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Internal Audit of Sub Con Dept of Engg Cos

Vikas Kalyanshetty, ACA 
on 24 August 2009

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Sub Contractor: A subcontractor is hired by a general contractor (or prime contractor) to perform a specific task as part of the overall project. The most common concept of a subcontractor is in building works and civil engineering. The incentive to hire subcontractors is either to reduce costs or to mitigate project risks. In this way the general contractor receives the same or better service than the general contractor could have provided by itself, at lower overall risk.

 
Majority of the large scale manufacturing companies involving extensive Sub Contracting of the work needs to have separate Sub Contracting Department and rightly so, as this department involves various functions which are required to be handled by a distinct department specialized in this activity.
 
Sub Contracting Dept involves various functions such as sending the raw material to the sub contractor, receipt of finished material, excess raw material sent, scrap, leftovers back from the sub contractor, accounting of the same etc. Sub Contracting Department also has to continuously co ordinate with other departments also such as Design Department, Stores, logistics etc.
 
The internal controls of the company must be very strong to operate such a complicated department efficiently. Here, the importance of the internal audit comes in to picture.
 
Functions of the sub contracting department:
 
1.     The function of the sub contracting department starts when the design department sends the part list and the drawings of the finished product which has to be manufactured or processed by the sub contractor. Part list contains all the details of raw material required to be sent, weight and dimensions of the material to be sent, total weight of the finished product which should be received from the sub contractor, order quantity etc. Drawing of the material has the drawing of the finished material prepared by the engineers according to which the sub contractor is supposed to manufacture the finished material.
 
2.     A purchase order is made on a sub contractor, selected through an elimination process, containing the agreed labour charges per unit.
 
3.     Sub contracting department now has to send the raw material to as per the part list to the selected sub contractor. The sent material has to be recorded in the Material Accounting report (MAR) maintained by the department.
 
4.     MAR consists of debit and credit side. Debit side has the weight or any other unit of measurement of the raw material sent. MAR is credited when the material comes back from the sub contractor. The MAR must clearly mention the form in which the material sent has come back into the factory. Following are the forms in which the returned material weight has to be bifurcated:
 
·        Finished Material sent
·        Finished material received
·        Normal Cutting wastage
·        Prime Material (Raw material not used) returned
·        Scrap/Leftovers
·        Balance lying with the party
 
5.     Sub contracting department has to continuously monitor that the material lying with the sub contractor is being properly utilized and there is no wastage of material except the normal loss and percentage of scrap as per the engineering designs and drawings.
 
Internal Audit Functions:
 
1.     First of all Internal Audit department has assign the audit to an auditor having basic knowledge of reading engineering designs and understanding technical terms.
2.     The auditor has to first spend some time understanding the part list and the designs in order to gather knowledge of the product sought to be manufactured or processed through the sub contractor.
 
3.     Check the quotation analysis of the sub con dep’t for selecting the contractor and ensure most cost efficient contractor has been given the order.
4.     Check the PO details and match with the part list details given by the design department. Ensure that the PO terms are not prejudicial to the interests of the company. If all the material has been sent to the sub contractor then the PO should contain only labour charges.
 
5.     Check the debit side of Material Accounting Report to check whether all the material sent has been properly recorded with reference of the delivery note/challan no. Check the delivery notes along with the weighment bridge slips in order to check the weight of the material sent, in case unit of measurement in MAR is in Metric Tons or KGs.
 
6.     Check the credit side to ensure all the material sent has been received in the same quantity and units as it was supposed to be as per the PO. Credit side must have the reference to the Material Receipt Note no.
 
7.     Scrutinise cases of higher scrap percentage and find out the reasons why scrap is higher than the engineering estimates.
 
8.     Reconcile the raw material sent with the finished material received, scrap received and balance excess raw material sent back. Any irregularity should be scrutinized as the possibility of siphoning off of such highly expensive raw material by the sub contractor cannot be eliminated.
 
9.     Ensure the labour charges are as per the PO and the delivery of the material is as per the terms of delivery schedule. In case of delays check if liquidated damages have been recovered as per the terms of the PO.
 
Conclusion:
 
·        Sub contracting department deals with highly expensive raw materials .A tiny loophole in the internal controls can lead to disastrous frauds which eventually may result into incurring of devastating losses.
·        Internal Auditors can be extremely helpful in unearthing such frauds and ensuring stringent internal controls in the company.
 



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Vikas Kalyanshetty, ACA 

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