Assignment on the responsibilities of internal audit department

The ordinary role of internal audit is to provide:

- An independent assurance service to the board (here in after The Chairman) focusing on
reviewing the effectiveness of the governance, risk management and control process that
management has put in its ordinary course of business.

- Advice to the board on governance risks and controls.

Benefit of internal audit:

Internal audit can contribute to independent assurance on the overall risk management, control and
corporate governance process. It can also be a useful catalyst for change and improvement within the
organization. It’s an important tool for the management to manage the misconducts including fraudulent
activities within the organization in its ordinary course of business.

My plan and activities considering the current status of Talisman ltd is:

• To recognize the different ordinary cycle of the business such as: the sales cycle, purchase cycle,
production cycle, treasury cycle, HR cycle etc.

• To review the scope of each of the complete cycle and determine the current status of control,
underlying risk associated with the cycle.

• To point out the effective controls and to determine the control weakness of the cycles.

• To review the necessary published manuals and policies such as the accounting manual, HR
manual, procurement manual, segregation of duties policy, the fixed asset policy etc.

• To formulate a comprehensive scope of internal audit department’s guidelines partly proactively

and partly reactively that is appropriate for the business of Talisman ltd, with the help of my team
members.

• To update or where necessary to create a manual for each cycle in a manner that may enhance the
operating effectiveness of the ordinary course of business. To do this I will pick the references of
 renowned multi-national companies manuals and policies that I observed and retained for further
references and practical application.

• To follow up the existing accounting system of the company, its reporting style to management
and will put necessary recommendation where appropriate.

Understanding the cycle and related control and the internal audit team’s contribution on that
cycle (only the purchase cycle is illustrated below due to scope limitation):

Proposed cycle:

A purchase cycle usually consist all the purchase of the business including the fixed assets,
inventories and others. The standard procedure should be more or less the following flow chart:

Step 1: An approved purchase requisition (PR) from the end user department should be delivered to
procurement department.

Step 2: Procurement department will check the requisition in accordance with the budget and other
factors and takes necessary approvals from the management to procure the item.

Step 3: Procurement department, after proper approval will offer the approved suppliers (if any) or
different suppliers to send quotations for the approved proposal to purchase.

Step 4: Procurement department will collect at least 3 suppliers quotation and prepare a comparative
statement in accordance with the specification required and value approved. The procurement
department will also consider the quotations in terms of value for money (VFM).

Step 5: Procurement department must take the approval from the respective management for the
selected supplier and send an approved purchase order (PO) in accordance with the proforma invoice.

Step 6: an L/C is opened and the supplier will deliver the goods (for foreign and EPZ territory
procurement).

Step 7: After the arrival of goods upon the reception of delivery note (DN), a clearly identifiable
goods received note (GRN) is issued by the store in charge.

Step 8: Commercial Invoice is received and approved by the end user department or procurement
department after due verification and passed to the treasury department for payment procedure.

Control points:

1. Approval of the appropriate responsible person for the PR from end user department.
 2. Budget reconciliation and approval of the appropriate responsible person from the
procurement department.

3. Fair quotation submission channel on which management should have necessary involvement.

4. Approval of comparative statement by the top level management.

5. Approval on PO by respective management.

6. Approval or acknowledgement of store in charge in DN and GRN.

7. Approval of Commercial invoice.

Internal Audit department’s responsibilities on purchase cycle:

Internal audit department will ensure the operating effectiveness of the control points. The
department will have some tool to do so. It may include the checking of necessary approval, to
consider the appropriateness of the transaction, to comply 3 way match principle (by reconciling the
PO-Commercial Invoice-GRN).

Accounting perspective and control in usage of inventory and fixed assets:

1. Recording process of inventory, fixed assets and payables.

2. Valuation process of inventory and fixed assets

3. Usage of store ledger and BIN card.

4.Inventory obsolescence and write off policy.

5.Monitoring the production process.

6.Periodic count of physical existence of inventory and fixed assets.

Internal Audit department’s responsibilities on purchase cycle:

 Internal audit department will follow up the proper recording process of inventory and fixed assets
to ensure the proper reporting of financial position and performance to the top management. In the
course of continuous follow up it will also be monitored whether the applicable accounting
standards are complied and whether it is beneficiary for the company to meet up the reporting
requirement of various regulatory bodies. The department will also conduct a periodic physical
verification of inventory and fixed assets and review the fixed assets register and store ledger and
BIN card position for the given period

[NB: The above illustration is not covered the other cycle’s characteristics and role for internal audit
department. It is provided only upon the discussion with the management of Talisman ltd. It may
make a sense to management about my understanding of the responsibilities of an internal audit
department.]

