Inventory Audit in India

Inventory audit or stock audit refers to physical verification of a corporation or institution’s inventory assets. There are several sorts of stock audits depending upon the aim and each stock audit would require a special approach. Every business institution a minimum of must perform a stock audit once during a year to update and assure that the physical stock and therefore the computed stock is correctly matched. A stock audit helps to correct discrepancies between the physical stock and therefore the book stock. The stock audit helps to trace the quantity of physical assets remaining and make necessary arrangements to order new stock. If the corporate is handling different suppliers and vendors, a stock audit will make the inventory management process easier.

Why Stock Audit?

• Records accurate level of inventory and help to avoid shortage or overstocking of materials.
• It helps to detect inventory losses caused thanks to wastage, damage or theft.
• It disclose obsolete raw materials and incorrect orders supplied to customers.
• Analyze the particular quantity of stock against that noted on the accounting records.
• Avoid unnecessary investment on raw materials and may help to save lots of money.
• Enable the business owners to know truth financial status of the company.
• Helps to seek out out discrepancies within the packaging and warehouse procedures.

It is very essential to conduct inventory audits to take care of inventory accuracy, spot causes of shrinkage, and make sure that one always have the proper quantity of stock at the proper time. an honest understanding of stock flow also will help make sure the business runs smoothly.

Inventory audit checklist
 The inventory audits have three phases: planning, execution, and analysis. Inventory is one among the important areas for any business where chances of fraud are more as it’s a department where thefts and damages occur. Having effective controls, appropriate processes, proper checklist and regular stock audit is important for this function. Following is that the checklist for Inventory audit:

• Evaluate which items to audit: Higher-risk inventory items should be assessed more frequently. it’s also referred to as ABC Analysis. High-value items are given the grouping of products A, mid-tier are B, and low values are C. ABC analysis also can help to manage a stockroom better and save time. you’ll sort inventory out by SKU (Stock keeping units) or Universal Product Code , then prioritize. Check Stock valuation process, components of cost of inventory, method of valuation.
• Create an audit schedule: map an auditing schedule. Unfortunately, conducting a listing audit can disturb the regular business flow. we would like to settle on times that are least effective for the business, but also happen at an honest frequency to make sure those high-value items are going to be accounted for. The policies and procedures of shopping for and shipping items also can affect the schedule of your audit.
• Physical verification of Inventory: It is that the process of counting each item of inventory. Firstly, we schedule this before time because it’ll likely be an inconvenience to normal business flow. Also, think about using technology, sort of a Universal Product Code scanner, to assist physically count each item and reconcile the counted inventory with ledger .
• Collect the required documentation: Get out any important documents before time and confirm they’re easily accessible, but secure. Categorized inventory in High, Medium and Low value stock.
• Conduct the inventory audit: There are different numbers of audit which will be essential, counting on the character of your business. Check Inventory lying with third parties, i.e. for paperwork , in third party warehouse.
• Record the findings: Stock related MIS format and contents. the most purpose of an audit is to get gaps in compliance and appearance at opportunities to repair the deficit and improve operational processes.
• Reconciling items investigation:If there are inconsistency between inventory counts as per company’s records and therefore the actual amounts on the warehouse shelves then find out why there are differences between these two amounts and make adjustments to the records to reflect this analysis. Inventory reconciliation is extremely important a part of cycle counting.

Inventory stop Process
 Cut off process is an important process in Inventory valuation. When inventory is physically counted and inwards (receipts) and outwards (issues) movement of inventory isn’t stopped, it’s going to cause many difficulties within the counts. this is often why near of the date of inventory counting day, stop the movement of stock. If during this era stock is moved for any reason, it’s likely to affect the inventory count. Auditor requires studying the stop process of management and ensuring it’s adequate.


Source: Inventory Audit in India

Internal controls and Audit of Fixed Assets

 

Fixed assets, in an organization represent the long-term tangible assets which are used,

-to produce and deliver its products or services, and

-to manage its operations.

They are assets held for the purpose of providing or producing goods or services and are not meant for sale in the normal course of business. Therefore, an asset can be classified as a fixed asset or otherwise, depending upon the use to which it is put or intended to be put.

In many capital-intensive industries such as manufacturing, power generation and healthcare, fixed assets represent the largest item on the balance sheet. Historically, fixed assets have received little audit scrutiny and, as a result, some major financial frauds have been perpetrated through significant misstatements of fixed asset balances in the financial statements of public companies.

