2 Costing Lens provide check functions on use of Poor Quality material in Manufacturing Concern

Costing Lens provide the check functions on use of Poor Quality material in Manufacturing Concern in Internal Audit

As per Global Manufacturing Risk Index 2021, India has emerged as the second most sought after manufacturing destination across the world indicating the growing interest shown by manufacturers in India as a preferred manufacturing hub over other countries, including the U.S and those in the Asia-Pacific region. The rising focus on India can be attributed to India’s operating conditions and cost competitiveness.

As India has emerged as the second most competitive manufacturing nation, generates an ample amount of opportunities for local players as well as for international players to invest and grow.

India’s sectoral advantages in key manufacturing sectors such as automotive, electronics, industrial machinery, engineering and pharmaceutical are driving employment and contributing to GDP. Apart from this, these sectors are unfortunately facing challenges and among all these challenges are most important and traditional one is manufacturer’s margin.

The things get worse and serious when any deceptive practice intended to produce financial gain from/for a business take place in between, which causes significant losses to the shareholders and creditors of the targeted companies.

There are several forms of fraud which can occur in any business either it be a manufacturing sector, services sector etc. irrespective of its size, its activities & nature.  The impact of fraud is that it hurts the bottom line as well as the reputation of the business, which ultimately shakes the trust of the investor, stakeholders, consumer, employees etc.

Today we are going to focus on frauds in manufacturing sector, as this sector is one of the most sensitive sectors in comparison to others because of huge amount of involvement of manufacturing activities like purchase of raw materials, involvement of numbers of suppliers/agents, huge amount of inventory left out, scraps/defectives, involvement of technology etc.

There are few commonly encountered frauds and it has increased after COVID -19, according to one of the studies disruptions caused by the Covid-19 pandemic have led to 95% of Indian companies being affected by new types of fraud. After work from home concept, companies are exposed to new risks which are related to digital security, after COVID companies were happy by cutting cost but they were not aware that what types of frauds are going to take place in near future. There are few examples of frauds such as tax fraud, Billing fraud, credit card fraud, claiming false qualifications for a job, Material poor quality frauds, securities fraud, and bankruptcy fraud, Insurance fraud, customer & KYC frauds, inventory frauds, cyber frauds etc.

Preventing losses, increasing profitability by Identifying/compromising with quality of material Frauds

Now a day’s what is happening in small or medium class manufacturing companies where there are not a strong quality control checks and systems, poor quality or low graded or sub standard materials is used in production, generation, construction, assembly lines for manufacturing of finished goods.

Poor quality or inferior quality of the material used in manufacturing of the product (Material Quality Fraud). In many of the organization where there is internal quality control system even they are not able to detect poor quality material because the control procedures which are used in the organization can be able to find out defects after completion of the product.

Amongst the above mentioned frauds few of them are very frequently affecting or will affect the manufacturing sectors such as low graded supply of material, theft of inventory frauds, sale of scraps, false identification of defectives etc.

As margins are getting condense, most of the manufacturer’s inclination is towards sub-contracting either be a critical and non-critical production processes to third parties. And that to becoming more dangerous when suppliers were engaged without knowing his financial and reputational back ground in the market and most important is there links within the organization and when they are engaged without proper due diligence they will tend to become more risky for the organization.

Now frauds due to compromise in quality of material is generally due to use of poor quality or sub standard quality of material

Costing Lens to prevent fraud during Internal Audit

A costing of an organization is an insight into costs, efficiency, productivity, profitability and sustainability of various products/segments of the company for enabling the management to assess the performance in the strategic and operational context. The aim would be to discover various drivers of costs and profitability and their impact on the performance variables with the objective of helping the organizations to improve profits and profitability; to optimize efficiency, resource allocation and utilization, to monitor performance of the company.

Calculating costs related to quality problems is not straightforward. Some of the expenses are apparent, but many are not. Quality is a top customer requirement, and lowering costs is key to a profitable business. So, truly understanding the cost of quality warrants the effort. Fortunately, advanced manufacturing technologies can help analyze and understand expenses plus quality problems and escapes.

So to discourage fraud and to detect before its occurrence strong, energetic steps are to be taken, few checks or points need to be analyzed such as:

  • Calculation of Input output ratio
  • Wastage/Scrap ratio
  • Process time involve in production
  • Impact on Machine Efficiency (Hourly production rate)
  • Impact on machines wear & tear
  • Impact on productivity
  • Increased Cost
  • Decreasing base of Customer
  • Increases the legal cases of consumer forum

Calculation of Input output ratio

“Input Output Ratio” represents the raw material used in terms of quantity to generate one unit of finished goods or intermediate goods. As a result of use of poor quality of raw material in production process the output will certainly be affected. Similarly it can also be compared to quantity of fuels, power used which can be obtained by dividing the input of raw materials to output produced or power/fuels utilized to generate one unit of production in each sector. Significant fluctuation or frequent fluctuation in Input coefficients is indicator that something is not in line and which needs to be closely monitored and analyzed. If products with different input structures and unit prices are placed in the same sector (which is known to as a “product mix”), changes in product structures within the sector will change the input coefficients of the entire sector, even if there is no change in input structure or unit price of each product. For example 1 kg of raw material is required to produce 5 units of output, which remains the same until unless there is some compromise with use of quality of raw material used (one of the factors)

Wastage/Scrap ratio

Compare the original waste % with the standards % set for the industry, this will give the management a clear picture about the wastages and is able to analyze the reasons of increase in wastages. By calculating this ratio we will not only be able to track wastage in amount, but also able to calculate in terms of quantity.

Process time involve in production

The operational related consequences of poor quality can include lost time, wasted resources, and decreased efficiency. These could lead to increased production costs and also will lead to a higher cost of repairing. If poor quality of material is used for the production it will certainly increase the rate percentage of wastage and simultaneously it will increase the process time involved in production/manufacturing which ultimately increases the cost of product.

Impact on Machine Efficiency

Anyone can easily understand the impact and effect of poor quality on customer satisfaction, but what about the impact on the manufacturing plant’s process efficiency?  In most processes, raw material quality issues can have a desolating impact. Identification of quality issues with a raw material lot can help a great deal with reducing scrap and downtime. So to prevent this we have to focus on use of hourly production rates etc.

So, an Internal auditor has to check Whether the company has maintained proper records in respect of available & utilized machine hours, direct & indirect labour hours available and actually utilized for production of goods or rendering of services, computation of idle time of machines or labour, and whether the reasons for idle time & shortfalls in actual utilization have been duly analyzed and recorded.

Views expressed are strictly personal. For feedback or queries email us at cmahemendra@gmail.com, kbsaxena_associates@rediffmail.com

Author Bio

Qualification: CMA
Company: K. B. Saxena & Associates (Cost Accountants)
Location: Lucknow, Uttar Pradesh, India
Member Since: 10 Aug 2020 | Total Posts: 2
CMA Hemendra Soni (Managing Partner) K. B. Saxena & Associates (Cost & Management Accountants) FCMA, DISSA, MBA, PGDCA, ID, Dip. in Forensic Audit Cost Consultant, Corporate Trainer, An Educator, A Motivator, Fitness Fanatic H.O. 10/287, Near Gautam Buddha Park, Munshi Puliya, Indira Na View Full Profile

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