ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com.

, FCA

8
MANAGEMENT AUDIT
Management Audit can be defined as “an audit of Management”.
In other words, Management Audit can be defined as
a. systematic independent appraisal activity
b. within an organization
c. for review of Management’s Efficiency
d. in its decision-making function
Management Audit is concerned with
a. appraising management’s accomplishment of organizational objectives
b. management functions of planning, organizing, directing, and controlling;
and
c. the adequacy of management’s decisions and actions in attaining its
stated objectives.

DISTINCTION BETWEEN FINANCIAL AUDIT AND MANAGEMENT AUDIT

Aspects Financial Audit Management Audit

1. Legal It is compulsory in the case of There is no legal compulsion as
Requirement enterprises like Companies, Trusts, regards Management Audit. It is
Societies, etc. voluntary.
2. Periodicity Financial Audits are conducted Management Audits are conducted
annually. once in 2 or 3 years.
3. Time Period It covers business transactions of There is no limitation as to the period
Covered the past financial year. to be covered.
4. Scope To express an opinion on the true To express an opinion on
and fair view of the financial performance of the
statements. Management during a particular
period and to suggest remedial
measures, if required.
5. Reporting The Statutory Auditor reports to The Management Auditor reports
Authority the owners, i.e. Shareholders in to the Management.
case of the Company.
NEED/DESIRABILITY OF MANAGEMENT AUDIT
The importance of management audit may be understood from the following points:
1. Detecting Managerial Deficiencies:
Management Audit is required for detecting and overcoming current managerial deficiencies
and the resulting problems in ongoing operations. If certain managers are ineffective
in their present positions, appropriate corrective action can be taken.
Moreover, management audit represents a positive, forward-looking approach when
compared with financial audit which is back-ward looking. This audit evaluates
a. How well Management accomplishes its stated organizational
objectives.

8.1
ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com., FCA

b. How effective Management is in planning, organizing, directing and

controlling the organization’s activities, and
c. How appropriate Management’s decisions are for reaching the stated
organization objectives.
A Management Audit questionnaire helps to evaluate managerial performance. This
questionnaire helps in understanding the follow of systems, procedures and method of
work within the organization. This helps in identifying managerial problems and
related operational difficulties can be spotted immediately unlike a financial audit. Periodic
management audits pinpoint problems as they develop from a small scale. When
these problems are detected at later stages, they results in higher costs to the
organization.
2. Assist the management in accomplishing desired objectives
Management audit is a tool to assist the organization in accomplishing desired objectives by
pinpointing important problem areas that relates to managing an organization.
Problem identification is very difficult aspect which cannot be undertaken by the
management because of time constraints. Once, management auditor identifies the
problems, the management may follow the suggestions given by the management auditor to
overcome those problems thereby management can achieve the desired objectives. In this
way, management audit helps in accomplishing desired objectives.
3. Helpful for ailing industries
It helps ailing industries to identify their problems. In case of ailing industries, it is very
important to properly diagnose the financial health and specific reasons that caused
to the decline in the business. If the management is not efficient, any amount of money
pumped in may go waste.
4. Helpful for Sound entities:
Management Audit also helps a sound entity to further improvement in its operations.
Brewing or latent problems may be detected and analyzed and opportunities can be
known.
ORGANIZING THE MANAGEMENT AUDIT
The following are the steps involved in Organizing the management audit.
1. Devising the Statement of Policy
2. Location of Audit Function
3. Allocation of Personnel
4. Staff Training
5. Time and other aspects
6. Frequency
1. DEVISING THE STATEMENT OF POLICY:
a. Management’s support for audit must be reflected clearly in the company’s
policy statement
b. The policy statement should spell out clearly the
i. scope of management audit
ii. its authority to carryout audits
iii. issue reports
iv. make recommendations

