FM 7-2 Audit compliance

8/7/2019 FM 7-2 Audit compliance

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Power Finance Corporation Ltd.(A Govt. of India Undertaking)

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Financial Management of Distribution Management Distribution Reform, Upgrades and Management (DRUM) Training Program

Case Study – Cost Audit CompliancePisupati Karthikeya, Emerging Markets Group, Ltd

Ashok Kumar is an Accounts Officer working in the accounts compilation section of thecorporate office of an electricity distribution company. He receives a file from hisController of Accounts containing the enquires issued by the Auditors on the draftaccounts of the Company for the year 2004-05.

“The Controller of Accounts has made the following remarks on the file:-

a) Review the audit observations and propose suitable journal entries (wherever required) to ensure compliance.

b) Bring out the impact of the journal entries on the P&L account and the Balancesheet of the company.

c) Examine the implications from the angle of regulatory accounting.d) Suggest remedial measures to avoid recurrence of such mistakes

Complete the work in 3 hours time and resubmit the file”.

Following are the audit observations:-

1. Account Group 14- Capital works in progress.

This does not include the following bills/materials issued to the works, which

pertain to the year 2004-05 but paid subsequent to March 2005.

J.E.No. & date Particulars Bill No. & firm Amount (Rs.)

02/9.4.2005 Issue of Materials Inter unittransaction21.3.2005

27,830

05/23.4.2005 Erection bill NLM64/15.12.2004

49,382

11/30.4.2005 Labour contractbills

All 10 bills pertainto March 2005

1,97,998

Total 2,75,210

This has resulted in understatement of Account Head 14 series-CWIP andAccount Head 46 series-Provision for liability for expenses.

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2. Capitalization of assets- Buildings

Amount capitalized during the year from cost register in respect of Work Order No. 14/SDE/1103 dated 13/6/2004 is Rs. 4,85,300 as against the actual

expenditure of Rs 8,45,300 booked in the cost register. This has resulted inunderstatement of AH 10 series-Buildings and overstatement of AH 14 series-CWIP Buildings by this amount.

3. Provision for unbilled revenue for March 2005

On a review of provision for unbilled revenue for March 2005 in respect of HighTension installations, it was observed that, an excess amount of Rs. 1,57,973has been provided in excess of the actual demand as shown below.

Tariff Unbilled revenue

provided for

Actual demand as

per DCB

Difference

(Rs.)HT-1 1,48,605 1,49,031 (426)

HT-2(b) 2,46,121 1,05,725 1,40,396

HT-5 41,521 23,518 18,003

Total 1,57,973

This has resulted in overstatement of unbilled revenue to the exRs.1,57,973. Account Head for Revenue from sale of power HT category is 61series and the Account Head for provision towards unbilled revenue is 23 series.

4. Miscellaneous recoveries

As per the terms of PPA entered with a generating company, the company isentitled to a rebate of 0.05% for prompt payments. As per the audit note issuedby the internal auditor of the company, the rebate recoverable from the generator for the year 2004-05 is Rs.20.12 lakhs. Non-consideration of rebate in theaccounts of the company for the year has resulted in overstatement of AH 41series-sundry creditors for purchase of power and understatement of AccountHead 62 series-Miscellaneous recoveries by Rs. 20.12 lakhs

5. Power purchase from IPP

The company began purchasing power from the IPP which commcommercial production from 1st September 2004. Between September and March05, the company purchase 45.100 million units. On receipt of monthly bills, thecompany released adhoc payments which was charged to the power purchasedaccount. As against Rs. 16 crs. of adhoc payments made for power purchasedduring the year 2004-05, the actual amount billed and payable by the companyworks out to Rs. 23.27 Crs.(Fixed cost Rs. 12.00 Crs & variable cost Rs.11.27

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Crs.). The company has not provided for the balance amount of Rs.7.12 Crs. inits accounts, resulting in understatement of AH 70 series-Power purchase andAH 41 series-Sundry creditors for purchase of power. Had the company followedthe merit order dispatch approved by the regulator is company should havedrawn only 38.000 Mus.

6. Ex-gratia payable to employees

A division has made a provision of Rs.3,83,000 towards ex-gratia payable to theeligible employees. Against this provision, the correct amount payable isRs.3,33,000 only. This has resulted in overstatement of AH 75.5 series and AH44.3-ex-gratia payable. However, the regulatory commission for the purpose of ARR does not consider the ex-gratia payable as a legitimate expenditure anddisallows the same while approving the ARR of the company.

