Management Audit | UGC NET Commerce Preparation Course PDF Download

Introduction

• Management Audit: Management Audit is a more recent form of audit compared to statutory audit. It is also known as Operational Audit. When the responsibilities of the statutory auditor expanded, there was a need to assess the management processes. Initially, the statutory auditor was only required to confirm if the Balance Sheet and Profit and Loss account adhered to the Companies Act and presented a true and fair view of the company's affairs.
• Evolution of Management Audit: Due to the increasing size and complexity of business organizations, a new type of audit emerged, known as Management Audit. Unlike the statutory auditor, the management auditor delves deeper into evaluating the implementation of management policies, functions, and processes to enhance efficiency. This includes assessing the benefits of altering purchasing methods or business operations for the company's advantage.
• Significance of Management: The success or failure of a business hinges greatly on effective management. Management Audit serves as a comprehensive evaluation of management quality. In the modern business landscape, it is crucial for management auditors to consider factors like production costs to optimize efficiency and competitiveness.
• Management Consultancy Services: In today's digital age, companies seek management consultancy services to identify and rectify deficiencies in management functions. Due to a scarcity of skilled personnel in specialized areas such as operation research and electronic data processing, businesses opt to engage Management Consultants, who often charge substantial fees due to their expertise and potential for delivering profitable insights to clients.
• Expansion of Internal Audit: Management Audit represents a new dimension in auditing, marking the evolution of internal audit practices.

Definitions

Management Audit Definition:

• Management audit involves examining and reviewing management's actions and policies based on specific objectives.
• It aims to evaluate management activities and effectiveness independently.

Various Definitions of Management Audit:

• William P. Leonard: Management audit is a detailed examination of an organization's structure, plans, operations, and facilities.
• Institute of Internal Auditors Inc.: It is a forward-looking assessment of management activities at all levels to enhance organizational profitability and achieve goals.
• H. Washbrook: Management audit includes checking managers' effectiveness, compliance, data reliability, and performance quality.
• Leslie R. Howard: It is an investigation of a business from top to bottom to ensure efficient management.
• American Institute of Management: Management auditing is a diagnostic process to identify weaknesses and improve operations.
• Taylor and Perry: It evaluates management efficiency throughout an organization and provides recommendations for improvement.
• William F. Kelly: A critical review of organizational structure and administration to suggest adjustments.
• Michael Stephen R.: Management audit evaluates administrative operations against accepted standards.
• Federal Financial Officers' Institute, Canada: It is an independent appraisal activity within an organization to assist management effectively.
• Roy A. Lindberg and Theodore Cohn: A technique to appraise units' effectiveness against standards to ensure goals are met.

A careful analysis of the above definitions of experts enables to ascertain that management audit covers the following areas:

• Examination of organization structure completely or partly.
• Reviewing the functioning of management and how well it works.
• A careful assessment of the tasks carried out by management leaders.
• Experts conducting an independent examination.
• Assessment of how well the management board operates.
• Looking into the objectives, strategies, rules, and deeds of the management.
• Assessment of the management's ability to make profits.
• Spotting weaknesses in the management and proposing solutions to fix them.
• Helping the management effectively deal with any future issues.

Concept

• Management audit can be described as a thorough and impartial examination, analysis, and evaluation of the overall performance of management. This evaluation considers both financial and non-financial aspects, including the economic environment and their impact on the organization's administration and objectives. 
•  It essentially involves assessing the total performance of management through an objective and comprehensive review of the organizational structure, its components like departments, plans, policies, operational methods, controls, and utilization of resources. Management audit, therefore, represents a critical evaluation of the enterprise's management from a broad perspective, focusing on improvement for industrial development. 
•  According to George A. Terry, management audit involves comparing the planning, organizing, activating, and controlling aspects of a company to the standards of successful operation. It examines the company's past, present, and future endeavors to determine if it is maximizing its results effectively. 
•  Management audit covers all activities of the organization, from top to bottom, with a primary focus on management control at the top level. The aim is to ensure that general management functions smoothly and satisfactorily. 
•  Another definition of management audit is a thorough and constructive review of an organization's structure, including its departments, plans, objectives, operational methods, and utilization of human and physical resources. 
•  Management audit involves an informed and constructive analysis, evaluation, and a series of recommendations related to an economic entity's various plans, processes, people, and issues. 

