Internal Audit

How to perform Internal

Audit of Manufacturing
companies

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

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

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

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

Areas of Audit of
Manufacturing Companies.
Purchases
Sales
Creditors
Debtors
Sub Contracting
Inventory Scrap
Export Incentives

Price Escalation
Cash Management
Payroll
Labour Contractors
Review of MIS and
Internal Controls

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

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.

3.Creditors Review

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.

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.

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.

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.

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.

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

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.

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.

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

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