Introduction : Raj Sawhney, the Internal Auditor of ABC Limited — a family-owned large diversified conglomerate had in a short span of time established Internal Audit as a frontline staff function within ABC which was slowly being integrated in the core business activities. Their scope was sought to be expanded to include overseas operations. The Audit Committee was discussing the activities in their 5-year old venture in the US. A large amount of sum was blocked in Inventory in their US businesses. Hitherto, the audit was being done by a large outsourced audit firm. Looking at the performance of Raj’s audit team, the Audit Committee was confident that they could perform the overseas audit well. They partially reduced the scope of the outsourced firm and introduced the in-house team from India for the audit.
Methodology : Raj had the flexibility in his team in terms of qualifications that suited the new request from the Audit Committee. In addition to being a Chartered Accountant, he had a CISA, CPA — himself, CIA (Certified Internal Auditor) and Engineers in his team. Given the need for localised knowledge, he built up a team consisting of himself, a senior audit manager, who was an engineer and a recently joined CIA. They decided that in addition to audit quality, they could demonstrate to the management the cost effectiveness of the audit team efforts from India without compromising on quality. As a measure of the same, they brainstormed on the ways and means to achieve this objective. The team also listed out various audit objectives. Shantanu took up the initiative to set up audit tests which could be run locally in India, based on data downloaded from the servers of the US Company. It was decided that the visit to the US should be limited to physical verifications, manual document checking, security evaluations and softer issues identifiable through interactions. The audit team on this assignment changed their audit timings and started their day from evening 9.00 p.m. coinciding with the day in the US. Coordinating with the US team, they understood the activity and the way it was captured by the application software. There were 885 product lines in the database with depots located in Detroit, Dallas and Denver. Shifting back to Indian day timings, they initiated the audit using the tool. They listed out the various audit objectives that they wanted to meet. They sought access rights to the tables and wherever access was limited, the audit team requested for information from the IT.
Those issues that were highlighted using CAAT’s are given hereunder.
Calculations check :
As a first step towards arriving at stock values being reported, an audit objective to verify stock values was taken up.
Errors in MIS :
Considering the concern of the Audit Committee on the stock levels, the first test was to verify the accuracy of the report presented to the Audit Committee. Using data available in the application software, the audit team obtained the stock valuation report as on the last date of the year. They were surprised to find a significant variation from the reported stock figures. The values were higher than those reported in the MIS.
During discussions with the Corporate MIS, it was identified that the team used to download data and then submit for inclusion in MIS. In this process, there was an error in copying data. They also requested the soft copy of the MIS spreadsheet.
Data from the spreadsheet was compared with figures as per the application software system and the specific differences worked out. The team identified the difference and did not disclose it to the US corporate team, keeping it pending for discussion during the visit.
Stock valuation check :
Data pertaining to stock movements was then obtained. The values were also obtained. Based on the movements, the stock values were worked out for all the items. The company was following weighted-average method for valuing stock. On recalculating the figures, an analysis of the values was carried out in the descending order.
The engineer in the team was surprised to find 1 ‘C’ class item and 5 ‘B’ class items in the first 50 items. The ledger was obtained for these items and a detailed analysis was carried out. It appeared that one large consignment of these B & C class items was bought 6 months back to fulfil an order on hand at that point of time. This material was lying in stock although the order was executed. A further analysis showed that the items were rejected and lying in stock and not returned to the vendor.
A physical verification of these items was then carried out. There was a 50% gap between the stock as per books and as per that physically available. On enquiry, it was identified that this material was issued as an alternative as there was an urgency in that order. As a result of this, during the audit period, there were a number of free-of-cost deliveries of the alternative product required to be sent, resulting in a huge loss to the company not just in monetary terms, but also in terms of reputation.
Inventory analysis :
Aging of inventory was done using the Aging feature based on date of receipt.
Based on the total sales and purchase of items, the number of months inventory was computed. Items where the volumes exceeded the norms were listed out for clarifications.
Inventory was stratified into value bands to understand the pattern of stocking vis-à-vis the A B C classifications, as they existed. Variations to the norms were further extracted and analysed for discussions.
The stock adjustment entries were isolated using extraction function and then scrutinised further.
The analysis was forwarded to the indentors to identify the reasons for requisitioning the items and not utilising the same. The feedback was analysed and was to be taken up for discussions during the visit.
Validity tests :
Inventory levels :
The company had a policy of maintaining inventory levels. The level master file was joined with the stock files. Using field manipulation and the comparative ‘if’ conditional statement, the difference between the stock levels and the level master was calculated in a new field. Using display functionality, all those items where the difference was less than minimum levels and more than maximum levels were isolated. This list was then forwarded to the US Office for clarifications.
Items with expired shelf life :
The inventory master contained details on the shelf-life settings. Using the receipt date details in the inventory transactions file, the shelf life of items in stock was calculated. The Master was then joined to the transactions file. The differences in the master ‘shelf life’ and transactions ‘shelf life’ were then calculated. Those items where the shelf life had been exceeded were isolated for further analysis.
Items from group companies :
The inventory transaction file had data on the supplier. A list of group companies was available in a spreadsheet file. The transaction file was joined with the inventory transaction file to create a list of all group company transactions. A quick summary of these transactions on item codes was carried out. This file was then joined with the inventory level file. In 2 out of the 5 top items with high inventory, it was largely on account of group company transactions. A desk research on th
is group companies was carried out. It was identified that these companies had business difficulties and one of them, which was listed, was also facing a drop in market capitalisation. It appeared that these were accommodation sales. This aspect was studied in detail and the case noted for discussion during the visit.
Gaps and duplicates :
Using the feature of identification of gaps and duplicates, a check was carried out on the receipt notes, requisition slips, issue slips, return notes, adjustment notes and rejection notes. Those identified in the same were to be taken up for discussion.
Using the analysis done offline in India, the auditors were able to focus their energies during a short visit on the core-concern areas and arrive at conclusions that were startling. Considering the focus on accountability in the US with the Sarbanes-Oxley legislation, the CEO and the CFO were taken aback at the status of internal controls in their organisation. Emergency measures to establish an elaborate exercise for implementing a robust internal control system with self- ssessment questionnaires was taken. Considering the success that Raj and his team had in meeting these new challenges, the management asked Raj whether his team would take this assignment in addition to the audit responsibility, which he gladly accepted. This resulted in considerable cost savings. Further, looking at the tremendous cost savings and approach towards auditing by Raj and his team, a performance bonus was sanctioned.