CMA Final · Cost and Management Audit

Operational Audit and Internal Audit under Companies Act, 2013: formula sheet

Full chapter guide

Key formulas

Section 138(1): who must appoint: Such class or classes of companies as may be prescribed must appoint an internal auditor; The Act only sets the principle. The classes come from Rule 13.
Who can be appointed (Section 138(1)): Chartered accountant OR cost accountant OR such other professional as the Board decides; The Rule allows the person to be an employee or an outsider. A CA or CMA need not be in practice.
Rule 13: every listed company: Listed company → internal auditor required; No size test applies. Listing alone is enough.
Rule 13: unlisted public company (any one test, preceding financial year): Paid-up share capital ≥ ₹50 crore, OR turnover ≥ ₹200 crore, OR bank/PFI loans and borrowings > ₹100 crore at any time, OR outstanding deposits ≥ ₹25 crore at any time; Meeting any one test is enough. Note ≥ for capital, turnover and deposits, but > for borrowings.
Rule 13: private company (any one test, preceding financial year): Turnover ≥ ₹200 crore, OR bank/PFI loans and borrowings > ₹100 crore at any time; Paid-up capital and deposits tests do not apply to private companies.
Scope and reporting (Section 138(2) and Rule 13): Audit Committee/Board, in consultation with the internal auditor, fixes scope, functioning, periodicity and methodology; report goes to the Board; The Board or Audit Committee decides these, not the management whose functions are audited.
Applicability of Section 378ZF: Every Producer Company → internal audit of its accounts; No prescribed class, size or turnover test. The duty applies to all Producer Companies.
Who may be internal auditor: Chartered accountant as defined in section 2(1)(b) of the Chartered Accountants Act, 1949; The section names only a chartered accountant. A cost accountant or other professional is not mentioned.
Interval and manner: As specified in the articles of the Producer Company; The Act does not fix the frequency. The articles do.
Section 138 contrast: applicability: Such class or classes of companies as may be prescribed; Section 138 applies only to prescribed classes. The details come from the rules.
Section 138 contrast: auditor: Chartered accountant, or cost accountant, or other professional decided by the Board; Wider choice than Section 378ZF.
Section 138 contrast: interval and manner: Prescribed by the Central Government by rules; Under Section 138(2) the rules fix the manner and intervals, including reporting to the Board.
Appointment of internal auditor (Section 138(1)): Prescribed class of company → appoint internal auditor (CA, cost accountant or other professional decided by the Board); Applies only to prescribed classes. Do not say every company must appoint one.
Scope of internal audit (Section 138(1)): Scope = functions and activities of the company; Wider than financial statements. Include operations, controls and compliance.
Manner, intervals and reporting (Section 138(2)): Central Government may prescribe by rules: manner + intervals + reporting to the Board; Say 'as prescribed'. Do not invent frequencies.
Audit Committee composition (Section 177(2)): Minimum 3 directors; independent directors form a majority; Most members, including the Chairperson, must be able to read and understand financial statements.
Audit Committee and controls (Section 177(4)(vii)): Terms of reference include evaluation of internal financial controls and risk management systems; Link internal audit findings to this role.
Audit Committee powers (Section 177(5) and (6)): Call for auditors' comments; investigate; obtain external professional advice; full access to records; Shows why internal audit reports to this committee.
The 3 Es: Economy = lowest reasonable cost of inputs; Efficiency = output ÷ input; Effectiveness = actual results ÷ intended results; Use these as tests for every finding. Efficiency and effectiveness can be measured as ratios if data is given.
Phases of operational audit: Planning → Fieldwork → Reporting → Follow-up; Some books split planning into preliminary survey and detailed planning. Keep the order.
Audit finding structure: Criteria → Condition → Cause → Effect → Recommendation; Write each finding in this order to earn marks for application.
Three Es of operational audit: Economy = cost of inputs vs. benchmark; Efficiency = output ÷ input; Effectiveness = actual result vs. planned objective; Frame each finding under one of the three Es. A function can be efficient but not effective.
Structure of a finding: Finding = Condition + Criteria + Cause + Effect + Recommendation; Use this five-part structure for every observation. Missing cause or effect loses marks.
Capacity utilisation: Capacity utilisation (%) = Actual output ÷ Normal or rated capacity × 100; Useful production indicator. Always state which capacity base you use.
Material yield: Yield (%) = Actual output ÷ Input quantity × 100; Wastage (%) = 100 − Yield; Compare with the standard yield to assess production efficiency.
Stock turnover: Inventory turnover = Cost of materials consumed ÷ Average stock; A low ratio suggests overstocking or slow-moving items. Compare with the industry norm or past trend.
Order-to-delivery variance: Delay (days) = Actual delivery date − Promised delivery date; A supplier performance measure in purchase audit.

