304961 56283 Internal Audit Report on Review of System of Monetary Incentive Based on Production...

8/10/2019 304961 56283 Internal Audit Report on Review of System of Monetary Incentive Based on Production Performance

1/11

ABC Clothing Co.Internal Audit Report

1

Background Information and Executive SummaryInternal Audit reviewed the accuracy and method of performance measurement of ProductionManagers (Stitching Dept. only) and Monetary Incentive paid to them on the basis of productionefficiency in the last uarter ended !"stDecember# $%"". &he ob'ective of this review was toevaluate the feasibility# adeuacy and effectiveness of the performance measurement system#the associated ris# and identify opportunities for improvements in system. *ased on our review#the method of the performance measurement is in+effective and needs improvements to mitigatebusiness ris.Production (Stitching Dept. only) department,s performance is being measured on daily basis byengineering and planning department in the factory on MS+-cel worsheets# the benchmar forthe measurement of -fficiency is /01# the greater than the /01 will be rewarded with themonetary incentives of 2s. "#%%% per percent to the individual production manager and less than/01 there is deduction of 2s. 0%% per percent.During the review we observed that production lines were having huge idle time(37%inDecember# $%"") as well as overtime for the production lines is the "01 of the total time woredon the products during the month. &he efficiency is being calculated by the engineeringdepartment is not accurate3consistent with information obtained from the time eeping records(42 &ime payroll)# 4aving enuired about the idle time from the concerned department it came toour nowledge that the idle time is mostly because of the un+availability of the raw material andproduction lines are stopped so this idle time is not considered while calculating the efficiency ofproduction managers. 5n the other hand when Internal Audit &eam carried out the physical stoccount we found that there was much stoc which was purchased in advance for the styles will bestarted in future.

Objectives:&he ob'ective of this review was to evaluate the feasibility# adeuacy and effectiveness of theperformance measurement system# the associated ris# and identify opportunities forimprovements in system. *ased on our review# the method of the performance measurement isin+effective and needs improvements to mitigate business ris.

Scoe:Production 6ine,s efficiency# Accuracy and adeuacy of Monetary Incentives paid to Managers on

the basis of production efficiency# Idle &ime variances.

!rocedures !erformed: 2ecalculation of line wise efficiency using the payroll and 42 &ime eeping software.

Performed analytical reviews.

7ariance analysis.

5btained understanding of the performance measurement system.

D

b

3 1

2 0 1 1


2/11


2

"udit #indings and Observations:

During the review we found the following discrepancies in the calculations of8

&he idle time which is not reported to management at all in the efficiency reports whereas idle time

if reaches to a certain level (more than the standard idle time) must be informed to highermanagement.

&he 5vertime reported while calculating the production efficiency and the actual overtime paid as

per payroll342 &ime payroll.

Production efficiency calculated by engineering3planning department and efficiency calculated by

Internal Audit Department.

Monetary Incentive payments to production managers based on their efficiency which is measured

by accumulating the production floors efficiency for which the individual production manager isresponsible.

Idle $ime $rend for last uarter ended &'((

Effect of Idle time on roduction in units

Month

Net IdleTime (Net

of Standardidle time

20%)

ActualProduct

ionOutput

EtimatedProduction!aed ona"aila!le

Time

EtimatedProduction

Output #o

EtimatedProductionOutput #o

(%)

Oct$

14% 138,176 160,670 (22,494) 14%No"$

4% 126,032 131,283 (!,2!1) 4%&ec$

17% 162,9!1 196,327 (33,376) 17%

D e c e m

b e r

3 1

2 0 1 1


3/11


3

&he idle time in the above calculations is net of the standard idle time allowed (assumed rate) of

$%1 (e)g) Dec+"" actual idle time was !91 6ess8 standard idle time allowed $%1 :et idle time ;

"91)

"ctual Overtime !aid and Overtime *eorted

+ont, *eorted O)$ "ctual O)$ !aid -n.*ecorded O)$

5ct+"" 0%/ ""#"


4/11


4

+anagers Incentive0$arget:

?hile calculating Incentive3&arget amounts idle time is not being considered by-ngineering 3Planning Department while calculating the production efficiency and there isno 1Standard Idle $ime2so we have assumed that standard idle time is il#@urthermore# we have also calculated the efficiency considering standard idle time onassumption basis (assumed standard idle time rate "%1# "01 and $%1)

Standard Idle $ime as il: Standard Idle &ime is considered as :il in the

following calculations.

+ont, Efficiency*eorted

Efficiency"s er"udit

4orking

/ifference

Oct.(( 9!.


5/11


!

+OE$"*8 I9E$IE

Standard Idle $ime as ('%; (5% and &'%: &he following calculations are based

on three different assumed standard idle time rates# because there is no standardidle time in the company.

&ecem!er' 20

&ecription

Standard IdleTime0%

StandardIdle Time

%

StandardIdle Time

20%

+ont, Incentive !aidIncentive

"s er "udit

4orking

/ifference

Oct.((


6/11


6

$otal +inutes available to consume >"s erattendance of !roduction @ines? ((;6'';6'= ((;6'';6'= ((;6'';6'=

Actual Minutes onsumed as per 2eports 9##!%% 9#


7/11


7

% &% &% &%

@ess:Standard Idle $ime(Assumed rate as nostandard Idle &ime is nown) "%1 "01 "%1

et Idle $ime ariance in +inutes "dverse0>#avorable? &;'=;(( (;9#9/!