Scope 

Studying the prescribed organisation: 

• Examining the formal structure of an organization, relationships between individuals, policies, procedures, information systems, and decision-making hubs to identify the most effective setup for managing a business.

Evaluating the 'live-entity': 

• Assessing the actual objectives pursued by operational staff, the methods and schedules they use to achieve these goals, and measuring the outcomes against predetermined standards and objectives.

Searching for profit inhibitors: 

Identifying issues like poor organizational hierarchies, breakdowns in operations, inadequate communication, evaluation and measurement processes, and results that significantly fall short of established benchmarks.

The management audit concept involves thoroughly assessing an organization or management processes, scrutinizing system functionality and performance in-depth, aligning with the focus areas recognized by the American Institute of Management.

These are as follows:

• Economic function vis-a-vis social responsibility: This involves evaluating how much the public values a company concerning various interests like shareholders, employees, creditors, distributors, consumers, and the community it operates in.
• Corporate structure: This evaluation involves testing aspects such as information flow, supervision span, authority relationships, and centralization/decentralization of authority.
• Health of earnings: This involves assessing how much profit the resources have actually generated in real terms.
• Service to shareholders: The assessment is mainly based on three criteria: (a) Minimizing investment risks, (b) Providing a reasonable return on investment, and (c) Ensuring reasonable capital appreciation over time.
• Research and development: This evaluates how successful past research and development activities have been in contributing to the company's progress and future development.
• Analysis of the board of directors: The assessment focuses on three key elements: (a) Each Director's quality and contribution, (b) Teamwork, and (c) Trustee roles.
• Fiscal and financial policies: This involves evaluating the evolution of capital management systems, dividend policies, fiscal policies, controls, and their application in various corporate areas.
• Production efficiency: This assesses the management sub-systems related to materials, labor, waste control, machinery, production policies, and achievements in terms of quantity and quality.
• Sales vigor: This measures criteria such as sales personnel development, achievement of past sales potentials, and current sales policies to realize further sales potential.
• Executive evaluation: This evaluates personal qualities essential for business leaders, including abilities, industry knowledge, and integrity.

Objectives

• To determine how well the main goals of the organization have been met.
• To pinpoint any flaws or irregularities among management executives.
• To ensure that the management is on track to achieve its goals.
• To assist the management in efficiently running operations.
• To aid management executives in carrying out their duties effectively.
• To recommend strategies for achieving objectives to the management.
• To enhance the organization's profitability.
• To maximize the management's efficiency.
• To support management executives in effectively fulfilling their responsibilities.
• To assess the accomplishment levels of strategies, goals, and objectives.
• To evaluate the alignment of the organizational structure with the strategies.
• To monitor the utilization of resources in line with the strategies.
• To identify any deviations from industry standards and suggest corrective actions.
• To help management improve the implementation of policies and objectives.

Need and Importance (With Reasons)

Management Audit is needed for several reasons: 

• Checks if company policies are being followed correctly.
• Improves the performance of managers, including the general manager.
• Provides suggestions to reduce waste and production costs.
• Enables independent performance analysis by the general manager or managing director.
• Identifies ways to maximize profits and resource utilization.
• Pinpoints weaknesses causing inefficiencies and suggests improvements.
• Evaluates the financial health of the company.
• Aids in designing financial and non-financial incentive schemes tied to performance.
• Helps banks and financial institutions ensure proper utilization of loan amounts.
• Assists foreign collaborators in assessing management performance in partnerships.
• In India, advises public enterprises to shift focus to efficiency improvement.
• Essential for discovering optimal methods to enhance efficiency.