7. Depreciation on Plant and Machinery

This does not include Rs. 50,140 being the short provision of depreciation onlightening arrestors. The division has calculated the deprecation at 7.84% insteadof 12.77% per annum. Out of the short provision, Rs.12,535 pertains to thecurrent year and the balance amount relates to previous years. This has resultedunderstatement of AH 77 and 83 series (prior period) – depreciation on plantand machinery and AH 12 series -provision for depreciation.

8. Inter Unit Accounts

AH 37-IUA materials include Rs. 80,000/- being the expenditure incurred by

CEE Corporate for repairs of power transformers and transferred to the O&Mdivision for acceptance of Advice of Transfer and debiting the final head of account. Non-acceptance of AT by the division by crediting the IUA account of corporate office has resulted in understatement of AH 74 Series-R&M expenses

9. Advances to suppliers (interest bearing)

The company proposed an advance of Rs. 14,00,000/- to a supplier againstsupply of materials. Against this amount, the supplier took an advance of Rs.12,00,000 from the company in April 2004 (AH 25.5 series- Advances tosuppliers-interest bearing). The advance paid by the company to the supplier

carried on interest of 12% P.A. Against this amount, the supplier suppliedmaterials worth Rs. 6,20,000 & repaid Rs 1,80,000 of advance along with theinterest at applicable rate on 31st December 2004. While finalizing the year endaccounts, the accounting unit concerned has not accounted for the interest dueon the balance amount for the period form January to March 2005. This resultedin understatement of income by Rs. 12,000/- under AH 62 series- Miscellaneousrecoveries and AH 28 series-Sundry debtors for other miscellaneous income.

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10.Incorrect sanction of estimate.

An estimate prepared by the division for release of an existing assets andreplacement by a new one contained three parts.

Part-A Estimate for releasing the existing asset (Original value of the AssetRs. 20,000/- (AH 10 series), Accumulated depreciation Rs. 6,000/- (AH 12series) & WDV of the asset Rs.14,0000 (AH-16 series).Part-B Labour charges for dismantling the existing asset (AH 77.5) Rs. 3,000/-Part-C Estimate for commissioning of new asset Rs.40,000/-

Time for completing the work: One month from 1st September 2004.

Estimate was sanctioned for Rs. 23,000 i.e. (Rs. 40,000 value of new asset-Rs. 20,000 original value of released asset + Rs. 3,000/- labour charges for

dismantling). While sanctioning the estimate, one single Work Order No. 4246was assigned (instead of assigning distinct numbers viz. 4246 A, 4246 B and4246 C for each of the parts). As a result of this error, the accounts section of thedivision has made the following mistakes

a) opened one folio in the cost/works register & has booked all the transactionsb) upon completion of the work, has capitalized the work for Rs. 23,000/- and

transferred to asset account (10 series) by crediting CWIP (14 series)

The audit points are:

a) Estimate should have been sanctioned in three parts duly assigning separateWork Orders.b) When an existing asset is released, the asset account at original value has to

be credited duly debiting the WDV of fixed assets and provdeprecation.

c) Labour charges for dismantling of the existing asset is revenue expenditureand should directly be debited to 77.5 series.

d) Estimate for creation a new asset should be sanctioned under AH 14 –CWIPand the cost register should reflect only the capital expenditure incurred for new asset.

e) As a result of not following the above procedure:

- Rs.20,000 being the original value of the existing fixed asset is creditedto AH 14-CWIP instead of AH 10- Fixed Assets.

- Rs. 3,000 being the labour charges for dismantling is debited to AH 14instead of 77.5 series.

- Rs 23,000 is transferred to asset account from CWIP instead of Rs.40,000.

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11.Deposit contribution works

There is a difference of Rs. 3,28,830/- between the balance as per general ledger /trial balance and the balance as per cost/works register. This needs to be

reconciled.

12.Stock shortage pending investigation

The company on 31st March 2005 ordered dismissal of an employee from servicewith immediate effect & to recover the stores shortages amounting to Rs.3.48 lakhsfrom his assets in movable and immovable properties by taking immediate legalaction. In view of the above order and considering the amount involved, adequateprovisions should have been made in the accounts towards the above sum whicharrears doubtful of recovery

13.Non-maintenance of voltage class wise asset registers

The company is not maintaining the asset registers on the basis of the voltage classof the assets, through the regulatory commission has given a directive that theCompany has to provide information regarding voltage-wise break up of FixedAssets and accumulated depreciation by ensuring that the deficiencies in theaccounting system are rectified.