8.2
ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com., FCA
v. initiate corrective action
c. The statement should clearly state that Management Auditor is capable of
reviewing administrative and management controls over any activity
within the company.
d. Management Auditor should not be expected to evaluate the performance of
professional and technical activities calling for specialized knowledge and
skill.
e. This policy statement becomes the charter under which the Management Auditors
should operate.
2. LOCATION OF AUDIT FUNCTION:
a. It is desirable to establish a separate department for conducting management
audit and head of this department should report directly to the top executive.
b. The function should be as independent as possible so that pressures from various
groups in the enterprise can be avoided. The greater the independence, greater is
the freedom to work effectively.
c. The management auditor is expected to make a report, to the person who can
command prompt consideration of auditor’s opinions and
recommendations.
d. In other words, reporting should be done to Managing Director or Finance
Director or to an audit committee.
3. ALLOCTION OF PERSONNEL:
a. All the persons selected and assigned for audit should possess good
understanding of
i. Auditing Theory
ii. Thorough Knowledge of the fundamentals of Organization and
Management
iii. Knowledge of commercial practices of the enterprise
iv. Basic knowledge of commerce, law, taxation, cost accounting,
economics, quantitative methods and EDP Systems.
b. This knowledge helps the auditor to identify problems and to determine
steps to be taken when the problems is identified.
c. He should have ability to write and express clearly and logically.
4. STAFF TRAINING PROGRAMME:
a. The management auditor must keep abreast of new ways to improve auditing
standards.
b. An effective and continuous training program enables staff to conduct audit more
effectively.

8.3
ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com., FCA
5 TIME AND OTHER ASPECTS:
a. The time required to carry out management audit will vary and is dependent
upon the extent and nature of assignment.
b. Generally in a very big organization, conducting management audit may take several
months. The time required to complete the audit is also dependent upon
number of auditors assigned to perform the work.
c. In a study of the results of sales contracts, one might require to study the expenses
reports and other costs incurred in making contracts.
6. FREQUENCY:
a. The frequency of management audit depends upon the nature of the
organization.
b. Where the organization is subject to rapid changes, a two year basis might be
adequate.
c. For those organizations which are in stable industry, the frequency may be once
in three years.
d. In any case, the frequency of the audit shall not exceed 3 years.
CONDUCTING A MANAGEMENT AUDIT
The following are the steps involved in conducting the management audit.
1. Getting the facts through interviews
2. Measuring performance through the Management Audit Questionnaire
3. Concluding the Management Audit

I. GETTING THE FACTS THROUGH INTERVIEWS:

1. To avoid waste of time and effort, adequate audit planning is necessary in
management auditing just as in financial auditing.
2. The management auditor should know what information is desired and
should ask a number of direct questions to get the desired information.
Reference can be had to the management audit questionnaire for specific
questions.
3. The auditor should select proper managers for interview to get pertinent
information.
4. The persons to be interviewed must be notified beforehand, they should be
informed what reports, records, or other documentation should be made available
at the time of the interview.
5. State the purpose of audit before starting the interview.
6. The auditor should be friendly and interview should be conducted in an open
atmosphere to encourage free exchange of ideas.
7. The auditor should be tactful and diplomatic at all times, otherwise it may
result in getting only part of the desired information.
8. The auditor should listen to tentative solutions offered by managers for
problems identified and as far as practicable these solutions should find a place in

