AUDIT REPORT

NAME: Saad Ahmad

Roll #: 17110014

Major: BSc. (Hons) ACF

Audit Firm: KPMG Taseer Hadi & Co.

Klynveld Peat Marwick Goerdeler (KPMG) was formed as a result of the merger of Peat Marwick International (PMI) and Klynveld Main Goerdeler (KMG) in 1987. PMI was formed in 1911 when William Barclay Peat & Co. and Marwick Mitchell & Co. merged together. Similarly KMG was formed in 1979 with the merger of Deutsche Treuhand-Gesellschaft and McLintock Main Lafrentz. The head office of KPMG is located in Amstelveen, Netherlands. KPMG has revenues amounting to about $24.82 billion for the FY 2014 (KPMG) and it excels in having the largest number of clients amongst the Big Four Audit Firms.

In Pakistan, KPMG Taseer Hadi& Co. is operating as an affiliate of KPMG International/Global. It has a professional staff of over 1300, 31 Partners and 1 Executive Director. The firm has regional offices in the major cities of Pakistan like Lahore, Karachi and Islamabad. The professional services provided by KPMG include Information Risk Management, Financial Advisory, Risk Advisory, Tax services, Corporate services, and Audit and Assurance services, which is the major contributor of revenues to the firm. KPMG’s major specialization is in Financial Audit services. KPMG has the pleasure of auditing a huge number of local organizations that include Ferozsons Laboratories Ltd., JDW Sugar Mills Ltd., Rafhan Maize Products Co. Ltd., Tariq Glass Industries Ltd., Ghani Glass Ltd., Shakarganj Foods, Allied Bank Limited, Fazal Cloth Mills, Azgard 9 Ltd., Agritech Ltd., NTDC Ltd., and Adamjee Insurance Company Ltd. From the next year onwards there will be an addition to the list of its audit clients in the form of Muslim Commercial Bank (MCB).

Client:

During the course of my internship I was appointed as a team member on an audit assignment of Style Textile Pvt.Ltd. Style was founded in 1992 and is considered a pioneer in designing and manufacturing apparel for huge corporations like Nike, Adidas, Reebok, Tommy Hilfiger, Levis, Calvin Klein and other acknowledged international brands. Style Textile uses high quality imported machinery in its processes and has an inhouse quality control laboratory which helps guarantee the high quality of the products as per the requirements of the clients (Style).

Organizational Hierarchy:

As Style Textile is a private company so the owners themselves are the Director, and the Chief Executive Officer. The management hierarchy is such that the Director reports directly to the CEO/Chairman. The CEO and the director are the strategic managers as well i.e. all management plans, and production plans are created by them. They set the rules and expect the operational managers to implement the plans. Apart from the director there is also a CSR department that directly reports to the CEO and under this department come the front line staff and lower level managers. Chief Financial Officer, Chief Operating Officer, and Chief Information Officer report to the directors. Similarly, Manager Accounts, Operations, Information Technology report directly to the CFO, COO, and CIO’s and respectively managers gather information from the lower level staff and officers. Style currently has a labor force of over 10,000 working in its factories located around Lahore.

Industry Analysis:

Pakistan is the fourth largest producer of cotton and contributes 5% to the global textiles after China and India and approximately 40% of the total work force is employed in the textile industry. Pakistan’s textile industry consists of large scale organized sector and highly fragmented medium and small units. The textile industry has experienced reasonable growth over the span of last few years internationally due to economic growth in China, Bangladesh, Vietnam, Turkey and India. The overall changes in the exchange rate have affected the exports of the textile industry and this is because the Pakistani rupee appreciated against the US dollar in the recent year so this had resulted in a fall in the GDP. However, the currency has depreciated and hence the exports have become slightly cheaper. The current inflation rate in Pakistan is approximately 8% and the growth rate is approximately 2% so if the growth rate is adjusted from inflation then still 6% remains. This has increased the cost of inputs used for manufacturing export quality items e.g. yarn. There are government policies that allow rebates like tax credits to the textile industry because it is a major contributor towards Pakistan’s GDP but some other counter policies like unscheduled load shedding and increased electricity rates have affected the operations. Most of the companies in the textile industry have adopted a Just in Time (JIT) inventory system due to intense competition which allows it to produce products on demand in a shorter period of time and at a lower cost. The use of a number of quality control procedures has helped some companies add value to their products. So this gives some textile companies a comparative advantage over others. Some businesses have also made use of Enterprise Resource Planning (ERP) software that enables the integration of all operations of the entity into one smooth flow.

