nternal Audit of Manufacturing Companies

1. 1. Internal Audit<br />How to perform Internal Audit of Manufacturing companies<br />

Prepared by<br />VikasKalyanshetty<br />CA, B.Com<br />
2. 2. Index <br />Definition<br />Internal Audit: A Statutory requirement<br />Auditing
Standard<br />Areas of Audit<br />Each area explained<br />Conclusion<br />
3. 3. 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 />
4. 4. 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
5. 5. Average Annual Turnover – Rs 5 Crores
6. 6. 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 />
7. 7. 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 />
8. 8. 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 />
9. 9. 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 />
10. 10. 3.Creditors Review<br />Scrutinize debit balances in creditor&apos;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 />
11. 11. 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 />
12. 12. 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&apos;s
exist and are reasonable.<br />
13. 13. 6.Inventory - Scrap<br /><ul><li>Procedure for selection of party e.g. alternative
quotations, tenders etc.
14. 14. Whether advance earnest money deposit is given before clearance of material.
15. 15. Whether scrap cleared is correct type & weighed before clearance.
16. 16. Whether scrap is sold by the subcontractor & proceeds/debit notes received by the
company.
17. 17. Whether scrap retained by subcontractor is forwarded to company.
18. 18. Whether excise duty has been correctly paid.
19. 19. 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.
20. 20. All dutyfree eligible imports under advance license have been fully made.
21. 21. Whether all exports made against a particular advance license are properly allocated
thereto.
22. 22. All advance licenses are properly redeemed after completion of export
23. 23. Review of penalties for not completing export obligation
24. 24. Whether AIR (All Industry Rate) for exported item has been claimed as drawback
25. 25. Where drawback is claimed on a brand application basis,
26. 26. whether all imported items have been properly considered.
27. 27. Whether combination of claims i.e part advance license, part duty drawback have taken
place.
28. 28. Whether all eligible DEPB claims have been lodged.
29. 29. Review of Exim Policy & Procedures together with SION and products eligible for DEPB.
30. 30. Whether all export / trading House benefits have been claimed
31. 31. Whether deemed export claims have been properly lodged.
32. 32. 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 />
33. 33. 9.Cash Management<br /><ul><li>Identify all the Bank CC Accounts, Current accounts &
EEFC Accounts of the company
34. 34. Analyze the Daily Bank Balances at the end of the day to find out the monthly unutilized
balance
35. 35. Prepare a frequency Distribution Table of daily balances
36. 36. Check whether the balances at banks are lying idle over a period of time.
37. 37. Find out if there are any loans taken by the company
38. 38. Analyze the need for taking loans, if surplus bank balances are in existence.
39. 39. 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.
40. 40. Payments are made for time spent in the office/factory.
41. 41. Payroll calculations are correct.
42. 42. Statutory deductions and other deductions are properly made and paid over to the
concerned authorities.
43. 43. 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.
44. 44. Check attendance record maintained by the contractor with that of time office.
45. 45. Check whether requisition slips for casual labour (i.e extra labour) are authorised.
46. 46. Surprise Check the physical attendance of laborers in the company with that of
attendance record at time office.
47. 47. Check whether wages/overtime wages/other allowances are paid as per agreement
48. 48. Check whether any other deductions like canteen, leave etc. are made as per the
provisions of the contract
49. 49. Check whether statutory deductions like PF,ESI etc are properly made and paid by the
contractor & the Company
50. 50. Check whether other reimbursements like Service tax/PF/ESI are paid after producing
sufficient documentary evidence.
51. 51. 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
52. 52. Check if these controls are followed by all department
53. 53. If not then identify the reasons
54. 54. Find out loopholes and risks in the system
55. 55. Recommend ways to eliminate the loopholes and mitigate the risks
56. 56. Draw Flow Charts of the Business process flow
57. 57. Draw a flow chart of the inter department document flow
58. 58. Study the flow and recommend improvements
59. 59. Specifically look for delays in the document flow in any particular department and find
ways to pace up the flow.
60. 60. 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.
61. 61. There can be no standard audit programme for all the manufacturing companies but I
have tried to put most common areas to be scrutinized.
62. 62. Hope this would be useful for all the readers concerned with the internal audit </li>