14.Accounting of Material Cost Variance (MCV)

Material Cost Variance is accounted by the Company at the time of payment to

suppliers and not at the time of purchase when standard rates are applied to thematerials brought. As a result, the Company to the extent of unpaid materials is notaccounting the MCV on accrual basis and the quantification of the same is notarrived at.

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Answer

a) Review of audit observations and passing of Journal entries

Out of 14 audit enquiries journal entries are required to be passed for first 10 audit

enquiries. For enquiry no. 11 to 14 our reply will be:

(i) AE No.11: The reconciliation is in progress. Work will be completed shortlyand audit will be informed.

(ii) AE No.12: Since the employee was dismissed with effect immediate effect onthe last working day of the financial year, the company is not in a position toimmediately identify the movable and immovable properties of the employeeand quantify the same on the date of the balance sheet. Besides, anyprovision for write off of this amount would dilute the stand of the companyany may affect the legal proceedings against the employee. In view this

situation, we have to request the audit to drop the audit para.

(iii) AE No.13: Company is not maintaining the asset registers on the basis of thevoltage class of the assets. Besides complying regulatory requirement, thesedetails are also required for the Cost to Serve study. The company needs toinitiate necessary measures to address this requirement.

(iv) AE No.14: Currently the company is accounting MCV at the time of passingbills of the suppliers. If the company has to comply the requirement of audit,i.e. accounting MCV on accrual basis, it needs to change its accountingmethodology by issuing fresh instructions to the field units, b

examining providing of additional account code in the Chart of Accounts.

Journal Entries (In Rupees)

JVNO.

A/CGroup(followed byactivity codenumbersspecific tothe activity)

Journal Entries to be passed in the Booksof the Company

Debit Credit

1 14----

46----

Capital works in progress A/CDr.

To Provision for liability for expenses A/C

(Being accountal of short provision as pointedby auditors vide their audit enquiry no.-------)

2,75,210

2,75,210

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2 10----

14----

Fixed Assets A/CDr.

To Capital works in progress A/C

(Being the difference between the amountalready transferred to asset account & theactual amount that should have beentransferred to asset account now accountedas per auditors observation vide their auditenquiry no.-------)

3,60,000

3,60,000

3 61----

23----

Revenue from sale of power -HT A/CDr.

To Provision for unbilled revenue A/C

(Being the removal of excess provision madetowards unbilled revenue from HT category asper auditors observation vide their auditenquiry no.--)

1,57,973

1,57,973

4 41----

62----

Sundry creditors for purchase of power A/CDr.

To Miscellaneous recoveries A/C

(Accounting of 0.05% rebate due formprompt payment from generator as per auditors observation vide their audit enquiryno.--)

20,12,000

20,12,000

5 70----

41---

Power purchase A/CDr.

To Sundry Crs. for purchase of power A/C

(Accounting of short provision of power purchase cost payable to the generator as per auditors observation vide their audit enquiryno.--)

7,12,00,000

7,12,00,000

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6 44----

75.5---

Ex-gratia payable to employees A/C Dr.

To Ex-gratia A/C

(Removal of excess provision of ex-gratiapayable to employees as per auditorsobservation vide their audit enquiry no.--)

50,000

50,000

777----83----

12---

Depreciation A/C Prior period expenses-Depreciation Dr.

To Provision for depreciation A/C

(Accounting of short provision of depreciation

on lightening arrestors as per auditorsobservation vide their audit enquiry no.--)

12,53537,605

50,140

8 74----

37---

R&M expenses A/C

To Inter Units Account

(Accounting of R&M expenses transferred bythe corporate office as per auditorsobservation vide their audit enquiry no.--)

50,000

50,000

9 28----

62.---

Sundry debtors for other misc. income A/CDr.

To Miscellaneous recoveries

(Providing for interest due on advances tosuppliers as per auditors observation videtheir audit enquiry no.--)

12,000

12,000

10 14----

10.---

Capital works in progress A/C D

To Fixed Assets A/C

(Removal of wrong credit given to 14-CWIPinstead of 10-Fixed Asset account as per auditors observation vide their audit enquiryno.--)

20,000

20,000

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77.5…..

14…..

10.----

14.---

Asset decommissioning cost A/CDr.