Importance of Management Audit

Management Audit Importance:

• Management Audit plays a crucial role in enhancing company efficiency due to several reasons:
• Management Audit ensures that the company's policies and objectives are aligned with changes in the environment, strategies of competitors, technological advancements, and consumer preferences.
• It assists management in enhancing its systems based on evolving management principles, techniques, and approaches.
• Management Audit aids in boosting performance by effectively implementing policies and optimizing resource utilization.
• It establishes the direction of objectives, policies, and business definition.
• By fostering open interaction with the environment, Management Audit allows businesses to capitalize on environmental opportunities and mitigate the impact of environmental threats.

Process Adopted for the Implementation of Management Audit

 Process for Implementing Management Audit:

1. Setting Objectives for Introducing Management Audit System: Initially, directors establish goals for implementing a management audit system while also appointing a management auditor. 
2. Collecting Information: Once the auditor is appointed, the investigation process begins. This involves reviewing records, interviewing managers, examining enterprise policies, organizational structure, motivation, communication systems, and evaluating managerial decisions made within a specific timeframe. 
3. Evaluating Findings: Upon gathering all relevant data, the auditor analyzes it to identify unnecessary activities, ineffective decisions, and reasons behind failures. 
4. Recommendations for Enhancements: The role of a management auditor extends beyond identifying weaknesses to proposing ways for improvement. Subsequently, the auditor submits a report to the Board of Directors containing suggestions. 

Top 13 Approaches

• Management auditors should create an audit plan before beginning a management audit.
• They should assess the formal structure of the organization and its charts.
• Evaluating the current management information system is crucial.
• Understanding the different policies implemented by the management is important.
• Reviewing the authority levels and responsibilities of management executives is necessary.
• Examining the rules and procedures related to leaves is part of the process.
• Observing how various management executives interact with each other is essential.
• Checking the existing organizational layout is a key step.
• Reviewing the standards set by the management is crucial.
• Understanding the consequences of management decisions is significant.
• Studying the legal regulations followed by the company is important.
• Evaluating the working conditions and environment of management executives is necessary.
• Understanding both the primary and secondary objectives of the company is crucial.
• Reviewing the different levels within the organization's hierarchy is necessary.
• The effectiveness of a management audit depends entirely on the skills and capabilities of the management auditor.

Preliminaries

• Management audit is best done by a team of experts from various fields like accounts, engineering, science, and psychology.
• Team members should receive proper training and support from top management.
• Before starting the audit, the auditor should: observe the organization's environment, examine how management executives are appointed, understand the psychology of management executives, recognize the talents of executives, determine their involvement in work, set standards for activities, observe how executives and workers are treated, assess the level of freedom given to executives, analyze management's control techniques, evaluate job satisfaction levels, and check the adequacy of staff.
• The Management Auditor needs proper authorization from management to conduct appraisal activities.

Qualification of Management Internal Auditor

• There are no specific qualifications required to be a management auditor because management auditing is a recent aspect of internal auditing and is not mandated by laws. Hence, it is believed that an internal auditor can also perform management audits. 
• Reasons for assigning management audit tasks to internal auditors include their deep understanding of the organization's structure, business nature, and management challenges, enabling them to provide valuable insights. 
• Internal auditors get a comprehensive view of the management's performance across all areas, aiding in identifying strengths and weaknesses of employees and understanding personnel dynamics. 
• Internal auditors scrutinize the operations of all organizational departments, allowing them to grasp the reasons necessitating management audits. 
• Some argue that management audit responsibilities should be given to external auditors due to their impartial perspective and ability to offer unbiased suggestions for enhancing performance. 
• External auditors, being independent, can draw from their diverse experiences and technical expertise to suggest efficient methods for improving staff productivity. 
• Management audits are not part of mandatory audits, and there are no specific qualifications set by regulatory bodies for management auditors. Management consultants, known for their expertise, are commonly engaged to conduct such audits. 
• When appointing a management auditor, it is advisable to consider their technical proficiency. To receive valuable recommendations for enhancing management efficiency, it is recommended to appoint someone other than the internal or statutory auditor. 

