Internal Audit<br />How to perform Internal Audit of Manufacturing companies<br /> Prepared by<br />VikasKalyanshetty<br />CA, B.Com<br />
Index <br />Definition<br />Internal Audit: A Statutory requirement<br />Auditing Standard<br />Areas of Audit<br />Each area explained<br />Conclusion<br />
Definition<br /><ul><li>Frequent or ongoing audit conducted by a firm's own or independent auditors appointed by the company to </li></ul>Monitor operating results<br />Verify Financial Records<br />Evaluate Internal Controls<br />Assist Management in increasing efficiency and effectiveness of business operations<br />To detect Fraud<br />
Internal Audit: A Statutory Requirement<br />As per Companies Audit Report Order (CARO) 2003 every statutory auditor has to comment on the companies having<br /><ul><li>Paid Up Capital – Rs.50 Lakhs and
Listed Companies irrespective of above limits</li></li></ul><li>Auditing Standard<br />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<br />
Areas of Audit of Manufacturing Companies.<br />Purchases <br />Sales <br />Creditors<br />Debtors<br />Sub Contracting<br />Inventory – Scrap<br />Export Incentives <br />Price Escalation<br />Cash Management<br />Payroll<br />Labour Contractors<br />Review of MIS and Internal Controls<br />
1. Purchases<br />To check whether quotations are received from various suppliers.<br />To check whether Comparative Statements are prepared for each Purchase Order.<br />Match the Purchase Orders with the Purchase Requisitions in respect of quantities.<br />Receipt of materials is recorded through Material Receipt Note (MRN) against all Purchase Orders.<br />To check whether bills are passed after adequate inspection.<br />Quantity and Rates match with the PO<br />Check of bills are properly accounted in the books<br />
2. Sales<br />Scrutiny of contract with the client and ensure that design, supply and erection phases are properly billed.<br />Provision of Guarantees/advances <br />Review Project Status <br /> Check the Billing Break Up as per Contract & Ensure the same is followed <br />Collection/ Receivables/ Retention <br />Taxes & Duties reimbursement from the client <br />Taxes & Duties in case of Direct Dispatches <br />All Materials dispatched is billed <br />Sales Returns <br />Compare budgeted profit with actual profit. <br />
3.Creditors Review<br />Scrutinize debit balances in creditor's ledger, to determine the following: <br />Excess payment <br />Bill not booked<br />Advance made but material not received <br />Whether new advance given to the same party from which earlier supplies are pending since a long time.<br />
4. Debtors Review<br />Check age wise listing of the debtors<br />Filter out debtors aging more than the credit period<br />Investigate into the reasons of delay in payments<br />Ensure the adequacy of the debt recovery measures and recommend ways to eliminate the inefficiency<br />Reconcile the debtors as per the branch/site and as per the Head Office. <br />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.<br />
5. Sub Contracting <br />Matching bills to Work Order and receipt of material.<br />Check whether Excise/CENVAT implications<br />Quotations are invited for new jobs / new contracts.<br />Material Accounting Report / PO wise Material Accounting Report is checked with issue and receipt details for reasonableness.<br />Perform material reconciliation to ensure whether correct credit has been given for expensive material for e.g. Stainless Steel.<br />Perform material reconciliation to ensure that input/output ratio's exist and are reasonable.<br />
6.Inventory - Scrap<br /><ul><li>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.
Scrap invoices raised are in accordance with contract rates. </li></li></ul><li>7.Export Incentives<br /><ul><li>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. </li></li></ul><li>8.Price Escalation<br />Objective:- To ensure that price escalations are claimed in all eligible sales components and are claimed correctly. <br />Read all contract provisions in general, and in particular for price escalation, to determine the plan of action. <br />Check ceiling on price escalation claimable, in respect of various project price components and total claims made during the review period. <br />Examine the formula provided in the contract, has been applied correctly. <br />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. <br />Examine various dates i.e. scheduled date and execution date of work done, used are correct. <br />Check currency conversion factors, in case project price is expressed in foreign currency. <br />Check arithmetical accuracy of calculation of value billed, adjusted price payable by customer and net adjustment amount (escalation amount). <br />Check whether escalation claims are made in respect of billing done, upto the date of claim/s. <br />Review status of claims lodged with the customer with respect to acceptance and payment of the same. <br />
9.Cash Management<br /><ul><li>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</li></li></ul><li>10.Payroll<br /><ul><li>Ensure that gross pay paid is in accordance with contract of employment.
Payments are made for time spent in the office/factory.
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. </li></li></ul><li>11. Labour Contractors<br /><ul><li>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. </li></li></ul><li>12.Review of MIS & Internal Controls<br /><ul><li>Study the internal control manual of the company
Check if these controls are followed by all department
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</li></li></ul><li>Conclusion<br /><ul><li>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 </li>