Internal Audit Consulting Service in Automobile/ Automotive Industry
The automobile industry encompasses the design, manufacturing, sales and maintenance of motor vehicles. Internal auditing in the Automobile Sector involves examining financial records, operational processes, evaluation of vendors and compliance with regulations of industry.
Within the automotive industry, internal audit assumes a critical role, ensuring the financial integrity and regulatory compliance of organisations operating in this sector. This essential function systematically examines and oversees financial processes, risk management, and adherence to industry-specific regulations. As a vigilant overseer, internal audit assesses the transparency of financial transactions, secures sensitive company data, and evaluates the efficiency of operational procedures.
Automotive Industry Standards (AIS)
The Automotive Industry Standards (AIS) are for OEMs, parts manufacturers, and vehicles. They cover body type, devices, radiation, lights, and safety critical components. AIS 037 ensures type approval and conformity of production for safety critical components.
List of Components Covered Under AIS-037 are follows:
- Tyres
- Rear View Mirrors
- Speed Limiting Devices
- Safety Belts
- Warning Triangle
- Lighting and Light Signalling Devices
- Retro Reflectors
- Bulbs
- Safety Glass
- Brake Hose
- Wheel Rims
- Horns
- CNG/LPG Regulators and Vaporisers
- CNG/LPG Kit Components
All the rules suggested in the AIS must be followed by any new vehicle that is introduced into the market. Also, vehicles for conformity of production shouldcomply by the standards and there should be no variation from the previousmodels unless otherwise stated.
Regulatory Compliance in Automobile Industry
Regulatory Compliance in Automobile Industry
- Audit/ Surveillance Checks
- Import regulations
- Third Party Certification (Type Approval)
- Conformity of Production
There are other rules that apply to the automobile industry:
- Vehicle level includes the engine, brakes, emissions from the vehicle, and engine noise.
- System Level includes seating, anchoring of seats, forward vision, blindspots, and other related issues.
- Components Level includes horn, mirror, safety glasses, and other items.
- General Level includes Anti-theft measures, curb weight, and dimensions.
Risk Mitigation in Automobile Industry
According to Standards on Internal Audit (SIA) 1, “Planning an Internal Audit”, an Internal audit plan is a document defining the scope, coverage and resources including time, required for an internal audit over a defined period. Internal auditor needs to understand the audit risk involved in a process prior to planning review. Audit risk, therefore, is essential to influence the audit planning methodology in a significant manner.
Types of risks under risk mitigations are as follow:
- Inherent Risks: Inherent risks in business transactions are the risks that are present regardless of the internal controls in place. For example, purchasing materials with prices linked to the London Metal Exchange (LME) is a higher risk than purchasing materials with stable prices.
- Control Risks: The chances of design flaws in a process due to inadequate internal controls are called control risks. For example, journal voucher recording without maker-checker controls would not prevent unauthorized, inaccurate, or back-dated journal entries.
- Detection Risks: The deficiency of an internal auditor to not depict error in the process through substantive tests and data analysis is called detection risk.The auditor shall assist the audit risk in identifying the quality and quantity of evidence that are required to be gathered and the detailing required in the analysis while performing the audit. The auditor is expected to plan the audit in a manner that reduces audit risk to an acceptably low level that is consistent with the objective of an audit.
Risk Assessment in Automobile Industry
The internal audit methodology requires risk assessment. The internal auditor can assess the importance of risks in transactions and audit areas. The internal auditor may take into account the following parameters for risk evaluation and assessment:
Critical to Business Objective: The risk of an activity/sub-process is determined by its criticality to the business objective and management's strategy. The more critical the activity, the higher the risk.
Some of the critical risk activities with respect to processes are as follow:
| Process | Sub-Process | Activity |
| Manufacturing Operations | Assembly and Inspection | Final inspection and costing, maintenance of production facilities, productivity in manufacturing, and rework and rectification. |
| New Product Development | New Product Introduction | Managing abandoned projects, expenditure, and failures; manufacturing prototypes; and testingand validating products. |
Value at risk: The risks involved in a business process are impacted by the total value of transactions.The higher the value of transactions, the higher the risk.This is because larger transactions are more likely to attract fraud and other malicious activity.
List of key risk areas based on value of transaction are given below:
| Process | Sub-Process | Activity |
| Manufacturing | Manufacturing Process | Maintenance of BOM for Regular Models. |
| Order to Collection | Vehicle Sales | Manage invoicing, warranty expenses, post-sales expenses, dealership management, supplementary invoices, and price revisions. |
| Procurement to Pay | Direct Materials | The inwarding of materials through CRS/CRDO, invoice verification, payment processing, quality validation, acknowledgment, and storage are managed, along with vendor evaluation and rating. |
| Capital Expenditure | Asset verification |
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| Information Technology & IT Security |
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| Inventory Management | Direct Materials | Inventory analysis, verification & reconciliation of subcontracted materials, physical verification & adjustments |
Volume at Risk: The volume involved in an activity is the number of transactions impacted by the activity in the review period. The propensity of errors increases in a high number of transactions; therefore, the risk involved in activities with higher transactions tends to increase.
