratios by lines of business
• Differences in accounting methods
used by companies can distort
financial ratios.
• Differences in corporate strategies
can affect certain financial ratios.

c) Industry norms…
• Economic conditions: For cyclical
companies, financial ratios tend
to improve when the economy is
strong and weaken during
recessions. Therefore, financial
ratios should be examined in light
of the current phase of the
business cycle.

4.3.5 Understand the Accounting System
Internal Controls
• The depth of the audit
examination is determined in
great part by the reliability of the
taxpayer's internal control
system.

a) Initial Interview
The initial interview is important because
it provides an opportunity to obtain
valuable information which might not be
available later. Interview the Production
Manager to:
• Understand the product.
• Understand the production process (that
is, steps, job functions, sub contract
functions).
• Identify potential cost types.

a) Initial Interview…
• When do you consider WIP present?
• How is WIP computed and by whom?
What departments are included?
• How do you allocate indirect cost?
• Do you purchase supplies/services
from any related parties?

a) Initial Interview…
• If you use standard cost system,
when are standards updated?
• How do you arrive at your
standard costs?
• How do you account for difference
between standard cost and actual
cost and when?

b) Touring the facilities
• During the tour, it is important to
observe the operation of the
business and its facilities. Keep in
mind the initial interview
responses and any notes made
while pre-auditing the financial
statements of a taxpayer.

c) Questions for the initial
interview
• General Information and
Compliance Questions
• Background
• Records
• Manufacturing Process
• Inventory

c) Questions…
• What kind of controls is used
for pricing and verification?
• Sales
• Purchases
• Fixed Assets

c) Questions…
When you start document
verification after you complete
the entrance conference it would
be advisable to conduct
Preliminary Review (Short
Testing)
For example: Analyze trial balance

4.4 Specific Auditing Techniques
Cost of Goods Sold
General Audit Techniques:
• Understanding the production
cycle
• Understanding how the
accounting system integrates the
production cycle
• Comparative Analysis

4.4 Specific…
• Reconciliations Specific Audit
Techniques/Issues
• What kind of controls is used for
pricing and verification?

c) Understanding Accounting
System of manufacturing
industry
The companies may use a
standard cost system. In this
case, it becomes essential to
understand how the standard
cost entries are integrated
into the basic accounting
system.

Comparative Analysis
• Gross profit ratios
• Cost to cost comparisons. If 3-5
years of cost comparisons can be
performed, it may pinpoint
unusual fluctuations.

Substantiation Test work
• Ordinary and Necessary
• Timing
• Allocations
Factors Affecting Direct/Indirect
Cost Classifications

April 26, 2025 Cost Short-Term Training: Unit Two 43
Factors Affecting Direct / Indirect
Cost Classification
• Cost Materiality
• Availability of information-
gathering technology
• Operational Design

Factors…
• Design of operations
• Confirmations
• Substance
• Cost of Labor
• Other Costs and Deductions
• Standard Cost Variance
Treatment

April 26, 2025 Cost Short-Term Training: Unit Two 45
Cost Behavior Summarized
Cost per Unit
Variable Costs
Change in
proportion with
output
More output = More cost
Fixed Costs
Unchanged in
relation to output
Change inversely
with output
More output = lower cost
per unit
Total Cost Per Unit
Variable
Costs
Change in
proportion
with output
More output = More
cost
Unchanged in
relation to
output
Fixed
Costs
Unchanged
in relation to
output
Change
inversely with
output
More output = lower
cost
per
unit

Cost Behavior…
• Relevant Range – the band of
normal activity level (or volume)
in which there is a specific
relationship between the level of
activity (or volume) and a given
cost
– For example, fixed costs are
considered fixed only within the
relevant range.

Cost Accounting:Short-Term Training
Accounting Distinction Between
Costs
• Inventoriable costs – product
manufacturing costs. These
costs are capitalized as assets
(inventory) until they are sold and
transferred to Cost of Goods Sold.
• Period costs – have no future
value and are expensed as
incurred.
Saturday, April 26, 2025 47

e) Packing materials
• Primary Packing Material: Packing
material which is essential to hold the
product and bring it to a condition in
which it can be used by or sold to a
customer.
• Secondary Packing Material: Packing
material that enables to store,
transport, inform the customer,
promote and otherwise make the
product marketable.

e) Packing…
• Cost of primary packing materials
shall form part of the cost of
production. These materials are
essential to hold the product and
bring it to a condition in which it
can be used by or sold to a
customer.

e) Packing…
• Primary packing materials are of
various types and their use varies
with industry to industry. For
example:

e) Packing…
• Pharmaceutical industry:
Insertions related to product,
Foils for strips of tablets /
capsules, vials.
• Industrial gases: Cylinders /
bottles used for filling the
gaseous products.

