Audit Trails and maintaining a Log – Understand with a Scenario

Summary: Audit trails are essential for ensuring transparency and compliance in business operations, particularly under Indian laws. According to the Companies Act, 2013, businesses using accounting software must have an audit trail feature, recording all transactions without modification, and maintaining logs for at least eight years. Other laws, such as the Income Tax Act and GST Act, mandate record retention for six and five years, respectively. Regulatory bodies like SEBI also require companies to implement audit trails. The failure to comply with these regulations can result in hefty penalties. A scenario at ABC Limited, a washing machine manufacturer, demonstrates how an effective Procure-to-Pay (P2P) process integrates audit trails. Key steps such as procurement planning, vendor selection, goods receipt, and invoice processing are recorded in the system, ensuring transparency and preventing fraud. By using Internal Financial Controls (IFC) and audit trails, the company improves efficiency, prevents errors, and ensures compliance with tax and regulatory requirements. This case study illustrates the importance of maintaining accurate audit logs to avoid potential financial discrepancies and legal issues.

Audit Trail Requirement Under the Different Laws (India)

The audit trail requirement for companies is primarily governed by the Companies Act, 2013, and the Companies (Accounts) Rules, 2014, as well as Income Tax and GST Laws in certain cases.

1. Companies Act, 2013 & Accounting Software Requirement

• Rule 3(1) of the Companies (Accounts) Rules, 2014) (Amended):
  • Every company using accounting software for maintaining its books of accounts must ensure that the software has an audit trail feature.
  • The audit trail must:
    • Record each and every transaction.
    • Not allow modification or deletion of the audit log.
    • Be retained for a minimum of 8 years.
• This requirement was deferred multiple times but became mandatory from April 1, 2023.

2. Income Tax Act, 1961 – Rule 6F (For Tax Audit Cases)

• Businesses required to maintain books under Section 44AA & Tax Audit (Section 44AB) must ensure:
  • Books of accounts and supporting documents are preserved for 6 years from the end of the assessment year.

3. GST Act – Rule 56(18) (Electronic Records)

• Businesses maintaining records in electronic form must:
  • Retain audit logs for the period required under GST laws (5 years from the due date of filing annual return).

4. SEBI & Other Regulatory Requirements

• Listed companies & SEBI-regulated entities must have an effective audit trail system under SEBI (LODR) Regulations and other compliance frameworks.

and many more applicable laws like Rule 6 (1) CERT-In (Cybersecurity Guidelines, 2022) , Section 8,9,13 Digital personal data protection act 2023,  Section 65B Indian Evidence Act. 1872,Sec.7,65,66,72A Information Technology Act ,2000,payment and Sec, 5 and 6  Settlement systems Act 2007, Sec. 12 Prevention and money laundering Act 2002 etc.

Penalty for Non-Compliance

• Companies Act Violation:
  • Penalty of ₹50,000 to ₹5,00,000 for the company.
  • Officers in default may be fined between ₹5,000 and ₹50,000.
• Income Tax & GST:
  • Disallowance of expenses or penalties for non-maintenance of proper records.

Now understand the Audit Trail with the help of an example

P2P Process with Audit Trail & IFC in a Washing Machine Manufacturing Industry (ABC Limited)

Company Overview: ABC Limited

ABC Limited is a washing machine manufacturing company that procures raw materials such as steel sheets, plastic components, motors, and electronic control panels from various suppliers. The company follows a structured Procure-to-Pay (P2P) process to ensure transparency, efficiency, and compliance with Internal Financial Controls (IFC).

Step-by-Step P2P Process in ABC Limited

1. Procurement Planning & Requisition

• The production department identifies the need for raw materials (e.g., motors and plastic covers).
• A Purchase Requisition (PR) is generated in the ERP system (SAP).
• PR is sent to the procurement team for approval.

Audit Trail & IFC Control:

• Every PR is logged in the system with a timestamp, requestor name, and approval hierarchy.
• Ensures no unauthorized purchase requests are raised.

2. Vendor Selection & Purchase Order (PO) Creation

• The procurement team sends Request for Quotation (RFQ) to pre-approved vendors.
• The procurement manager evaluates quotations based on cost, quality, and delivery time.
• A Purchase Order (PO) is created and approved by the finance team.

Audit Trail & IFC Control:

• Vendor selection process is documented with a comparative analysis report.
• PO approval workflow prevents unauthorized vendor selection.
• PO details (vendor name, quantity, price, payment terms) are logged in SAP.

3. Goods Receipt & Inspection

• The vendor delivers washing machine motors to ABC Limited’s factory.
• The warehouse team verifies the delivered goods against the PO and prepares a Goods Receipt Note (GRN).
• The quality control team inspects motors for defects.
• If any defect is found, a rejection note is sent to the vendor.

Audit Trail & IFC Control:

• GRN is recorded in SAP with batch numbers and timestamps.
• Ensures that goods received match the ordered quantity and quality standards.
• Prevents fraud (e.g., over-invoicing or fake receipts).

4. Invoice Processing & Three-Way Matching

• The vendor submits an invoice for the delivered motors.

The accounts payable team performs a three-way matching:

✔ PO (Purchase Order)

✔ GRN (Goods Receipt Note)

✔ Invoice

• If all details match, the invoice is approved for payment.
• If discrepancies exist (e.g., excess invoicing), the invoice is put on hold for resolution.

Audit Trail & IFC Control:

• The three-way match is recorded in SAP, ensuring payments are made only for valid transactions.
• Prevents duplicate invoices and unauthorized payments.
• Any invoice mismatch is flagged in the system for resolution.

5. Payment Approval & Processing

• Once the invoice is verified, the finance manager approves the payment.
• Payment is made via bank transfer (NEFT/RTGS) as per agreed terms (e.g., 30 days credit).
• A payment confirmation is sent to the vendor.

Audit Trail & IFC Control:

• Payment approvals are documented in SAP with approver details.
• Bank payment records are linked to invoice numbers.
• Prevents unauthorized or early payments before due date.

6. Reconciliation & Reporting

• Monthly reconciliation of vendor accounts is conducted.
• The finance team ensures that all POs, GRNs, and invoices are correctly accounted for.
• Management receives reports on procurement efficiency and vendor performance.

Audit Trail & IFC Control:

• Reconciliation ensures no missing payments or duplicate invoices.
• Vendor performance reports help in negotiating better pricing.
• Ensures compliance with statutory audit requirements.

Final Summary of Audit Trail & IFC in ABC Limited’s P2P Process

Key Benefits of Audit Trail in ABC Limited’s P2P Process

√ Fraud Prevention: Ensures all transactions are approved and documented.

√ Regulatory Compliance: Meets financial regulations like GST, TDS, and statutory audits.

√ Efficiency & Accuracy: Reduces manual errors and improves transparency.

√ Cost Control: Prevents overpayments and duplicate invoices.

By integrating audit trails and IFC controls into the P2P process, ABC Limited ensures a secure, efficient, and compliant procurement system that enhances financial integrity.

I will also incorporate the Real case study so as to understand the concepts in a logical manner in the upcoming posts.