Quick revision

Section 138: prescribed classes of companies must appoint an internal auditor.
Section 138 auditor: a chartered accountant, a cost accountant, or another professional decided by the Board.
Section 138 scope: internal audit of the functions and activities of the company.
Under Section 138, the Central Government may prescribe by rules the manner and intervals of internal audit and its reporting to the Board.
Section 378ZF: every Producer Company must have its accounts internally audited.
Section 378ZF: the auditor must be a chartered accountant, and the interval and manner are as specified in the articles.
Do not mix up the two: Section 138 is for prescribed classes and rules; Section 378ZF is for Producer Companies and articles.
Internal audit reports go to the Board in the manner prescribed.
Operational audit judges economy, efficiency and effectiveness of operations.
A good operational audit report gives findings, causes, effects and practical recommendations.
In case questions, always end with a clear recommendation tied to the facts.

Common mistakes

Saying every company must appoint an internal auditor Fix: Remember that Section 138(1) covers only prescribed classes. Always check Rule 13 before answering.
Applying the paid-up capital or deposits test to a private company Fix: Keep two lists. Private company: turnover and borrowings only. Unlisted public company: capital, turnover, borrowings and deposits.
Saying a cost accountant can be internal auditor of a Producer Company under Section 378ZF. Fix: Remember that Section 378ZF names only a chartered accountant. Tie the cost accountant option to Section 138.
Writing that Section 378ZF applies only to prescribed classes of companies. Fix: Section 378ZF says 'every Producer Company'. No class is prescribed.
Saying every company must appoint an internal auditor. Fix: Write 'such class or classes of companies as may be prescribed' and test the case company against it.
Limiting internal audit scope to financial statements. Fix: State that scope is the functions and activities of the company, including operations and controls.
Treating operational audit as a financial audit of a department. Fix: Say the focus is performance and use of resources. It does not give an opinion on true and fair view.
Mixing up efficiency and effectiveness. Fix: Efficiency is about inputs versus outputs. Effectiveness is about whether goals were achieved. Give one example of each.
Treating operational audit like a financial audit and checking only accuracy of records. Fix: Always bring in economy, efficiency and effectiveness. Ask whether the process is well run, not just whether it is recorded correctly.
Listing checklist points with no criteria or benchmark. Fix: Name the standard for each point: budget, policy, past trend, industry norm or rated capacity.

Exam tips

MCQs usually give figures and test the exact boundary. Underline ≥ versus > before choosing an option.
Always name both Section 138 of the Companies Act, 2013 and Rule 13 of the Companies (Accounts) Rules, 2014 in written answers. Marks go to both.
For applicability questions, write the company type first, then each test with a tick or cross, then the conclusion.
In case scenarios, check whether the appointee is a CA, a cost accountant or another professional decided by the Board, and note that being an employee is not a bar.
Link the topic to related areas in the same answer: Audit Committee role, internal audit scope and reporting, and internal financial controls under Section 143(3)(i).
Expect a comparison question. Prepare a four-row table in your head: applicability, auditor, interval and manner, scope. Write it as short points in the exam.
In MCQs, watch the word 'only'. If an option says a cost accountant may be appointed under Section 378ZF, it is wrong.
In case questions, first identify whether the company is a Producer Company. That one fact decides which section applies.