When asked if fixed assets are represented accurately in year-end financial statements, most organizations will answer with “yes.” However, audits may yield a different answer. Although many organizations do not perform an inventory of current fixed assets and a corresponding reconciliation, these steps provide an essential internal control for the financial reporting of fixed assets.

Moreover, fixed assets need attention to ensure the organization’s records are accurate and its controls provide effective oversight of this area. As with other asset classes, best practices enhance proper accounting, valuations and financial reporting.

Internal Controls over Fixed Assets
Fixed-asset transactions typically represent the acquisition and disposal of assets and the allocation of related costs to reporting periods through depreciation expense. The internal controls over the acquisition of fixed assets include the following:

• Issuance and approval of a purchase order
• Receipt of assets and preparation of a receiving report
• Receipt of an invoice from a vendor
• Reconciliation of the vendor invoice to the related receiving report and purchase order
• Authorization of the payment of the vendor invoice
• Issuance of a check for payment of the vendor invoice
• Posting of the entry in the equipment sub-ledger
• Posting of the equipment sub-ledger activity to the related general ledger control accounts
• Reconciliation of the general ledger control accounts

Audit of Fixed Assets
External Auditors of most manufacturing organizations usually scope in Property, Plant & Equipment (PPE) as a risk area during their annual audit due to its materiality. A combination of controls testing and substantive testing is usually adopted when obtaining audit assurance on PPE.

An auditor should review the system of internal controls relating to fixed assets, particularly the following:

Verification under audit
Verification of fixed assets consists of examination of related records and physical verification. The auditor should normally verify the records with reference to the documentary evidence and by evaluation of internal controls. Physical verification of fixed assets is primarily the responsibility of the management.

Verification of Records

• The opening balances of the existing fixed assets should be verified from records such as the schedule of fixed assets, ledger or register balances.
• Acquisition of new fixed assets and improvements in the existing ones should be verified with reference to supporting documents such as orders, invoices, receiving reports and title deeds.
• Self-constructed fixed assets, improvements and capital work-in-progress should be verified with reference to the supporting documents such as contractors’ bills, work-order records and independent confirmation of the work performed.
• The auditor should scrutinize expense accounts (e.g. Repairs and Renewals) to ascertain that new capital assets and improvements have not been included therein.
• Where fixed assets have been written-off or fully depreciated in the year of acquisition/ construction, the auditor should examine whether these were recorded in the fixed assets register before being written-off or depreciated.
• In respect of fixed assets retired, i.e., destroyed, scrapped or sold, the auditor should examine

(a) whether the retirements have been properly authorized and appropriate procedures for invitation of quotations have been followed wherever applicable;

(b) whether the assets and depreciation accounts have been properly adjusted;

© whether the sale proceeds, if any, have been fully accounted for; and

(d) whether the resulting gains or losses, if material, have been properly adjusted and disclosed in the Profit and Loss Account.

It is possible that certain assets which were destroyed, scrapped or sold during the year have not been recorded. The auditor may use the following procedures to ascertain such omissions:

• Review work orders/physical verification reports to trace any indicated retirements.
• Examine major additions to ascertain whether they represent additional facilities or replacement of old assets, which may have been retired.
• Make enquiries of key management and supervisory personnel.
• Obtain a certificate from a senior official and/or departmental managers that all assets scrapped, destroyed or sold have been recorded in the books.
• The ownership of assets, like land and buildings should be verified by examining title deeds. In case, the title deeds are held by other persons, such as solicitors or bankers, confirmation should be obtained directly by the auditors through a request signed by the client.

Concluding Remarks
In order to help the auditors undertake quality audits and adhere to the audit compliance standards, ICAI has released guidelines advising auditors with regards to conditions that may arise due to COVID-19 pandemic, how they can carefully examine specific circumstances while undertaking audit and assess the risk accordingly. For auditors, it is majorly “remote” auditing, going through virtual data, but continuing to comply with the requirements of standards on auditing.

The COVID-19 outbreak may affect the useful life and residual life of fixed assets which requires management review. In case the expectations differ from previous estimates, then change in estimate should be accounted for in accordance with Ind AS 8, Accounting Policies, Changes in Accounting Estimates and Errors.