8.4
ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com., FCA
the final recommendations. When manager sees that his solutions are
included in the final report, he is supposed to support those recommendations.
9. After the conclusion of the interview, the management auditor is expected to verify
the accuracy of information by requesting the person interviewed to read the
notes taken and place his or her initials thereon. This makes the individual feel an
important part of management audit
II. MEASURING PERFORMANCE THORUGH THE MANAGEMENT AUDIT
QUESTIONNAIRE:
 A Management Audit Questionnaire (MAQ) aims at a comprehensive and
constructive examination of an organisation's Management and its assigned tasks.
 MAQ helps to define problems in terms of specific situations in which they exist.
 MAQ is concerned with the appraisal of Management actions in accomplishing
organisation objectives. Its primary objective is to highlight weakness and
deficiencies of the organisation for possible improvements.
The following aspects are covered in a MAQ for any business function
 Long Term Plans
 Medium and Short Term Plans
 Organization Structure
 Leadership
 Communication and
 Control.
There are three possible answers to the Management Audit Questionnaires –
 “YES” - the specific area, function, or aspect under study is fulfilling in an acceptable
manner. No written explanation is needed in that case.
 “NO”- indicates unacceptable performance and should be explained in writing.
Remarks for negative answers provide documentation for future reference and
background information for undertaking remedial action.
 “NOT APPLICABLE”- Those questions that are not applicable to the given situation
are ignored.
III. CONCLUDING MANAGEMENT AUDIT:
Concluding the audit means preparation of management audit report which include
the findings and recommendations of the management auditor.
In order to prepare the report, management auditor, normally meet with the
management and other concerned personnel for the purpose of discussing any finding
of the audit.
I. ORAL RECOMMENDATIONS FOR IMPROVEMENT
Generally, there is an oral presentation of specific recommendations to members of the
top management team who approved the audit.
Upon completion of the presentation, oral recommendations become an integral part of the
final report.
In the oral presentation, recommendations having feasible solutions that can be accepted
by the management without much difficulty are discussed initially.

8.5
ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com., FCA
While presenting the recommendations, the auditor should back his recommendations
with a cost/benefit analysis that flows from implementing the recommendations.
If certain recommendations are not accepted during the oral presentation, it is wise to
offer alternatives.
By this oral presentation and after having discussions with appropriate personnel, the
management auditor may be in a position to determine when and where the
recommendations can be put into operation. This assists the auditor to draw up an
implementation time-table for inclusion in the final report.
MANAGEMENT AUDIT REPORTS
The written report is the medium by which the comments, criticisms and recommendations
of management auditor are to be conveyed to the Board, to function directors.
TYPES/CLASSIFICATION OF REPORTS:
a. ORAL REPORTS
b. INTERIM WRITTEN REPORT
c. REGULAR WRITTEN REPORT
d. SUMMARY WRITTEN REPORT
ORAL REPORTS
It is an informal way of communicating the Audit findings to the Auditee /department
head.
In many situations, management auditor is required to report the results on an oral basis.
This is because of a result of emergency action needs. The main limitation of this
method is that there is no permanent record. This will result in misunderstandings at
a later stage. Moreover, the oral reports may not be taken seriously.
Therefore, the auditor should take care to ensure that matters covered by emergency oral
reporting, should be followed up immediately by a written report giving reference
to oral reporting.
For example, a management auditor, if he has come across any embezzlement, should
immediately inform the concerned management orally, so that steps may be immediately
taken to prevent further embezzlement.
INTERIM WRITTEN REPORTS
Where it is necessary to inform management about significant developments during the
course of audit, the auditor may have to issue interim report. This report should contain only
significant problems where there is a need for early consideration. This report
can also be issued where the auditor observes very exceptional developments.
Normally, interim reports are fully covered in the final regular reports unless certain
matters included in the interim report have been cleared/rectified to the auditor’s
satisfaction.
REGULAR WRITTEN REPORTS
These reports are submitted at the end of Management Audit work. The form and content of
such written reports will vary widely.
The work done by the Auditor will become worthless if his report is unable to hold the
interest of a reader.

8.6
ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com., FCA
Planning the Audit Report
Before starting the report, the auditor should ensure that the following points were taken care
of.
Supporting information:
(a) The Management Auditor should supplement his report by such documents and data,
which support his conclusions.
(b) Supporting information may include relevant provisions of law, standards, regulations,
etc.
Draft Report:
The Auditor's draft report will help him to –
(a) find out the most effective manner of presenting his report, and
(b) analyse whether there is any superfluous information or a gap in reasoning.