Idle $ime +inutes 3;7(3;63& 3;7(3;63& 3;7(3;63&

% 3% 3% 3%

D

b

3 1

2 0 1 1


8/11


8

6ess8 Standard Idle &ime (Assumed rate as nostandard Idle &ime is nown) "%1 "01 "%1

et Idle $ime ariance in +inutes "dverse0>#avorable? 3;3&;< 3;(5=;757 &;


9/11


9

last uarter# $%"" having the effect of net idle time (Actual Idle &ime @ess:Standard idle timeallowed) as well as summariBed efficiency results.

After reviewing the above summariBed results we can see that the maimum efficiency in anymonth is euals to /%1 and it is less than the benchmar of /01 so there should not be anymonetary incentive paid to production managers as their efficiency is less than the benchmarset by the company# in fact the in+efficiency should be investigated and necessary action shouldbe taen to prevent the in+efficiencies in future.

"udit 9onclusion0Oinion on t,e System of !erformance +easurement:

"deAuacy and Effectiveness:

&he performance measurement system in place is attainable and motivate production

managers but does not motivate all over management to contribute in theimprovement of the company,s performance# only production manager,s performance(stitching Dept. only) is being measured and they are supposed to be paid themonetary incentive against the production efficiency instead of overall factorymanagement.

Information used to measure the performance of production is not adeuate and

accurate# the reported overtime is understated when compared with the overtimeactual paid (stitching dept. only)# and idle time is not considered while measuring theproduction performance (-fficiency).

"ssociated *isk Cit, 9urrent +easurement System:

It is observed that Production lines are idle more than !%1 (!91 in December# $%"")

and while measuring the performance of the production managers this idle time andovertime (around 0%1 of total 5.&) are being ignored by the management when weenuired it was said by planning department that the idle time is mostly due to the non+availability of the raw material# and overtime is demanded by the management forurgent shipments etc. that,s why production managers don,t allow us to consider theovertime while calculating efficiency for incentive purpose.

5nly production managers are being paid the monetary incentive in return of a

favorable efficiency so other management (Procurement# utting# @inishing# etc) theymight not be motivated because of the monetary incentive paid to productionmanagers only# they might thin that their contribution is not so much valuable ascompare to production managers. &his might be the cause of un+availability of the rawmaterial because we found during the annual stoc count that there was much stoc inware houses for the styles3ordered which are to be started in future which means rawmaterial is being purchased in advance so raw material purchasing should be on thepriority basis to avoid the woring capital problems.

Internal "udit *ecommendations:

&arget should be attainable and there should be an element of challenge so that employee could

be motivated# and performance measurement should be effective that all employees should


10/11


10

contribute for the performance of the company not only a particular department# when every

manager is nown that his contribution is valuable to the company and he will be rewarded with a

monetary incentive (e.g. uarterly bonus etc.) if the decided target is achieved on time and

efficiently. -ach manager will be motivated to improve the performance of the company.

Performance should be measured on the basis of overall achievement of the ob'ective of thecompany (-.g. Carments produced within the allocated time and shipped to the customer# total

cost per unit is not more than the budgeted cost per unit).

:ot only production managers but other managers whose contribution is supposed to improve

the performance of the company (e.g. Procurement# utting# @inishing# ?ashing# Pacing and

@inance etc.) should be rewarded with a monetary incentive or a uarterly3annual bonus when

the desired ob'ectives are achieved effectively and efficiently -.g)the order3style is completed

and shipped to customer within allocated time and specified budgeted cost# certain level of

profits etc.

#or examle:

5nly production managers are rewarded with a Monetary Incentive when they achieve the

efficiency of the production floors pertains to them greater than the /01# so they are only

supposed to increase the efficiency of their production floors.

As discussed above there is a big Idle time in production lines and the resulting Idle time might

be the because of the following8

!re.Stitc,ed $roubles:

n+availability of the raw material (Procurement Dept.)

2aw Material in process yet not received (utting Dept.)

Machinery *rea down (Maintenance Dept.)

!ost.Stitc,ed $roubles:

Ma'or Alterations found because of the pressure of achieving the targets and maintaining

the efficiency by stitching department.

Machine *rea downs.

It is ,ig,ly recommended t,at comany s,ould:

se standard costing system to evaluate the performance of the factory.

&he variance analysis should be done and variances should be investigated (if material) to

find out the causes. Prepare an action plan to prevent it to be incurred in future.

Manager,s incentive should be based on overall performance of the factory.

Examles of ariance analysis:

/esired Objective ariance "nalysis !rocess of ariance

D e c e m

b e r

3 1

2 0 1 1


11/11


11

0$arget "nalysis

ompletion of products

within the allocatedtime and shipped to thecustomer.

Efficiency ariance:

Standard &ime Allowed @ess:Actual &ime incurred tocomplete the Style35rder

Idle $ime ariance:

Standard Idle &ime @ess:Actual Idle &ime

7ariance should be investigated(if Material) and actions shouldbe taen to prevent it to beincurred in future.#or ExamleD

If production lines are

stopped due to un+availability of raw material#machine breadown etc.responsible departmentshould be accountable forthe inconvenience.

Material purchased at

higher rates# Material

used is more than the tyallowed.

Material purchased

within the budgetedprice without ignoringthe uality of thematerial.

+aterial !rice ariance:

Standard Material Price @ess:Actual Price of MaterialPurchased

Material sage should

be within the standardty allowed

+aterial -sage ariance:

Standard ty allowed @ess:Actual ty consumed

D

b

3 1

2 0 1 1

304961 56283 Internal Audit Report on Review of System of Monetary Incentive Based on Production...

Documents

Transcript of 304961 56283 Internal Audit Report on Review of System of Monetary Incentive Based on Production...