Associated Concerns:

One of the issues that Style has faced is the recent floods which led to the price of cotton being doubled. As cotton is a cash crop the constraint in its supply has led to constant lags in apparel production. Also due to the dominant energy crisis investment has been declining. There has been a fall in incentives for exporters so now producers are considering moving their production facilities to countries like Bangladesh where the labor and raw material is cheap. Some other associated concerns like poor worker training, lack of awareness about the job, use of inadequate tools, poor maintenance of machinery, and tight scheduling have led to minor industrial accidents. Style’s main source of revenues is its exports and these majorly relate to brands like Nike, Reebok etc. These companies favor outsourcing as a result of a lower comparative cost of manufacturing in developing countries like Pakistan due to low raw material cost. The major expense of Style is incurred on the purchase of yarn which is the prime raw material in the production of apparel. Now the expense has increased even more due to recent floods in the areas of Punjab.

Future Prospects:

Style uses a software called the Inventory Management System for production process and this has reduced the complications faced during communication of production orders. This software generates a request by the store when it needs something. The request is then transferred to the

Human Resource department and then it is further processed by the finance department so that the funds can be approved. It has also opened a new unit on Kot Manna Singh near Multan Road and it is yet to open another unit at Kana.

Audit Methodology:

The first and foremost thing in KPMG’s audit methodology is the KPMG Sampling Plan (KSP). This plan contains sampling techniques that determine the materiality and the effect of misstatements on the audit as well as the financial statements. There are 2 types of sampling techniques: random and haphazard. In the random approach (also called statistical approach) the KSP selects a sample size where every element has an equal probability of being selected. Whereas on the other hand the haphazard approach or the non-statistical approach follows a certain sequence. There is an equal chance of low value figures being selected i.e. a random approach and there is a 100% chance of high value figures being selected. Both of the approaches were used during the audit e.g. in the case of Transaction Testing of Journal Vouchers of accrued liabilities a total of 25 samples that contained JV's of salaries payable, expenses, provisions, bonuses, insurance claim etc. was selected via a random approach. Of course the materiality is also incorporated while using these approaches and materiality is set at 5% as per KSP.

Performance materiality (PM) which is calculated at 75% of materiality looks at the financial statements as a whole. This means that if a misstatement exceeds PM when aggregated or individual, then we report to qualify. There is also an audit misstatement posting threshold (AMPT) which is 5% of PM. If any misstatements are greater than the AMPT they are assessed further for identification of other errors. KPMG also performs some risk assessment procedures (RAP) where the control and inherent risk are tested. The control risk is assessed through a test of controls (TOCs), also known as test of effectiveness, which are applied on a company’s procedures like sales, purchases, and Standard of Procedures (SOPs) testing. They ensure that the relevant controls relating to the head are operating effectively on a consistent basis, there is no control deficiency, and they help identify, prevent and detect the fraud. For example for the TOCs of purchases for the head Stores and Spares the minimum sample size of 25 transactions was selected because as per the KPMG Audit Methodology (KAM) the frequency of control activity is multiple times per day with lower risk of failure. Another audit procedure is the substantive procedures that contain the Test of Details (TODs) and analytical procedures e.g. a sample of 111 transactions was selected using KSP for TODs of purchases for stores and spares. In the case of analytical procedures the difference between the actual amount and the misstatement divided by the total and then multiplied by 100, should never be greater than 5% otherwise there would be a risk of audit misstatement.

Use of IT:

IT structure that KPMG makes use of in most of its audit engagements is the ‘eAudIT’. It helps the user maintain and store electronic audit related data of its clients and provides industry knowledge so that the audit can be more effective. In each audit engagement the entire audit lifecycle from the planning stage to the execution stage and the subsequent completion of

deliverables and the resulting archiving of the engagement is electronically recorded in this software. It works in way that at the initiation of the audit an engagement file is created. The information that is stored in the planning tool is imported by the software and it is then adjusted in the work paper templates that are already available in the software. It also helps in understanding the entity, identifying risks, testing and evaluation of controls, and audit strategy. Communication to those charged with governance and forming the audit opinion are other features that the software performs (KPMG). The software provides easy and complete access to all the components of the audit engagement for future references and maintains a comprehensive database of all the audits performed by KPMG. The data is used for reference in the future audits and can be used for internal reviews such that the processes of KPMG could be reviewed and any shortcomings in the audit road map, if present, could be resolved through the review of this data base. This tool helps in the audit engagement by providing standardized work paper templates which are used throughout the KPMG Global network thus standardizing the audit procedures carried out throughout KPMG globally.

