Background :An engineering company, with a turnover of Rs.350 crores, is into manufacturing and giving services for cooling appliances like air-conditioners — window, split, cascade, etc., refrigerators, water coolers. Its main Stores is at its three factories located at Mumbai, Vapi and Hyderabad. Mumbai factory is the largest factory located at Thane with other two units at Vapi and Hyderabad. Inventory in Stores other than raw materials and capital items is around Rs.3.0 crores at Mumbai and Rs.1.3 crores and Rs.1.2 crores at Vapi and Hyderabad respectively.
The management has directed its outsourced internal audit firm to carry out an internal audit of Stores activity other than raw materials and capital items with a view to comment on the reasonableness of inventory and also to immediately look to areas for cost reduction. The management feels that store procedures are not properly controlled which is leading to lot of cost being incurred in making avoidable purchases, rising inventory holding costs and other issues. The management is of the firm opinion that the processes in Stores could be streamlined and it is looking for a thorough review from the internal auditors.
Methodology :
Based on the above background, the partner-in-charge of the internal audit firm had a meeting with his audit manager to chalk out the audit programme. As a first step, a flowchart of the Stores activity was prepared.
Based on the inputs gathered during the flow-charting process and arising out of the study of the flowchart and the audit manager’s experience, a detailed checklist was also prepared for meeting the audit programme objectives. The checklist identified the objectives for this area — Refer Exhibit 1.
Considering that this audit involved large volume of transactions — the software being used in Stores being an ERP, the traditional method of manual vouching would take a lot of time for the audit. It was therefore decided to use a data analysis software — IDEA to carry out a 100% check on all transactions depending on the objectives (using IDEA, the audit for the Stores activity would take only four to five days for the Mumbai-Thane factory). Additionally back up steps taken in the analysis would also be available in the software.
The methodology followed was therefore to :
à flowchart the process.
à prepare a control checklist.
à pinpoint control weaknesses based on this flowcharting and control checklist.
à conduct a transaction-based audit on a few transactions and documentation.
à use IDEA software to conduct a comprehensive check on all trans-actions based on deviations observed during the manual check on a few transactions — this is with a view to identify comprehensively the extent and value of the deviations to quantify and also to give an assurance to management that other than these transactions there were no deviations during the year.
à give recommendations to make the system robust to avoid controllable costs and enable smooth operations.
Observations arising from the internal audit :
Following the checklist and using IDEA, the audit was completed in a week’s time at the Thane factory. The same audit was to be repeated for Vapi and Hyderabad. Overall there were number of control weaknesses in Stores which were leading to avoidable costs being incurred.
A few major observations on systems and procedures are given below :
1. 40% items valued at Rs.76.0 lacs of the total inventory of Rs.1.5 crores are non-moving according to the ageing analysis of stock furnished by the company. Approx. Rs.9.12 lacs is the interest cost on such Stores @12% interest p.a. and in addition there is invisible carrying cost which is incurred in terms of space and salaries.
(Impact is avoidable cost in terms of ordering and storing items and items deteriorating as these were not required and ordered.
Recommendation is streamlining required in terms of clearance of indents by Production and understanding of these indents and requirements by Procurement).
2. The inventory included items worth Rs.12 lacs which were not issued to the shop floor within 90 days of purchase. It is not clear why these items had been indented as they were not below the standard re-order level. These had been ordered on emergency basis purchases and still not being used — to be investigated further as to indentors and why purchase department allowed purchase of the same. Responsibility for the same to be fixed and also emergency purchase system to be discontinued till the system of indenting is streamlined. The items are stored for a considerable period, again resulting in blocking of funds and high inventory carrying cost.
(Itemwise details are furnished to the company as part of the Annexure attached to the report)
(Impact is improper purchases in the guise of emergency purchases — as quotations are not required for emergency purchases. Additional review is required in terms of quantum of purchases, price, vendors, and why purchases on emergency basis.
Recommendation is to stop such emergency purchases by the present authorised personnel and authority for emergency purchase elevated to directors).
3. Due to improper understanding and utilisation of ERP System, stores and spares consumption cost changes from period to period. Also, valuation of stocks is not properly done and maintained. ERP system is not properly configured and needs review with expert help from outside the company.
(Impact is consumption cost cannot be evaluated for different periods leading to wrong MIS reports and wrong decision-making.
Recommendation is to invite an external expert consultant to set right the system on an urgent basis).
4. No records are maintained for zero value spares (spares received with machinery at the time of purchase of machinery). There are approximately 300 such items. No records of consumption of such items are maintained.
(Impact is the likelihood of loss of such items either intentionally or otherwise and then the company may have to import the spares at a high cost as most of the machinery/equipment is imported from South Korea.
Recommendation — to maintain records of such spares at zero value as part of the inventory).
Conclusion :
Major control weaknesses which had a material impact were highlighted and the system set in motion to prevent such recurrences. This also led to people at each of the units becoming alert to ensure that such deviant behaviour in circumventing the systems and procedures would not be tolerated.
The auditee became conscious of the costs involved and thereby reduced the costs by rationalising procedures and avoiding avoidable overstocking. The excess and non-movable spares were sold and cash brought into the system.
Source:http://www.bcasonline.org/
Helps in understanding roll &importance of internal audit