To Capital works in Progress A/C

(Being transfer of asset decommissioning cost(labour charges) wrongly booked under AH 14series as per auditors observation vide their audit enquiry no.----------)

Fixed Asset A/CDr.

To Capital works in progress

(Being transfer of CWIP to Fixed asset A/c torectify the short booking of amount to thefixed asset account as per auditorsobservation vide their audit enquiry no.-------)

3,000

17,000

3,000

17,000

b) Impact of the journal entries on the P&L account and the Balance sheet of thecompany.

Impact on P&L account (In Rs.)

JEreference

AccountHead

Head of account Debit Credit

1 NA Both AHs relate to Balance sheetitems

2 NA Both Ahs relate to Balance sheetitems

3 61 Revenue from sale of power –HTA/C

1,57,973

4 62 Miscellaneous recoveries A/C 20,12,000

5 70 Power purchase A/C 7,12,00,000

6 75.5 Ex-gratia A/C 50,000

7 7783

Depreciation A/CPrior period expenses-Depreciation

12,53537,605

8 74 R&M expenses A/C 50,000

9 62 Miscellaneous recoveries 12,00010 77.5 Asset decommissioning cost A/C 3,000

Total 7,14,61,113

20.74,000

Net Impact(Profit of the company will comedown by this amount)

6,93,87,113

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Impact on Balance sheet

Change in liabilities

JE

reference

Account

Head

Head of account Amount

1 46---- Provision for liability for expenses A/C 2,75,210

2

3

4 41.--- Sundry crs. for purchase of power A/C (20,12,000)

5 41.--- Sundry crs. for purchase of power A/C 7,12,00,000

6 44.--- Ex-gratia payable to employees A/C (50,000)

7

8

9

10

Change in liabilities (JVs) 6,94,13,210Transfer from P&L account (debit) 6,93.87,113

Net change in liabilities 26,097

Change in Assets

JEreference

AccountHead

Head of account Amount

1 14---- Capital works in progress A/C 2,75,210

2 10.---

14.---

Fixed Assets A/C

Capital works in progress A/C

3,60,000

(3,60,000)3 23.--- Provision for unbilled revenue (1,57,973)

4

5

6

7 12.---- Provision for depreciation A/C (50,140)

8 37.--- Inter Units Account (50,000)

9 28.--- Sundry debtors for other misc. incomeA/c

12,000

10 14.---10.---

14.---10.---14.---

Capital works in progress A/CFixed Assets A/C

Capital works in Progress A/CFixed Asset A/CCapital works in progress

20,000(20,000)

(3,000)17,000

(17,000)

Net change in assets 26,097

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c) Implications from the angle of regulatory accounting

Out of Ten Journal entries passed to account the auditor’s observations, two Journalentries, namely JE No’s 5 and 6 have regulatory implications.

(i) Implications of JE No. 5. -Power purchase from IPP

Though the company has purchased 45.100 Mus from the IPP that commencedits commercial production from 1st September 2004, as per the merit order dispatch approved by the regulator the company should have drawn only 38.000Mus. The regulator will not allow the variable cost on the incremental unitspurchased. Out of Rs. Rs. 23.27 Crs. payable to the IPP the element of fixed costis Rs. 12.00 Crs & has to be allowed by the regulator. The variable cost for 45.100 Mus is Rs.11.27 Crs. This translates to Rs.2.50/KWH. For 7.100 Mus thevariable cost works out to Rs. 1.78 Crs. This will be disallowed by the regulator and cannot be passed to the consumers through tariff increase or to the

government for subsidy support.

(ii) Implications of JE No. 6. -Ex-gratia payable to employees

Since the regulatory commission does not consider the ex-gratia payable as alegitimate expenditure for the purpose of ARR & has been disallowing thisexpenditure, the entire amount of ex-gratia payable of Rs.3,33,000 cannot berecovered through tariff increase or as subsidy from Government.

The company has to absorb both the costs amounting to Rs. 1.81 Crs. Theprofitability of the company to this extent comes down.

AEs 13 and 14 require regulatory compliances.

d) Remedial measures to avoid recurrence of such mistakes

Giving proper training to accounts staff in the accounting units

Visiting field units frequently for review of accounts registers

Circulating a compendium of audit observations for the current year

Brining accountability for major discrepancies

Providing incentives for the top 3 or 4 divisions in terms of accounts

quality Develop an Account Manual internally to help in standardising the

recording of business transaction.

Any other measure directed in improving the quality of accounts

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Documents

FM 7-2 Audit compliance