An illustrative list of high risk transactions based on the volume is provided below:
| Process | Sub Process | Activity |
| Procurement to Pay | Materials | Receipt of materials and storage, invoice verification, payment processing, liability recording, price amendment, approval and update, quality validation, and vendor evaluation |
| Order to Collections | Vehicle Sales | Dispatch controls and invoicing |
| Manufacturing | Warranties | Warranty expenses - Claim settlement |
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Treasury Functions |
1. Treasury 2. Accounting |
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| Capital Expenditure | Assets Procured/ Leased | Capex appraisal, procedures, capitalization, commissioning, CENVAT availability, leased assets, bank guarantee, post-implementation monitoring, and post-transfer issues for capital items and tooling assistance. |
Maturity level of system: Maturity levels of the ERP determines the controlling framework within the company. ERP maturity level can be assessed by the number of manual vs. automated controls in the company. If the company doesn't have transaction-level controls, such as maker-checker controls or automatic linking of subsidiary accounts to control accounts, the risk implication will increase.Companies typically use manual controls for vendor evaluation, credit limit assessment, price master maintenance, purchase negotiations, SLA compliance, dealership operations, discount scheme and claim verification, manufacturing process and finished goods recording, logical access granting, and hazardous waste management.
Regulatory & Ethical Issues: Fraud risk (ethical issue) are a major component of inherent risk in any activity. Higher the propensity of fraud in a transaction, higher would be the potential risk implication in the activity.
Revenue Recognition in Automobile Industry
The process of revenue recognition in auto and the auto component sector is complex, as it includes revenues from sales of goods and services and also income from customer financing. The internal auditor may review the contractual agreement and ensure that revenue is recorded only upon transfer of risks and reward and no significant uncertainty exists regarding the amount of consideration.
Revenue recognition in the industry is impacted by the following aspects typical of the automotive and auto component industries:
Consignment Sales/ Stock Transfer: Consignment sales are common in the sector. The company retains the risks and rewards, so the sales must be reversed and a provision created in the financials.
Dumping of Sales quantities: The automotive industry has fixed sales volumes, which are closely monitored. This can lead to dumping of quantities to dealers without demand. Internal auditors should review revenues and sales returns to confirm no dumping.
Extended Warranties: Revenue from extended warranty contracts should be deferred and amortized on a straight-line basis unless there is sufficient past evidence to indicate otherwise.
Cash Discounts: Companies in industries with high cycle times offer cash discounts for early payments. These discounts should not be deducted from sales volumes.
Information Technology (IT) Controls
The AM's IT server and systems are connected with vendors. This enables efficient data transportation and online reliable data interchange. AM specifies delivery schedules which are captured by the vendors in their respective production units. The production units activate the production plan according to the need based procurement schedule.
AM receives online dispatch intimations, which facilitates production scheduling and data capture. AM's system directly validates delivery notes and invoices, avoiding duplicate entries. Sufficient controls are needed to validate data, prevent unauthorised access, and ensure data secrecy and integrity.
Masters involved in these processes are as follow:
Material Master: The material master is a central repository of information on all materials used by a company. Auditors should ensure that the item master code creation is authorized and access is restricted.
BOM Master: Auditor to verify BOM & Cost sheet updates, restricted BOM change access, and margin %. Highlight negative margins to the controlling team.
WorkCentre Master: A work center is a group of machines used for production operations. It is used in routings and contains data for scheduling, capacity, costing, etc.
Routing Master: Routing is a document that defines the sequence of operations, machine time, labor time, and other data for production costing.
Product Planning: In component manufacturers, auditors need to ensure production planning and budgeting procedures, system controls, and manual controls for materials not covered by ERP.
Production Order: Only authorized personnel should be responsible for creating, updating, and releasing production orders.
MRP Run: The auditor is responsible for reviewing MRP usage for inventory items, reviewing the MRP run review process, and ensuring material requisitions and inventory controls.
Production Rejection: The post-production quality control process identifies defects, records rejections in ERP, and the plant head decides on corrective action.
Review of Production Control Framework
The primary responsibility of production management is to formulate and design various production policies.
The Internal auditor has to ensure existing written control procedures and practices of manufacturing and methods to control and monitor the smooth flow of all production processes, product cost savings, thereby improving button line, controlling wastage of resources and maintaining standard of quality throughout the production cycle.