Date for booking of the purchase of imported material

Query No. 3

Subject: Date for booking of the purchase of imported material.1

A. Facts of the Case

1. During the course of audit of accounts, the statutory auditors of a company observed that the imports
by the company are being booked at the exchange rates at which the bank debits the company on the
day of retirement of documents and not at the exchange rate prevalent on the date of the ‘transaction’ as
required under Accounting Standard (AS) 11, ‘Accounting for the Effects of Changes in Foreign Exchange
Rates’. The auditors are of the view that the date of transaction is the date on which significant risks and
rewards associated with the ownership are transferred. According to the auditors, the date of transaction
is as under:
(i) In case of FOB contracts – The date of Bill of Lading
(ii) In case of CIF contracts – The date of arrival of ship at destination AS 11 has since been revised. The
revised AS 11 comes into effect in respect of transactions entered into by the reporting enterprise itself or
through its branches, after 1.4.2004 and is mandatory in nature from that date.

(iii) In case of C&F contracts – The date on which the ship leaves the port of loading.
The statutory auditors are of the view that the difference between the exchange rate on the date of
transaction as defined above and the date of payment should be booked in ‘Foreign Exchange
Fluctuations Account’.
2. The company has contended that the ‘date of transaction’ has not been defined in AS 11. In case of
imports under sight Letter of Credit (LC), the Bill of Lading or Airway Bill is made in favour of the bank
which opens the LC. The documents are endorsed in favour of the company on the date of payment.
Accordingly, the bank which opens the LC has a lien on the goods until the documents are retired by the
company. In case of loss of goods during transit, the bank has also got a lien on the insurance claim.
Therefore, in case of all imports under sight LCs, the date of transaction is the date of retirement of
documents. In case of usance LCs, the date of acceptance of usance bill when the documents are
endorsed by the bank in favour of the company should be considered as the date of transaction and the
exchange fluctuation between the date of acceptance and the date of payment at the expiry of usance
period should be charged to the ‘Foreign Exchange Fluctuations Account’.
3. According to the querist, if the dates of respective transactions as defined by the statutory auditors for
different types of contracts are adopted, it may be a departure from the letter and spirit of AS 11. There
will also be practical problems, if the date of sailing or arrival of ship is taken as the date of transaction. All
imports are not by chartered vessels only. There are many import transactions of small quantities. There
is no record available for the date of sailing of the ship at the port of loading or the date of arrival at
destination for each import transaction. Secondly, no authentic exchange rate is available for a particular
date. The exchange rates differ from minute to minute and from transaction to transaction. The exchange
rates printed in newspapers differ from each other. The exchange rates quoted by different banks and
their card rates are not the same. Which source of exchange rate is to be relied upon is not indicated in
AS 11.
4. The querist has referred to paragraphs 3, 5 and 6 of AS 11 which, inter alia, provide as below:
“3. A multiplicity of foreign exchange rates is possible in a given situation. In such a case, the term
‘exchange rate’ refers to the rate which is applicable to the particular transaction.”
“ 5 . A transaction in a foreign currency should be recorded in the reporting currency by applying to the
foreign currency amount the exchange rate between the reporting currency and the foreign currency at
the date of the transaction ....”
“6. A transaction in a foreign currency is recorded in the financial records of an enterprise as at the date
on which the transaction occurs, normally using the exchange rate at that date. This exchange rate is
often referred to as the spot rate. For practical reasons, a rate that approximates the actual rate is often
used ....”
5. According to the querist, the provisions of AS 11 do not suggest that exchange rate for accounting of
imports be based on the dates of bills of lading, sailing of ship or arrival of ship at destination port. The
intention of AS 11 is to record foreign currency transactions as close to reality as possible. Ignoring the
reality and adopting exchange rates far from reality for accounting purposes will be a non-compliance of
AS 11. Therefore, the querist is of the view that the foreign exchange transactions for imports be
accounted for on the following basis:
(i) Transactions under sight LCs be booked at the actual exchange rate allowed by the bank on retirement
of documents.
(ii) In case of usance LCs, the import value may be calculated at the exchange rate on the date of
acceptance of usance bill. For this purpose, the exchange rate may be collected from the bank through
whom the LC was opened.

B . Query
6. The querist has sought the opinion of the Expert Advisory Committee as to what should be the
accounting treatment of import transactions to comply with AS 11 in the facts and circumstances of the
case.

