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Total Number of Subscribers: 464 |
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Date: 11th Aug 2009 |
Compiled by: M Sathya Kumar |
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Background : The
top management of the engineering company has been extremely happy with
the performance of the outsourced internal audit team for the Stores
activity (details given in the article in earlier issue of the Journal).
The management wants the internal auditors to now assess the procurement
activity in terms of process improvements with optimal controls,
compliance with laid down systems and procedures and cost rationalisation.
The engineering company, whose turnover is 350 crores, is into
manufacturing and giving services for cooling appliances like
air-conditioners — window, split, cascade etc., refrigerators,
water coolers. The
auditee has three units, the largest factory located at Thane with other
two units at Vapi and The
management feels that there is scope of improving the procurement activity
procedures leading to cost rationalisation. The
management aim also includes ac-curacy in financial reporting, compliance
with applicable laws and regulations. The management objectives are also
part of the three pillars of the ‘Integrated Framework — Internal
Controls’ by COSO (Committee of Sponsoring Organisations of the Tread-way
Commission), 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 ‘procurement activity’ was
prepared. Based
on the inputs gathered during the flowcharting process and the flowchart,
a detailed checklist was prepared for meeting the audit programme
objectives. The check-list identified the objectives for this area —
Refer Exhibit 1. Exhibit 1 : 1.
Have purchasing authority limits been established, and what mechanisms
prevent such limits being exceeded ? 2.
Are adequate purchasing procedures in place and what processes ensure that
they are maintained up-to-date ? 3.
How can management be assured that purchase orders are issued only from
authorised sources ? 4.
What mechanisms prevent the processing of purchase orders without
established policy conditions ? 5.
Are all purchase orders formally justified and suitably authorised, and
how is this evidenced ? 6.
Are purchase orders adequately
sup-ported with sufficient details, descriptions,
specifications, prices, delivery location and freight terms in order to
ensure that the precise requirements of the business are
met ? 7.
What processes prevent the despatch of inaccurate, incomplete or
ambiguous purchase orders ? 8.
What processes prevent the raising and despatch of duplicate purchase
orders ? 9.
What mechanisms ensure that optimal quantities of goods are ordered to
support the operational requirements of the business ? 10.
What mechanisms ensure that all sub-sequent purchase order amendments are
valid, authorised and correctly applied ? 11.
What mechanisms are in place to prevent over-ordering of
items ? 12.
How are potential vendors selected and what prevents the use of poor
quality vendors ? 13.
How can management be certain that
the purchasing function fully researches the optimum
sources for their require-ments ? 14.
Are vendors adequately and inde-pendently assessed for ‘approved’ status,
and what prevents staff/vendor misuse of the process ? 15.
Are accurate and up-to-date records of
approved/suitable vendors maintained, and what mechanisms
prevent either unauthorised or invalid access or amendment of such
records ? 16.
Is the performance of vendors monitored against all requirements and
expectations so that unsuitable, unreliable or poor quality suppliers can
be promptly identified and
ap-propriate action taken ? Further, whether
there is a suitable vendor rating mechanism and vendors are intimated of
their ratings every six months/year ? 17.
Would management be alerted if there was either undue preference being
given to a specific vendor, an unreason-able demand
being placed on any one vendor or the potential for an
unethical relationship being established between
a vendor and purchasing management ? 18.
Is there adequate liaison between the purchasing function and all other
affected activities (i.e. production, sales, stock control, etc.)
and how are problems and conflicts avoided ? 19.
Does the purchasing function maintain an adequate awareness of market
conditions, prices, etc. in order to ensure the placement of orders at the
optimum price ? 20.
How can management be sure that all available discounts are suitably
exploited ? 21.
Where applicable, are all relevant purchase versus leasing options
adequately appraised to ensure that the most advantageous purchase terms
are utilised ? 22.
How can management be certain that all the required quality and standards
for supplied goods are achieved ? 23.
Would the supply of sub-standard, inadequate or poor quality goods be
detected ? 24.
Are all rejected and returned goods correctly identified and a suitable
credit claimed and accounted for ? 25.
How can management be certain that all the goods ordered and invoiced have
in fact been received on time ? 26.
Are the processes of ordering, account-ing and receiving goods adequately
segregated to prevent staff malpractice ? 27.
Where goods are obtained from over-seas suppliers, how can management be
certain that all the relevant import and foreign exchange regulations have
been identified and correctly addressed ? 28.
Are management provided with ac-curate, timely and relevant information on
purchasing activities to support their decision-making,
etc. ? Considering
that this audit involved large volume of transactions — the
software being used in procurement 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 procurement 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, to : 1.
flowchart the process 2.
prepare a control checklist 3.
pinpoint control weaknesses based on this flowcharting and control
checklist 4.
conduct a transaction-based audit on a few transactions and
documentation 5.