The need of Internal Audit in the Automobile Industry is to ensure the adequate controls maintained for updation of necessary changes on regular review of production process.
Monitoring the progress and deviations from the plan is necessary to ensure plant efficiency and performance once production is set in motion.This involves identifying and fixing problems with routing and scheduling, misunderstanding orders and instructions, underloading or overloading work, and other factors such as late delivery of materials, machine breakdown, and errors in drawings.
Review of Financial Sector of Automobile Industry
Internal accounting controls provide the recording, classification and reporting of production costs such that inventories, cost of sales, and operating costs are properly reported in financial statements, and should provide for the safeguarding of company assets.Finance department should conduct periodic review to verify adequate controls for reporting, recording and tracking all production transactions under financial records.
- Recording of Production & Consumption: Auditors should verify production order closing, consumption recording, and cost accounting controls to ensure timely and accurate inventory and cost reporting.
- Utility Cost Analysis: Regular variance analysis of target and actual costs, including material, labor, overhead, and routing, to identify and address excess costs.
- Accounting of Scrap: Internal auditors are responsible for reconciling production scrap with stock records and investigating abnormal scrap by monitoring and taking necessary corrective action.
- Rework Cost of Products: The process of reworking materials should be automated in ERP and not controlled manually. Without this process, rework costs cannot be analyzed separately.
Inventory Management
The health of the supply chain, financial performance, and operational efficiency are all affected by the critical function of inventory management. Inventory involves costs such as holding costs, ordering costs, investments, space management, etc. To prevent overstocking, stockouts, and other risks that can affect the bottom line, it is crucial to have a robust inventory management system.
In automotive industry, inventories are classified as follow:
- Production Inventory: All materials and supplies used to produce finished goods are included in production inventories, but not for service and maintenance contracts. Examples of production inventories include raw materials, production materials, consumable supplies, and work in progress.
- Finished Goods: The classification of finished goods as ready for sale can vary depending on the company's accounting policies. Until they are sold and revenue is recognized, they are counted as inventories.
- Inventory (components) held for Service and Maintenance Contracts: To comply with regulations and maintain customer satisfaction, automakers must keep inventories of service parts for discontinued models. Internal auditors should ensure proper valuation.
- Goods in Transit: Internal auditors in the automotive industry should ensure that goods-in-transit and goods on consignment are accurately reflected in inventory records.
Review of Specific Items of Inventory
Other than regular inventory, there are specific items of inventory which are important in relation to the automotive industry.
- Moulds and Toolings: OEMs and component manufacturers often collaborate to produce toolings for automobile parts. The accounting treatment for toolings varies depending upon contractual agreements between the parties. To determine whether toolings should be capitalised by the OEM or the component manufacturer, internal auditors need to assess the economic substance of the arrangements.
- Consumable Supplies
These are divided into two major parts:
- Production Supplies: Internal auditors must make sure that production supplies are properly accounted for and controlled, regardless of whether they are expensed or inventoried.
- Other Supplies: The expense for other supplies used for product development, instructions, printed matter, and office supplies is immediately incurred upon acquisition.
- Produced Vehicles
Vehicles produced by the entity are divided into the given categories:
- Production Supplies: Internal auditors must make sure that production supplies are properly accounted for and controlled, regardless of whether they are expensed or inventoried.
- Other Supplies: The expense for other supplies used for product development, instructions, printed matter, and office supplies is immediately incurred upon acquisition.
Vendor Monitoring and Rating
Vendor monitoring and rating should be ongoing and periodic, assessing each batch against defined criteria based on risk assessment. This includes specifications, statistical QC data, delivery dates, certificates, and other documents. Each vendor should be evaluated annually for quality, full testing, complaints, audit reaction, response time, and regulatory changes.
Vendors should be rated objectively based on this evaluation, with categories such as completely satisfactory, partially satisfactory, and not satisfactory. Vendors may be reviewed, have their contracts reviewed, or be re-audited based on their ratings.
Maintenance of Plant and Machinery
Preventive maintenance is essential for capital-intensive industries to ensure breakdown-free production. A schedule of preventive maintenance tasks should be reviewed by the plant head to ensure that it is sufficient. Deviations from the schedule can lead to a range of negative consequences, including reduced capacity utilisation, increased production costs, higher maintenance costs, reduced product quality, and increased safety risks.
Conclusion
In conclusion,Internal Auditing in the Automobile Industry plays a pivotal role by ensuring operational efficiency, regulatory compliance, and risk management. Continuous improvement, cost reduction, and customer satisfaction are all facilitated by it, which is crucial for sustained success and competitiveness in this dynamic and complex sector.