Writing and issuing the Final Report:

(a) Before issuing the Final Report, he should discuss conclusions and recommendations
with appropriate levels of Management.
(b) The report should be duly signed and dated.
Follow-up of the Audit Report:
(a) The Management Auditor should review whether the Management has taken
appropriate follow-up action on the basis of his report.
(b) If no action is taken within a reasonable time, he should draw Management's
attention to it.
The following are the general guidelines, which should be kept in mind by the
management auditor while preparing a written report.
1. Title: The title should be short but descriptive so that its subject matter can be easily
identified.
2. Objectives: The objects and purposes of the Audit assignment should be described.
3. Scope: A brief description of the activities performed, areas covered, persons with whom
discussions etc. have been made will help in better appreciation of the report.
4. Findings, conclusion and opinions: All facts and data pertaining to the situation
should be assembled, classified and analysed. Each finding should be discussed
comprehensively and correlated with other findings. Tables or graphs may be used for the
presentation of statistical data. The findings may be given either department wise or in the
order of importance.
5. Recommendations: A Management Audit report may include recommendations for
potential improvements. The remedial measures for system or procedural defects may be
pointed out.
6. Auditee's views: The draft report should be discussed with the departmental chiefs to
check accuracy. The Auditee's views about Audit conclusions or recommendations may be
included in the final report in appropriate circumstances.

8.7
ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com., FCA
7. Summary: A summary of conclusions and recommendations may be given, in case of
long reports.
SUMMARY WRITTEN REPORT
Summary Written Reports are also called "Flash" Reports. Annual (or sometimes more
frequent) report summarizing the various individual reports issued, and describing the range
of their content -
 Useful to top-level managers who are interested in summary data and do not actively
review the individual reports.
Advantages/Disadvantages of written reports over oral reports
Advantages:
1. Permanent record or evidence is created.
2. Since Management is required to initiate corrective action, it will be taken seriously.
3. Easy for follow-up,
4. Avoids misunderstanding since communication is made clear.

Disadvantages:
1. Too formal and lacks personal touch.
2. Useless if immediate action is required
BEHAVIOURAL ASPECTS ENCOUNTERED IN A MANAGEMENT AUDIT
One of the biggest difficulties involved during the course of management audit is that people
working in the organization do not wish to accept any change.

While conducting interviews, it seems that people working are amenable to change but at the
time of actual implementation they come up with stiff resistance.
Another fear is that the management auditor’s recommendations may lead to their removal or
reshuffling in the process.
During the course of audit, management auditor may come into contact with the following:
a. Colleagues in their own department
b. Staff of the department whose functioning they audit
c. Top management who authorized them to perform audit
Therefore, the management auditor must develop and maintain good relations with auditee
to gain information. Yet, the general image about the auditor is that he is a critic, fault finder
or private spying authority of the top management.
The following are the causes of behavioural problems that the management auditor is likely to
face in the discharge of duties.
1. Staff/line conflict:
The staff/line relationship is inherently prone to conflict. Management auditors are staff.
The members of other departments may regard the management auditor in the same way
they regard other staff people. Management auditor may think that their approach is
correct and they tend to discount the difficulty people may face. They may feel that they

8.8
ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com., FCA
must point out defects to prove themselves to top management. In this scenario, there will
arise a conflict between line and staff.
2. Contorl:
Under this heading, the cause of conflict may arise because of the following:
a. Fear of criticism stemming from adverse audit findings
b. Fear of changes in day-to-day working habits because of changes resulting from
audit recommendations.
c. Punitive action by superiors
d. When the auditor is overly critical, focusing on deficiencies only
e. Hostile Audit Style - Lack of understanding of the auditee’s problems, superiority,
excessive concentration on insignificant errors, a prosecutional tone when asking
questions etc.
OPERATIONAL AUDIT
Operational auditing is “a systematic process of evaluating an organizations
effectiveness, efficiency and economy of operations under management’s control
and reporting to appropriate persons, the results of the evaluation along with
recommendations for improvements”.
Operational audit concentrates on effectiveness, efficiency and economy of operations and
therefore it is future oriented.
Operational audit is an audit for the management. It is undertaken at the instance of
the management. It aims to provide the information required by the management to
appraise their operations and activities. In other words, operational audit focus on
quality of operations.
Qualities of operational auditor
1. He should ask - who, why and how of everything. He should try to visualize
whether simpler alternative means are available to do a particular work.
2. He should possess an attitude of skepticism.
3. He should not give up or feel satisfied easily. He should follow a constructive
approach rather than a fault-finding approach and should give a feeling that
his efforts are to help attaining improvement in operations and not merely
fault finding. This leads to getting co-operation of the persons who are involved in
the operations.
Why Operational audit
Operational audit is considered as a specialized management information tool. It
helps to fill the void that conventional information sources fail to fill. The
following are said to be conventional sources of information to management:
 Departmental managers
 Routine performance report
 Internal audit reports and
 Periodic special investigations.

