M/s Grand Pharmaceuticals Ltd., a pharmaceutical manufacturing company, has appointed CA Rohan as its internal auditor. During his review of the…

The following principles of internal check have not been adequately followed in the given situation: (i) Rotation of duties: The Sales Manager has been dealing with the same customers for a prolonged period and has developed close relationships with them. Periodic rotation of duties helps reduce the possibility of collusion, manipulation and concealment of irregularities. Further, the same individual having authority over credit limits and write-offs creates an inadequate segregation of duties. (ii) Separation of custody from recording: The Stores Supervisor is responsible both for the physical custody of inventory and for maintaining inventory records. The functions of custody and recording should, as far as practicable, be entrusted to different persons so that the work of one person provides a check on the other. Absence of independent physical verification further weakens this control. (iii) Segregation of preparation and approval of payments: The Finance Manager both prepares and approves payment instructions. No single person should have complete control over an important financial operation. Independent review and approval should be performed by another responsible official. Inherent risks Associated with the relevant activities: Sales, inventory and payments are inherently susceptible to risks such as fictitious or unauthorised transactions, manipulation of receivables, inventory pilferage and fraudulent payments. The nature of these transactions gives rise to significant underlying inherent risks. Impact of Control Deficiencies on Control Risk: The deficiencies in rotation, segregation of duties and independent verification mean that the internal controls may fail to prevent or detect material misstatements or fraud on a timely basis. Accordingly, control risk would be assessed as higher, requiring the auditor to perform appropriate additional audit procedures.