It is imperative to ensure that appropriate level of disclosures are done in the financial statements (which in most cases is a judgment call, depending on the facts and circumstances of each case) for the users of the financial statements to understand the impact of pandemic on the company as assessed by the management, Board of Directors and Audit committees.

Source: Internal controls and Audit of Fixed Assets

“Risks” As in Internal Audit

 

Risk-based internal audit is an internal methodology which is primarily focused on the inherent risks involved in the activities or system and provide assurance that risk is being managed by the management within the defined risk appetite level.

Risk is defined as ‘the possibility of an event occurring that will have an impact on the achievement of objectives”. In general, risk management is concerned with positive and negative aspects of risk. The risk can have an adverse impact (downside risk) or it can also have potential benefit (upside risk). It can be applied holistically, and also used on specific activities, from the strategic to the operational.

Types of Risks:
♦ Inherent risk
♦ Control risk
♦ Detection risk

Inherent risk: The risk that could not be protected or detected by the entity’s internal controls. This risk could happen as a result of the complexity of the client’s nature of business or transactions.

Control risk: This is the risk that potential material misstatements would not be detected or prevented by a client’s controls system.

Detection risk: This is the risk that the audit procedures used are not capable of detecting a material misstatement.

Risk Management Framework

Risk management framework (RMF) is structured process to define the strategy for eliminating or minimising the impact of risks, as well as the mechanisms to effectively monitor and evaluate the strategy, for an organisation.

Steps in a Risk Management Framework (RMF)

⇒ Step 1 Identification (Identify potential threats (Risks))
⇒ Step 2 Measurement (Analyze Risks)
⇒ Step 3 Mitigation (Define the strategy for eliminating/ minimising impact of risks)
⇒ Step 4 Reporting & Monitoring (Decide & apply mechanisms to effectively monitor
⇒ Step 5 Governance

Risk Management Frameworks

A number of Frameworks are in use: brief description of some of the commonly used frameworks, is given below.

A. COSO: The COSO framework is one of two widely accepted risk management standards organizations use to manage risks. COSO stands for The Committee of Sponsoring Organizations of the Treadway Commission (COSO). The initial mission of COSO was to study financial reporting and develop recommendations to prevent frauds. This framework is commonly used in the United States and around the world.

The original COSO framework was published in 1992 and later updated in 2013.

5 components of COSO are:

– control environment
– risk assessment
– information and communication
– monitoring activities, and
– existing control activities

17 principles of COSO framework’s effective internal control are:

Internal Control ComponentPrinciplesControl environment1. Demonstrate commitment to integrity and ethical values2. Ensure that board exercises oversight responsibility

3. Establish structures, reporting lines, authorities and responsibilities

4. Demonstrate commitment to a competent workforce

5. Hold people accountable

Risk assessment6.Specify appropriate objectives7. Identify and analyze risks

8. Evaluate fraud risks

9. Identify and analyze changes that could significantly affect internal controls

Control activities10. Select and develop control activities that mitigate risks11. Select and develop technology controls

12. Deploy control activities through policies and procedures

Information and communication13. Use relevant, quality information to support the internal control function14. Communicate internal control information internally

15. Communicate internal control information externally

Monitoring16. Perform ongoing or periodic evaluations of internal controls (or a combination of the two)17. Communicate internal control deficiencies

B. CoCo: The CoCo (Criteria of Control) framework was developed by the Canadian Institute of Chartered Accountants (CICA) in 1995. This model builds on COSO and is thought to be more concrete and user-friendly by some. This framework outlines 20 control criteria that management can use to manage company performance and improve its decision-making.

The CoCo framework outlines criteria for effective controls in the following four areas:

• Purpose
• Commitment
• Capability
• Monitoring and learning

C. COBIT: Stands for Control Objectives for Information and Related Technology. This framework is created by the ISACA (Information Systems Audit and Control Association) for IT governance and management. The COBIT control model guarantees integrity of the information system. It allows to control IT operations of the company so that risk can be minimized and work power enhanced in a disciplined manner. It allows managers to fill the gap between technical issues, control requirements, and business risks.

5. Principles of COBIT:

1. Meeting stakeholder needs
2. Covering the enterprise end to end
3. Applying a single integrated framework
4. Enabling a holistic approach
5. Separating governance from management

Main focus areas of the Cobit are:

• Planning and Organizing
• Delivery and Support
• Acquiring and Implementation
• Monitoring and Evaluating

Risks As in Internal Audit