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 6.
in addition as will be seen from a few observations — external
evidence was also collected from vendors in the form of
quotations/statements for corroborating the internal incon-sistencies
observed 7.
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 two weeks time
at the Thane factory. Two more days were spent in collecting external
evidence from vendors. Since ‘Procurement’ was a
central function, visit to Vapi and A
few major observations on systems and procedures are given
below : 1.
Purchase from dealers rather than manufacturers : Materials
were purchased from dealers, rather than from manufacturers. This led to
an extra cost of Rs.7.8 lacs as worked out
from Excise Gate Passes. The study established,
in some cases dealer’s margin amounted to 25% to 30%. (Manufacturers
give Excise Gate pass which is given to customers based on dealer price
and dealers negotiate some more margin to this price based on credit
terms, freight and marketing costs. The procurement function should ensure
that this margin is not high as the dealer enjoys incentives in the form
of turnover discount, various schemes from manufacturer). Recommendation — Prices
should be negotiated with the dealers. Possibilities of sourcing materials
directly from the manufactueres should be investigated. Cost
savings — Based
on this input from internal audit, the cost savings were around Rs.5.6
lacs. 2. Quotations not available from all approved
vendors : o
For raw material-formulation and packing material-formulation, quotations
are not available from all approved vendors. In turn, no
Quotation Comparison Sheets (QCS) have been prepared. Each purchase should
have Quotation Comparison Sheet. Recommendation — Quotations
should be obtained from more than one supplier, and QCS should be prepared
for all orders. Monopoly suppliers should be listed separately, and
specific sanction of ‘pro-curement’ committee should be
obtained. (Process
improvement suggestion). 3. Order finalisation by Purchase
Committee : Benchmark
for Purchase Order finalisation by Purchase Committee has
been established at Rs.50 lacs and above. Purchase Order analysis shows
that only 17 out of 512 Purchase Orders are above Rs.50 lacs during
January 2003 to May 2003. Recommendation — There
is a need for increasing number of orders being finalised by Purchase
Committee. The base may be reduced in the range of Purchase Orders of
Rs.10 lacs and above. (Process
improvement and cost savings suggestion — Stricter review will
lead to better control for major purchases. Action — The
base was revised to Rs.10 lacs and above for all Purchase Orders. This
revised base was also incorporated in the SOP — Standard
Operating Procedure —effective from 1st June 2003). 4. By-product
being sold at Re.1/- per MT, basically to one buyer, while the value of
the by-product is much more in the market (The market price was known to
the internal auditor as similar by-product was sold by another
client). All
by-product was sold to one dealer without inviting tenders. Examination of
earlier years’ records revealed that by-product had been sold at an
average price of Rs.200 per MT, and the same was sold to two or three
dealers in a year. This
being the case, the internal auditor, with permission from his partner,
ap-proached three vendors in the market directly, including two who had
supplied earlier, and obtained quotes for the by-product. Sample was drawn
from the factory and supplied to these buyers. On receiving the quotes
directly from vendors it was observed that the quotes were in the range of
Rs.200/- to Rs.220/- per MT. The
main reason of this lapse was that by-product sale was not considered to
be a purchase activity and was outside the purview of the Purchase
Committee. Though transactions were huge, senior officials did not pay
attention to the systems and procedures being followed in terms of
quotations, vendor analysis, etc. This led to a junior Purchase Official
and Stores-in-charge (who certified the disposal) conniving and ensuring
that this was handed out at almost no cost to a supplier. The
matter was brought to the attention of the Materials Head, Finance
Director and CEO. They blacklisted the existing vendor, investigated
further and sacked one Purchase Officer and Stores-in-charge and also set
up the systems and procedures recommended by the internal
auditor. Recommendation — (Cost-savings
and systems streamlining suggestion). Other observations were : 1.
Indents pending with procurement function for more than a month and not
converted to Purchase Orders. 2.
Advances given to vendors but material not supplied for over two to three
months. 3.
Materials received more than the Purchase Orders but still accepted in
Stores and payment made for the same. Tolerance limits for excess material
were not specified in the Purchase Orders. Vendors therefore started
taking advantage of this and dumping excess material since they knew that
this would be accepted and not returned back. 4.
Freight not being negotiated properly with vendors and vendors starting to
charge extra at higher rates under the guise of freight. 5.
Cases observed where the bought-outs supplied by the vendor and the labour
job undertaken from another vendor; also in actual effect was the same
vendor in two different names and the same not communicated to Purchase
Committee. Conclusion : Based
on the thorough review and sug-gestions by the internal auditors, the
management strengthened the processes leading to a robust procurement
process and thus considerable savings to the company. Article by Deepak Singal and Manish paplia chartered accountants | |
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