Activities Performed by Management Auditor

• Management auditor carries out the following tasks:
• Investigating external surroundings
• Reviewing the company's vision, mission, goals, philosophy, policies, and strategies
• Assessing industry standards regarding goals, strategies, organizational setup, profitability, and productivity
• Assessing the internal conditions of the company against industry standards
• Evaluating the key managers, their abilities, styles, and performance
• Assessing management styles and practices in other companies
• Assessing managers' potential and their innovative abilities
• Examining the level of freedom and independence granted to employees to utilize their skills
• Reviewing managers' involvement in decision-making and implementation processes

Important Duties of Management Auditor

Management auditors have varied responsibilities, though they focus on specific tasks.

Key areas of inspection for a management auditor include:

• Purchasing methods used by the management.
• Sales procedures from order receipt to fulfillment.
• Thorough evaluation of the manufacturing process.
• Factory examination for cleanliness and organization.
• Storage provisions.
• Safety precautions for company assets, raw materials, and finished products.
• Internal transportation systems for both personnel and materials.
• Records maintenance.
• Customer service evaluation.
• Post-sales support.
• Handling and resolution of customer complaints.
• Marketing activities.
• Quality checks for both raw materials and finished goods.
• Communication effectiveness between production and sales departments.
• Efforts to reduce production costs.
• Company's distribution channels.
• Timely payments to creditors.
• Debt collection processes from debtors.
• Handling and write-off of bad debts.
• Ensuring worker safety within the production environment.

Management Auditor’s Report

The management auditor needs to accurately assess how the organization operates. He must create a report that includes the findings and conclusions of the audit in a clear manner. The information in the report should be accurate, based on what the auditor learned during the audit. The auditor should not shy away from criticizing the management. When presenting the report, the auditor should be polite and avoid using harsh language unnecessarily. He should also discuss the relationship between the management and the staff.

The report typically covers the following points:

• Give an opinion on the returns on investments.
• Compare actual performance with the established standards.
• Comment on the company's operating costs.
• Provide an opinion on the use of plant and machinery.
• Suggest ways for improvement.
• Present findings and conclusions.

Advantages and Disadvantages

The main benefits of management audit are:

• Identifying strengths and weaknesses in management for improvements.
• Helping in planning and assigning planning responsibilities.
• Enhancing communication and control systems.
• Improving decision-making processes.
• Protecting organizational interests and enhancing performance.
• Facilitating communication flow between responsibility centers.
• Identifying opportunities through innovation.
• Improving coordination and evaluating control techniques.
• Pinpointing factors affecting profitability for improvement.
• Suggesting ways to enhance efficiency and overall performance.
• Enhancing human resource development and performance appraisal.
• Relieving management pressure to focus on important matters.

Management audit also has limitations:

• Undefined scope.
• Not conducted annually.
• Lack of standard techniques.
• Difficulty in finding competent auditors.
• Potential for creating complexity in authority relationships.
• Requirement for interdisciplinary knowledge in auditors.
• Resistance from management to appraisal of policies and actions.
• Additional expenses for the business unit.
• Discouragement of executive initiative.
• Reliability issues in large concerns.
• Resistance from management executives to criticism.
• Challenges in assessing management competence.
• Potential bias in auditor's fault-finding.
• Risk of controversies due to auditor suggestions.
• Importance of focused recommendations and implementation.
• Focus on accounting correctness over production and efficiency.
• Management audit, when conducted effectively, can be a valuable tool for control and improvement, especially when linked to executive performance incentives.

Bradford Cadmus emphasized that auditors should present facts effectively to prompt management review and action.