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Financial Management of Distribution Management

Distribution Reform, Upgrades and Management (DRUM) Training Program

Case Study – Cost Audit Compliance


Pisupati Karthikeya, Emerging Markets Group, Ltd

Ashok Kumar is an Accounts Officer working in the accounts compilation section of the
corporate office of an electricity distribution company. He receives a file from his
Controller of Accounts containing the enquires issued by the Auditors on the draft
accounts 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 Balance
sheet 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 unit 27,830
transaction
21.3.2005
05/23.4.2005 Erection bill NLM 49,382
64/15.12.2004
11/30.4.2005 Labour contract All 10 bills pertain 1,97,998
bills to March 2005
Total 2,75,210

This has resulted in understatement of Account Head 14 series-CWIP and


Account 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 in
understatement 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 High
Tension installations, it was observed that, an excess amount of Rs. 1,57,973
has been provided in excess of the actual demand as shown below.

Tariff Unbilled revenue Actual demand as Difference


provided for per DCB (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 extent of


Rs.1,57,973. Account Head for Revenue from sale of power HT category is 61
series 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 is
entitled to a rebate of 0.05% for prompt payments. As per the audit note issued
by 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 the
accounts of the company for the year has resulted in overstatement of AH 41
series-sundry creditors for purchase of power and understatement of Account
Head 62 series-Miscellaneous recoveries by Rs. 20.12 lakhs

5. Power purchase from IPP

The company began purchasing power from the IPP which commenced
commercial production from 1st September 2004. Between September and March
05, the company purchase 45.100 million units. On receipt of monthly bills, the
company released adhoc payments which was charged to the power purchased
account. As against Rs. 16 crs. of adhoc payments made for power purchased
during the year 2004-05, the actual amount billed and payable by the company
works 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. in
its accounts, resulting in understatement of AH 70 series-Power purchase and
AH 41 series-Sundry creditors for purchase of power. Had the company followed
the merit order dispatch approved by the regulator is company should have
drawn 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 the


eligible employees. Against this provision, the correct amount payable is
Rs.3,33,000 only. This has resulted in overstatement of AH 75.5 series and AH
44.3-ex-gratia payable. However, the regulatory commission for the purpose of
ARR does not consider the ex-gratia payable as a legitimate expenditure and
disallows 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 on
lightening arrestors. The division has calculated the deprecation at 7.84% instead
of 12.77% per annum. Out of the short provision, Rs.12,535 pertains to the
current year and the balance amount relates to previous years. This has resulted
understatement of AH 77 and 83 series (prior period) – depreciation on plant
and 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&M
division 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 against


supply 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 to
suppliers-interest bearing). The advance paid by the company to the supplier
carried on interest of 12% P.A. Against this amount, the supplier supplied
materials worth Rs. 6,20,000 & repaid Rs 1,80,000 of advance along with the
interest at applicable rate on 31st December 2004. While finalizing the year end
accounts, the accounting unit concerned has not accounted for the interest due
on the balance amount for the period form January to March 2005. This resulted
in understatement of income by Rs. 12,000/- under AH 62 series- Miscellaneous
recoveries 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 and


replacement by a new one contained three parts.

Part-A Estimate for releasing the existing asset (Original value of the Asset
Rs. 20,000/- (AH 10 series), Accumulated depreciation Rs. 6,000/- (AH 12
series) & 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. 4246
was assigned (instead of assigning distinct numbers viz. 4246 A, 4246 B and
4246 C for each of the parts). As a result of this error, the accounts section of the
division has made the following mistakes

a) opened one folio in the cost/works register & has booked all the transactions
b) 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 separate
Work 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 provision for
deprecation.
c) Labour charges for dismantling of the existing asset is revenue expenditure
and should directly be debited to 77.5 series.
d) Estimate for creation a new asset should be sanctioned under AH 14 –CWIP
and 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 credited
to AH 14-CWIP instead of AH 10- Fixed Assets.
- Rs. 3,000 being the labour charges for dismantling is debited to AH 14
instead 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 service
with immediate effect & to recover the stores shortages amounting to Rs.3.48 lakhs
from his assets in movable and immovable properties by taking immediate legal
action. In view of the above order and considering the amount involved, adequate
provisions should have been made in the accounts towards the above sum which
arrears 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 class
of the assets, through the regulatory commission has given a directive that the
Company has to provide information regarding voltage-wise break up of Fixed
Assets and accumulated depreciation by ensuring that the deficiencies in the
accounting 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 the
materials brought. As a result, the Company to the extent of unpaid materials is not
accounting the MCV on accrual basis and the quantification of the same is not
arrived 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 shortly


and audit will be informed.

(ii) AE No.12: Since the employee was dismissed with effect immediate effect on
the last working day of the financial year, the company is not in a position to
immediately identify the movable and immovable properties of the employee
and quantify the same on the date of the balance sheet. Besides, any
provision for write off of this amount would dilute the stand of the company
any 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 the
voltage class of the assets. Besides complying regulatory requirement, these
details are also required for the Cost to Serve study. The company needs to
initiate necessary measures to address this requirement.

(iv) AE No.14: Currently the company is accounting MCV at the time of passing
bills 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 accounting
methodology by issuing fresh instructions to the field units, besides
examining providing of additional account code in the Chart of Accounts.