8.9
ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com., FCA
These conventional sources fail to provide information for the best direction of the
departments all of whose activities doe not come under direct observation of managers. The
shortcomings of these sources are:
1. Executives and managers are preoccupied with implementation of plans and
achieving targets. They are left with no time or very little time to collect
information and locate problems. They may come across problems that have
come to surface but they may not be aware of problems that are brewing
and potential.
2. The information transmitted by managers is not necessarily objective –
often it may be biased for various reasons.
3. Conventional internal audit reports are often routine and mechanical in
character and have a definite leaning towards accounting and financial
information.
4. Department managers can afford time only to glance over the performance
reports, cannot be expected to make an integrated reading of several reports or
to undertake an analysis of such reports.
Examples:
i. Sales may be shown at a higher monetary value compared to the
previous year and this may apparently suggest that the functioning of the
sales department is satisfactory. But this may have been caused by a number
of factors inspite of a really bad performance on the sales front. This fact
may not be readily known unless a careful analysis of the sales data is
carried out by reference to notes and explanations to the accounts and other related
accounting data. Even a study of this nature may not fully reveal the weakness, it is
quite possible that the established market for sales has been lost partly while
some fortuitous sales have compensated the loss.
ii. The routine weekly production report may include production that is
subsequently rejected by the quality control staff, or to avoid showing a bad
production performance; even the partly produced goods may also be
included. All this can happen inspite of specific management instructions
about the basis on which the production report is to be made out.
5. Surveys and special investigations, no doubt, are very useful but these are at
the best occasional in character. Also, they are costly, time consuming. These
are basically an attempt to carry out a post-mortem rather than to enlighten the
management about the ways on improvement or to give a signal for dangers and
disasters to come.
Objectives of Operational Audit
Like internal auditing, the scope and quality of operational auditing is predominantly
dependent upon management attitudes. An open minded management with broad
vision can appreciate the need of operational auditing and to give it the necessary
freedom to perform what it is capable of performing. Generally, operational audit
objectives include:
I. Appraisal of Controls
Internal controls, ensure proper performance in each functional or organisational area for
accomplishing the desired organisational objective. If controls are weak or breaking down,

8.10
ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com., FCA
however well- equipped or well-manned the organisation may be, it will fail to operate
effectively. Therefore, the operational auditor is responsible for
evaluation/appraisal of internal controls.
Appraisal of Organisational Structure
Organisational structure provides the line of relationships and delegation of authority and
tasks. This is an important element of the internal control design. Therefore, the
operational auditor should also appraise this also as a part of evaluation of internal controls.
The following aspects may be considered in this regard:
 Is the organisational structure in conformity with management objectives?
 Whether the delegation of responsibility and authority at each stage is clear
and overlapping are avoided?
II. Evaluation of Performance
For carrying out the task of performance evaluation, an operational auditor depends upon
acceptable standards. The operational auditor is required to design his evaluation
programme to ascertain how well or how poorly the department has fared by reference to
applicable standards, procedures, rules, policies and plans.
The principal basis of performance evaluation can be productivity, personnel, workload,
cost and quality.
Productivity
In the area of productivity, the operational auditor can undertake such tests as input-
output ratios for materials and labour in quantitative terms.
Personnel
Personnel is perhaps the most important factor in performance evaluation. Unless the
organisation has a sound personnel policy consistent with its requirements, the
facilities, materials and equipment that are available in the organisation may not be utilised
properly to obtain optimum performance.
Work load measurement
Work load measurement can be another significant area where operational auditor can be of
use because of ready availability of quantitative data. There can be measures like volume or
quantity of work handled and/or performed volume of new work, backlog of
work, etc.
Quality of work
The Operational Auditor can follow some quantitative measures to judge the quality
of work. These can be:
a. Number of customers’ complaints
b. Rejections by quality control department
c. Number of workers’ grievances
d. Number of errors in invoicing or recording transactions
e. Quantity of scrap and wastages, etc.
Cost