4.5 Industrial input-output analysis
• Manufacturing industries/other
sectors often produce secondary
products either as joint products
or as by-products apart from the
primary products.
• Waste, Scrap, Spoil and Defect

Waste
This is a loss connected with raw
material or inputs to the production
process and usually means to refer
that input has been lost due to any
reason either because of its
• nature of the material itself,
• nature of the process or
• some other conditions

Scrap
• This is a loss connected with the
output. Most of the time at the
end of production/conversion
process such outputs is
generated that were not intended
but cannot be eliminated due to
nature of material or process
itself.

Spoil
• This is also a loss connected with the
output. In the production process if the
output is produced which is not up to
the quality standard due to any
problem and now the product cannot
be brought back in good state even
after further processing or
reprocessing or it is simply not feasible
to do so then such output is called
spoil or spoiled output or spoilage.

4.6 manufacturing industries
attributes and issues
• there are many other areas where
industry information and industry
specific audit techniques can
make a substantial difference in
the final result of the tax audit
process.

5. Materiality
• concept of materiality
recognizes that some
transactions have a greater
impact in a given situation and
therefore warrant greater
attention.

Materiality…
Materiality for tax audits is
dependent on three factors:
• the monetary size of the
transaction in relation to the size
of the business;
• the implication of the tax
legislation on the transaction; and
• The nature or status of the item.
04/26/2025 58

Materiality…
• Materiality must be determined on a
case-by-case basis
• factors for consideration when
determining materiality
 the taxpayer operations
 cost vs. benefits
 inherent and control risk
 reason for the audit
 consistency
04/26/2025 59

Materiality…
• It is an expression of relative
significance or importance of a
particular matter in context to
financial statements/ Declaration
for specific type of tax.

Factors Affecting Judgment
• Materiality is a relative rather
than an absolute concept.
• Bases are needed for evaluating
materiality
• Qualitative factors also affect
materiality
04/26/2025 61

Non-monetary Factors to Consider
Non-monetary factors should be
considered when determining the
materiality of errors and
omissions. Factors to consider
include:

Non-monetary…
• Filing history of the taxpayer
• the taxpayer compliance history
• the effect of assessing or not
assessing on future compliance
• the effect on related and/or
associated persons

6. Audit evidence
• 6.1 Audit evidence should be
sufficient, reliable, relevant, and
useful in order to support their
audit findings and conclusions.
• Evidence:-Something that is
intended to prove or to provide
support for some belief.

6.2 Methods of Obtaining audit
evidence
• Inspection
• Observation
• Inquiry and confirmation
• Computation
• Analytical review

6.5 Reasonable assurance for tax
audits
• Auditors shall obtain sufficient
and appropriate evidence to
provide reasonable assurance
that the findings of the tax audit
have reasonably determined the
tax liability of the taxpayer.

6.6 Methods of Documenting –
Working Papers
• Working papers are the
supporting documentation for the
entire audit – they are the
mandatory for the accumulated
audit evidence.

Working papers- used to:
• Justify and provide proof of work
carried out
• Help auditors respond to questions
about coverage or results
• Facilitate supervisory quality
assurance reviews and
• Provide supporting evidence when
review committee or other reviewers
want to rely on the results.

7. Relationship of Taxpayer and
Auditor
• throughout the course of the audit
the taxpayer is expected to
receive fair, courteous, and
professional treatment. There is
no occasion for the auditor to
harass or to impress the taxpayer
with the thought that the object of
the audit is to find something
wrong with the filed declarations.
04/26/2025
69

Relationship…
The auditor should maintain an
objective attitude, tempered by the
fact that we are dealing with human
beings. To the extent possible, the
auditor should:
. Encourage a cooperative attitude by
being cooperative
.Trustworthiness and a strong sense
of ethics are assets of a tax auditor.
04/26/2025 70

Common challenges during audit
 Few taxpayers will have
technologically accounting
systems that allow for very
detailed records of sales and
purchases. They may describe the
quantities purchased and the
price paid each time. But they
don’t provide an access for all
information in system.
04/26/2025 71

Challenges…
 Other taxpayers will not have a
structured purchase journal, but
may only have invoices and
cancelled checks.
Taxpayers or their representatives
caused many of the them delayed
in providing information and in
responding to tax office requests
for information.
04/26/2025 72

Conclusion
• The purpose of this manufacturing
industry audit approach is to
provide:
• To provide how any audit team
must approach to know about
specific industry
• A guide for conducting and
coordinating the audit work to be
done

manufacturing company audit practice.pptx

More Related Content

Similar to manufacturing company audit practice.pptx

More from Leul28

Recently uploaded

manufacturing company audit practice.pptx