Journal Entries
(In Rupees)
JV A/C
NO. Group Journal Entries to be passed in the Books Debit Credit
(followed by of the Company
activity code
numbers
specific to
the activity)

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


Dr.
46---- 2,75,210
To Provision for liability for expenses A/C

(Being accountal of short provision as pointed


by auditors vide their audit enquiry no.-------)

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2 10---- Fixed Assets A/C 3,60,000


Dr.
14---- 3,60,000
To Capital works in progress A/C

(Being the difference between the amount


already transferred to asset account & the
actual amount that should have been
transferred to asset account now accounted
as per auditors observation vide their audit
enquiry no.-------)

3 61---- Revenue from sale of power -HT A/C 1,57,973


Dr.
23---- 1,57,973
To Provision for unbilled revenue A/C

(Being the removal of excess provision made


towards unbilled revenue from HT category as
per auditors observation vide their audit
enquiry no.--)

4 41---- Sundry creditors for purchase of power A/C 20,12,000


Dr.
62---- 20,12,000
To Miscellaneous recoveries A/C

(Accounting of 0.05% rebate due form


prompt payment from generator as per
auditors observation vide their audit enquiry
no.--)

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


Dr. 0
41--- 7,12,00,00
To Sundry Crs. for purchase of power 0
A/C

(Accounting of short provision of power


purchase cost payable to the generator as per
auditors observation vide their audit enquiry
no.--)

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

75.5--- To Ex-gratia A/C 50,000

(Removal of excess provision of ex-gratia


payable to employees as per auditors
observation vide their audit enquiry no.--)
7
77---- Depreciation A/C Dr. 12,535
83---- Prior period expenses-Depreciation Dr. 37,605

12--- To Provision for depreciation A/C 50,140

(Accounting of short provision of depreciation


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

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

37--- To Inter Units Account 50,000

(Accounting of R&M expenses transferred by


the corporate office as per auditors
observation vide their audit enquiry no.--)

9 28---- Sundry debtors for other misc. income A/C 12,000


Dr.
62.--- 12,000
To Miscellaneous recoveries

(Providing for interest due on advances to


suppliers as per auditors observation vide
their audit enquiry no.--)

10 14---- Capital works in progress A/C Dr. 20,000

10.--- To Fixed Assets A/C 20,000

(Removal of wrong credit given to 14-CWIP


instead of 10-Fixed Asset account as per
auditors observation vide their audit enquiry
no.--)

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77.5….. Asset decommissioning cost A/C 3,000


Dr.
14….. 3,000
To Capital works in Progress A/C

(Being transfer of asset decommissioning cost


(labour charges) wrongly booked under AH 14
series as per auditors observation vide their
audit enquiry no.----------)
10.---- 17,000
Fixed Asset A/C
14.--- Dr. 17,000
To Capital works in progress
(Being transfer of CWIP to Fixed asset A/c to
rectify the short booking of amount to the
fixed asset account as per auditors
observation vide their audit enquiry no.-------)

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

Impact on P&L account (In Rs.)


JE Account Head of account Debit Credit
reference Head
1 NA Both AHs relate to Balance sheet
items
2 NA Both Ahs relate to Balance sheet
items
3 61 Revenue from sale of power –HT 1,57,973
A/C
4 62 Miscellaneous recoveries A/C 20,12,000
5 70 Power purchase A/C 7,12,00,00
0
6 75.5 Ex-gratia A/C 50,000
7 77 Depreciation A/C 12,535
83 Prior period expenses-Depreciation 37,605
8 74 R&M expenses A/C 50,000
9 62 Miscellaneous recoveries 12,000
10 77.5 Asset decommissioning cost A/C 3,000
Total 7,14,61,11 20.74,000
3
Net Impact
(Profit of the company will come 6,93,87,11
down by this amount) 3

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Impact on Balance sheet

Change in liabilities
JE Account Head of account Amount
reference Head
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) 6,94,13,210
Transfer from P&L account (debit) 6,93.87,113
Net change in liabilities 26,097

Change in Assets
JE Account Head of account Amount
reference Head
1 14---- Capital works in progress A/C 2,75,210
2 10.--- Fixed Assets A/C 3,60,000
14.--- Capital works in progress A/C (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. income 12,000
A/c
10 14.--- Capital works in progress A/C 20,000
10.--- Fixed Assets A/C (20,000)
14.--- Capital works in Progress A/C (3,000)
10.--- Fixed Asset A/C 17,000
14.--- Capital works in progress (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 Journal
entries, 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 commenced
its commercial production from 1st September 2004, as per the merit order
dispatch approved by the regulator the company should have drawn only 38.000
Mus. The regulator will not allow the variable cost on the incremental units
purchased. Out of Rs. Rs. 23.27 Crs. payable to the IPP the element of fixed cost
is 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 the
variable 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 a
legitimate expenditure for the purpose of ARR & has been disallowing this
expenditure, the entire amount of ex-gratia payable of Rs.3,33,000 cannot be
recovered through tariff increase or as subsidy from Government.

The company has to absorb both the costs amounting to Rs. 1.81 Crs. The
profitability 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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