8.11
ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com., FCA
Cost is an indicator of performance. Costs are classified and recorded for a proper
assimilation of their implications on performance.
Review of Systems and Procedures
Systems
The definition can be better understood with reference to a complex biological system of
human beings which consists of various sub-systems, e.g. nervous system, digestive system,
respiratory system, blood circulation system, reproductive system, etc. Each sub-system in
turn, may be treated as a complete system in itself. For example, digestive system
consists of various organs, say stomach, intestines, etc. which are interdependent
and interrelated, so that failure of any part will lead to failure of the digestive
system.
Similarly, a business organisation may perform/carry various operations-manufacturing,
purchasing, marketing, accounting and finance, research and development, personnel -
comprise a system.
Procedures
Procedure is nothing but specifying precise uniform action to be taken by a large number
of people in respect of repetitive jobs. In other words, procedures are detailed
prescriptions of how things are to be done. Most often, procedures entail the use of
documents which contain precise instructions or methods to be used. By establishing
standard procedures, the element of discretion is reduced as far as possible and they
also ensure that each person understands what he is to do.
The operational auditor is required to review the systems and procedures established in the
organization to improve the methods, to get away from the old ways and traditional
routines and to reduce the cost in completing and processing the paper work -
eliminating waste, duplication and inefficiencies.
Operational Audit Questionnaire
Production Area
1. Relationship with suppliers and staff
2. Inventory management and control
3. Alternate sources of raw material
4. Maintenance procedures
5. Employee training programs
6. Technology
7. Environmental Protection Policies
Sales
1. Product Pricing
2. Sales Channels
3. Sales Personnel
Customer Services
1. Quality of customer service personnel responses
2. Feed back to determine customer satisfaction levels

8.12
ADVANCED AUDITING & PROFESSIONAL ETHICS CA C.V.SARMA, M.Com., FCA
3. Customer complaints and its position
Differences between Financial and Operational Auditing
The major differences between financial and operational auditing can be described as
follows:
Purpose
The financial auditing is basically concerned with the opinion that whether the historical
information recorded is correct or not, whereas the operational auditing emphasizes on
effectiveness and efficiency of operations for future performance.
Area
Financial audits are restricted to the matters directly affecting the
appropriateness of the presented financial statements but the operational
auditing covers all the activities that are related to efficiency and effectiveness of
operations directed towards accomplishment of objectives of organization.
Reporting
The financial audit report is sent to all stock holders, bankers and other persons having
stake in the organisation. However the operational audit report is primarily for the
management.
End Task
The financial audit has reporting the findings to the persons getting the report as its end
objective, however, the operational auditing is not limited to reporting only but includes
suggestions for improvement also.

Relationship between Internal Audit and Operational Audit

The internal auditing need not be confined to financial transactions and its scope may be
extended to the task of reviewing whether the resource utilization of the enterprise is efficient
and economical. For this, some times, the internal auditor may have to review the operations
carried out by the enterprise. In such a case, since the scope of the work carried out by the
internal auditor extended into operational areas also, such an internal auditor may also be
called as Operational Auditor.

8.13