C. Points considered by the Committee

7. The Committee notes paragraphs 3, 5 and 6 of AS 11 as reproduced in paragraph 4 above.

8. The Committee is of the view that the date on which a transaction is considered to have taken place
depends upon the nature of the transaction. For instance, Accounting Standard (AS) 9, ‘Revenue
Recognition’, issued by the Institute of Chartered Accountants of India, lays down principles with regard to
timing of recognition of revenue, i.e., the time when (date on which) revenue from sale of goods,
rendering of services, etc., can be recognised.
9. The Committee also notes that AS 9 lays down in respect of sale of goods, that revenue should be
recognised when (apart from fulfillment of other conditions laid down in this behalf) the seller of goods has
transferred to the buyer the property in the goods for a price or all significant risks and rewards of
ownership have been transferred to the buyer and the seller retains no effective control of the goods
transferred to a degree usually associated with ownership.
10. The Committee further notes paragraph 12 of the Guidance Note on Audit of Expenses, issued by the
Institute of Chartered Accountants of India, which provides as below:
“.... The auditor should pay particular attention to the cut-off procedures relating to purchases, both
indigenous and imported, to determine whether these procedures ensure recognition of purchases at the
time the significant risks and rewards of ownership of the related goods pass on to the entity.”
11. The Committee is of the view that from the view-point of the buyer, a transaction of purchase of goods
should be recognised when the property in the goods or all significant risks and rewards of ownership
have been transferred to the buyer and the seller retains no effective control of the goods transferred to a
degree usually associated with ownership. In case the transfer of property in the goods and the transfer of
all significant risks and rewards of ownership do not take place concurrently, the timing of recognition of
the purchase should be determined considering the substance of the transaction, i.e., the purchase
should be recognised when all significant risks and rewards of ownership are transferred to the buyer.
12. The Committee is of the view that the point of time when all significant risks and rewards of ownership
pass on to the buyer depends on the terms and conditions of the contract. The Committee is, therefore, of
the view that the dates on which all significant risks and rewards of ownership in cases of FOB, C&F and
CIF contracts are transferred should be determined keeping in view the terms and conditions of each
contract. The aforesaid dates should be considered as the dates of respective transactions provided the
condition of measurability of the amount of consideration is satisfied. The Committee is further of the view
that the rates published by a reliable source for the day can be used.
13. The Committee notes paragraphs 9, 10 and 11 of AS 11 which provide as below:
“9. Exchange differences arising on foreign currency transactions should be recognised as income or as
expense in the period in which they arise, except as stated in paragraphs 10 and 11 below.
10 . Exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed
assets, which are carried in terms of historical cost, should be adjusted in the carrying amount of the
respective fixed assets. The carrying amount of such fixed assets should, to the extent not already so
adjusted or otherwise accounted for, also be adjusted to account for any increase or decrease in the
liability of the enterprise, as expressed in the reporting currency by applying the closing rate, for making
payment towards the whole or a part of the cost of the assets or for repayment of the whole or a part of
the monies borrowed by the enterprise from any person, directly or indirectly, in foreign currency
specifically for the purpose of acquiring those assets.
11 . The carrying amount of fixed assets which are carried in terms of revalued amounts should also be
adjusted in the manner described in paragraph 10 above. However, such adjustment should not result in
the net book value of a class of revalued fixed assets exceeding the recoverable amount of assets of that
class, the remaining amount of the increase in liability, if any, being debited to the revaluation reserve, or
to the profit and loss statement in the event of inadequacy or absence of the revaluation reserve.”
14. The Committee is of the view that the exchange difference(s) should be recognised as income or
expense, or as an adjustment to the carrying amount of related fixed assets, depending on the nature of
the item to which the exchange difference(s) pertain, as per the requirements of AS 11 as reproduced
above.

D. Opinion
15. On the basis of the above, the Committee is of the opinion that the transactions of import should be
recognised when all significant risks and rewards of ownership pass on to the company provided the
condition of measurability of the amount of consideration is satisfied. Accordingly, the dates on which all
significant risks and rewards of ownership in cases of FOB, C&F and CIF contracts are transferred should
be determined keeping in view the terms and conditions of each contract. Further, the Committee is of the
opinion that the difference between the exchange rate as at the date of the transaction and as at the date
of settlement thereof should be recognised as income or expense, or as an adjustment to the carrying
amount of related fixed assets, depending on the nature of the item to which the exchange difference(s)
pertain, as per the requirements of AS 11.
1 Opinion finalised by the Committee on 26.3.2002.