Some of the rewards of this software that I observed were that it contains data systematically in a proper sequence so when one needs to look for specific data contained in the application it would be so much easier to find it. ‘eAudIT’ also acts as an authentic source of reference like when you want to cross check some data that is available in a physical form so that process can be performed with ease and this also makes it less time consuming. However, there were some shortcomings of this software. For a person who does not have complete knowledge of computer systems, he would face problems e.g. one of the juniors in our audit team was facing some trouble when working with working paper templates. Another disadvantage of this software I believe could be that if there is a system breakdown then there might be a chance that the data would be lost and it would be very hard to recover vital data.

Apart from ‘eAudIT’ another IT device by the name of encrypted USBs is also used. One advantage of these devices is that they have been configured to only work on the firm provided laptops. So this makes the client data somewhat more secure as compared to unencrypted USBs. On the other hand there can be a disadvantage associated with the device i.e. due to their small size they may be lost and all important data may be lost.

Assigned Area:

The area I had been assigned was Fixed Assets (FA) but my work was not confined to one head. I also worked partially on the Stores & Spares head but the main focus was on the FA. However, in the FA head the first thing that I had to do was to gain an understanding of the procedure used to purchase PPE for production and administrative purposes and then write it down. I learned that the department which requires assets raises an acquisition through General Demand (GD) on the Inventory Management System (IMS). The GD is then forwarded to the head of the relevant department. After the Head of Department’s (HOD) approval the GD is sent to the director for his approval and then it is sent to the relevant general store. If the required asset with same specifications & quantity is available with the store then it would issue the asset to the relevant department. In case when the asset is not available with the store, it forwards the GD to the procurement department. The procurement department would then raise quotations and after making a comparative analysis an item order/purchase order (PO) is generated and is also

forwarded to the selected vendor. The PO is prepared & approved by procurement department via the IMS. When the vendor has supplied the required item a Goods Gate Entry Pass is generated at the gate. It includes particulars like the supplier's name, receiving unit & time, the quantity received, vehicle number through which items have been supplied and remarks, if any. The pass is then forwarded to the administration department which then generates an Inward gate pass (IGP) and then sends the IGP to the relevant store which prepares the Goods Inspection/Receipt Note (GRN) on the basis of the IGP. The store then passes an entry

Dr Store & Spares

CrGR/IR Account Payable

The invoice created, which also holds the GRN number, is then forwarded to the Finance department which then enters the GRN number for data retrieval and generates a GRN Purchase Invoice. Once the invoice is created another journal entry is passed to eliminate the effect of GRN Accounts Payable.

Dr GR/IR Accounts Payable

Cr Trade CreditorA document is then generated through the Accounts Management System (ACMS). Later on a requisition issue is created by the relevant general store and another entry is passed so that the asset may be recorded in the FA’s head.

DrProperty Plant & Equipment

Cr Stores & SparesThis eliminates the effect of Stores & Spares which the store had debited earlier.The depreciation policy of the company states that it uses a straight line method for the whole class of assets. Depreciation is calculated for the whole month on a new asset in the month of purchase and no depreciation is charged on the asset in the month of disposal. Depreciation relating to Building, Lease Hold Equipments, Plant & Machinery, and Electric Installations is charged to Cost of Sales. Depreciation relating to Furniture & Fixture, Vehicles, Arms & Ammunition and Computers is charged to Admin. I also had to understand the company’s fixed assets disposal policy. The first step is to communicate information about the ‘to be’ disposed asset to the procurement department. The department then communicates the matter to the Director and afterhis approval the procurement department obtains the rate either through brokers or through company employees. In the case of Vehicles, the vehicle is tagged and parked in the company premises with contact details of the procurement department and then the highest of rate given from any of the employees or brokers is selected.

Once the above process was completed the next thing was to create a walkthrough. The purpose of a walkthrough is to review the entire process for the purchases of items of PPE and evaluate that the overall design of the process is existing and implemented in the same manner. So for this we select a single item from fixed assets acquisition and then look at the practical implementation of the process discussed earlier. The asset that I looked upon was a digital power analyzing meter and the walkthrough contained all relevant information regarding the asset like by whom was the order approved, who is the vendor, what is the PO #, IGP #, GRN

# and by whom are they prepared, who has received and delivered the order, what was the mode of transportation and the vehicle number etc. For cross checking reference the documents that contained all of the above information were physically verified and an electronic copy of the documents was attached with the working papers.

The next step that I performed was a TOC of additional assets purchased. The approach used here for sampling was a random approach in which a sample of any 25 transactions was chosen. For every transaction, I had been provided a voucher number and the amount (Rs.) of the asset. In the control testing process the first thing I checked was whether there is the approval of the HOD and the Director on the GD that was raised. Once this had been done I had to see if a PO was raised against the quotation called and secondly check if the IGP preparer has matched the quantity that was received with the PO. This was done by entering the voucher # in the system which gave us the IGP # and then via that the quantity was matched. So through this we were able to check the occurrence as well as the existence assertion. When the company receives an asset an entry is posted in the Accounts Payable (AP) as mentioned earlier in the process. Then an AP voucher (APV) is created through the system so there was an APV # for every transaction in the sample and we had to apply the TOCs on them as well. So, the first thing to test was whether the invoice is stamped and signed by the APV's preparer. Secondly, I had to ensure that the APV is prepared by the Accounts Supervisor and thirdly, make sure that the voucher is approved by the Accounts Manager. This was done by verifying the hard copy of the respective vouchers because it contains information about who prepared the voucher, who checked the voucher and who had approved it.

My next task was to do a TOD of additions in operating assets in order to ensure that they are not materially misstated. It was performed using the KSP and it gave us a sample of 28 transactions going from more material to less material amounts. Additional information provided to us was the assets names, dates, GRN #s and the APV #s. Through the voucher # I verified that the asset has been posted in the correct account and with the correct amount (Rs.) in the system as well as on the voucher in a hard form. So here the classification and the accuracy assertions were tested. The completeness assertion was also tested when I had to check that the expense had actually been recorded and for double reference I also checked the invoices that were attached with the vouchers and this also helped in knowing whether withholding tax was deducted at source, which was another TOD. Another one of the things to look at was whether the invoices are in the name of the company so I had to see that the original invoices stated the company’s name as a customer. Also by looking at the invoices we had an idea that the machinery was owned by the company and hence the assertion rights and obligations under balance sheet was also met.We also had to gain an insight on whether the expense is for the purpose of business and for this I had to question the accounts supervisor regarding the use of the asset. So the assertion, occurrence and rights and obligations, under presentation & disclosure was also ensured. I also had to make sure that the transaction related to the period and for this I had to look at the vouchers. So here the cut off assertion was tested. After all of the above had been done then I was required to physically trace the payments into the bank statement and also look at the payment dates. For this we retrieved the Bank Payment Voucher (BPV) and the bank name from the system which made it easier to trace the entries.

The bank payment tracing was not confined to the FA head. I also performed it under the Stores & Spares (purchases) head, prepaid insurance and rent and security deposit lease assets. Once the payments have been traced I was required to get a photocopy of the bank statements stating the amounts (Rs.) as a proof. I also created a physical verification sheet in which a total of 113 items were to be verified. For this we had to visit the plant/factory and then ensure that they were in the right location and the correct quantity of the items was present. Therefore, the existence assertion was also checked. Procedures regarding depreciation and disposal were not performed by me.

The overall experience in the audit firm was an excellent industry exposure. An individual gains an insight about how things actually work in the corporate world. The skills I learned at the managerial level were how to plan an audit and then how to delegate this plan of action. We felt motivated when we were entrusted by the senior with a responsibility because it showed his trust in our capabilities. I learned how to interact with the different departments for data collection. Although I faced issues regarding compliance of the staff but I was able to convince them and explain to them the importance of the relevant data required so it was a valuable experience as to how to handle such situations. I also learned that coordination between departments was also vital to us because that would ease our dilemma of gathering information. We were required to give a daily report to our Senior and at the end of the audit he would review the work done by us and inform us of any issues or discrepancies. We learned some presentation skills e.g. I had to report to the senior about the reason withholding tax was unclaimed for the ambulances kept by Style. Thus I had to ask the accounts supervisor about the basis behind it and then report forward. I also learned that time management was extremely central. We were required to deliver the work received within the due time because every process is dependent on another so a time lag could create a problem. We also worked overtime and this was only done so that today’s work would not pile up for tomorrow. The overall audit process was smooth because the control processes used by the client were no less than standard audit procedures e.g. their every entry was double checked by 2 to 3 employees in the department and then the manager.

Such experiences in one’s existence prove to be valuable when one approaches towards the practical life. For me the application of the processes and the rules learned will help improve my abilities and help excel in the field I have chosen.

(3943 words)

Citations:

"KPMG Revenues for FY14." KPMG UK, 2015. Web. 20 Sept. 2015.

Styletextile.com. Style Textile, n.d. Web. 22 Sept. 2015.

KPMG Taseer Hadi & Co., KPMG Pakistan Transparency Report - 2014Contents (n.d.): n. KPMG, 2014. Web. 26 Sept. 2015.