Internal Audit for Manufacturing Companies: Process, Checklist & More

Internal audit for manufacturing companies in India revolves around boosting performance and ensuring compliance within your organization. 

This guide explores the essentials of conducting these audits. From areas covered to process, checklist and format, here’s all you need to know. 

Role of Internal Audit for Manufacturing Companies in India

An internal audit of a manufacturing company is an independent, objective assessment of the company’s operations, processes, and controls. 

Internal audits are meant to ensure compliance, efficiency, and effectiveness in achieving the goals of the manufacturing business. 

Internal audits help Indian manufacturing companies in these key ways:

• Ensure Legal Compliance: Checks adherence to manufacturing-specific regulations – Factories Act, Labour Codes, GST, Environmental laws, BIS standards. This prevents fines, shutdowns, and reputational damage.
• Detect Fraud and Errors: Proactively identifies and investigates fraud like inventory theft, vendor kickbacks, payroll fraud. It also highlights operational/financial errors through transaction testing and control reviews.
• Improve Operational Efficiency: Audits shop floor processes, supply chain, inventory management, and maintenance. This identifies waste, bottlenecks, and opportunities for cost savings and efficiency gains.
• Financial Accuracy: Validates the accuracy of cost accounting, inventory valuation, revenue recognition, and financial reporting. This ensures reliable data for management and statutory purposes.
• Asset Safeguarding: Protects physical assets – machinery and inventory – through verification and control reviews. It also safeguards intellectual property from misuse or theft.
• Improve Safety and Environmental Controls: Assesses effectiveness of workplace safety programs and environmental management systems to minimize risks and ensure regulatory compliance.
• Technology & Digital Transformation: Evaluates controls and risks in key systems like ERP, data security, and emerging tech (IoT, Industry 4.0) implementations to ensure reliability and security.
• Better Decision-Making: Provides objective, data-driven insights on risks, controls, and process effectiveness. This allows management and the Board to make informed strategic and operational decisions.

Scope of Internal Audit for Manufacturing Company 

Manufacturing is complex, which is why its scope is wide and deep.  Here’s a quick breakdown of the key areas within the scope:

1. Procurement and Vendor Management

• Raw materials procurement: Audit sourcing processes for timely, cost-effective, and quality-compliant material acquisition.
• Pricing and vendor selection: Verify competitive pricing mechanisms and objective vendor evaluation/selection procedures.
• Contract and delivery verification: Ensure purchase contracts are properly executed and deliveries meet quality/quantity terms.
• Fraud detection in purchasing: Identify and test controls to prevent collusion, kickbacks, or inflated billing.
• Supply Chain Risk: Assess resilience to disruptions (geopolitical, logistics, supplier solvency).

2. Inventory Management

• Stock level checks: Audit inventory records against physical counts to prevent stockouts/overstocking and ensure accuracy.
• Material storage conditions: Review warehousing for proper handling, segregation, and preservation of raw materials/WIP/finished goods.
• Waste and spoilage review: Assess causes and controls for material wastage, spoilage, or obsolescence.
• Inventory valuation: Verify accuracy of inventory valuation methods and adherence to accounting standards (AS/Ind AS).
• Physical verification of goods: Conduct surprise checks to confirm existence and condition of inventory.

3. Production and Operations

• Machine maintenance logs: Verify adherence to preventive maintenance schedules for equipment reliability and uptime.
• Production line efficiency: Audit production planning, scheduling, and workflow to identify bottlenecks and optimize output.

• Downtime tracking: Review causes and recording of unplanned downtime for corrective action.
• Quality control systems: Test effectiveness of in-process and final quality checks to meet standards.
• Energy Efficiency: Audit monitoring and optimization of power/fuel/water consumption.
• R&D Controls: Review protection of intellectual property (formulas, designs) and project governance.
• Waste minimization: Evaluate processes and controls to reduce scrap, rework, and material usage.

4. Finance and Accounts

• Review of books of accounts: Ensure accuracy, completeness, and timeliness of financial records.
• GST, TDS, and other taxes: Verify compliance with GST invoicing, input tax credit, TDS deductions, filings, and documentation.
• Cost controls: Audit cost allocation (material, labor, overhead) and variance analysis for accurate product costing.
• Budget analysis: Compare actual performance against budgets and investigate significant variances.
• Payment and receipt tracking: Ensure proper authorization and recording of supplier payments and customer receipts.

5. Human Resources and Payroll

• Attendance and work hours: Verify accurate recording of attendance and compliance with working hour limits (Factories Act).
• Payroll and bonuses: Audit accuracy of salary, overtime, bonus calculations, and disbursements.
• Statutory compliance: PF, ESI: Ensure timely and accurate deduction/remittance of PF, ESI, PT, and other statutory dues.
• Fake employees or ghost workers: Test controls to prevent and detect payroll fraud through non-existent employees.
• Skill Development: Audit effectiveness of training programs for technical/quality/safety competencies.

6. Legal and Regulatory Compliance

• Factories Act: Audit compliance with safety, health, welfare, and working condition regulations.
• Companies Act (Section 138): Evaluate the effectiveness of Internal Financial Controls (IFC) over financial reporting.
• Pollution Control Board rules: Verify adherence to environmental consents, emissions norms, and hazardous waste disposal rules.
• Labour law compliance: Ensure adherence to Minimum Wages, Gratuity, Bonus, POSH, Contract Labour regulations.
• ISO/IS standards: Audit implementation and maintenance of certified quality/environmental/safety management systems.

7. Health, Safety & Environment (HSE)

• Fire safety systems: Verify installation, maintenance, and testing of fire detection/suppression equipment.
• PPE usage by workers: Audit enforcement of mandatory Personal Protective Equipment (PPE) usage in designated areas.
• Waste disposal checks: Review segregation, handling, storage, and disposal of hazardous/non-hazardous waste per regulations.
• Accident logs: Ensure proper recording, investigation, and reporting of workplace accidents/incidents.
• Safety training documentation: Verify provision and documentation of mandatory employee safety training.

8. IT and ERP Systems

• Tally, SAP, or other accounting software: Audit system configurations, master data accuracy, and transaction processing controls.
• Access controls: Review user access rights, segregation of duties (SoD), and password policies.
• Data backups and security: Verify regular backups, offsite storage, and cybersecurity measures for data protection.
• Accuracy of reports: Test controls ensuring integrity of management reports generated from ERP/systems.

9. Other Critical Areas

• Disaster Recovery: Verify plans and testing for production resilience (power failure, cyberattacks, natural disasters).
• Whistleblower Mechanism: Test effectiveness and confidentiality of the Vigil Mechanism (Sec 177(9), Companies Act).
• Sector-Specific Compliance (FSSAI/DCGI/AERB): Audit adherence to industry-specific regulators (food, pharma, aerospace).

Sample Internal Audit Checklist for Manufacturing Companies 

Download a free sample internal audit checklist for manufacturing company pdf

How to Conduct an Internal Audit For Manufacturing Company?

Conducting an internal audit for a manufacturing company requires a clearly designed approach. Here’s a step-by-step process:

Establish Scope & Objectives:

Define the purpose, objectives, and scope of the audit, focusing on areas such as quality control, regulatory compliance, operational efficiency, and risk management.

Identify key risks and business objectives relevant to the manufacturing process.

Assemble Audit Team

Select auditors from your team with expertise in manufacturing processes, quality management, compliance, and auditing.

Ensure team members have the necessary qualifications and training.

In case your team is lacking the necessary skills, consider outsourcing it to manufacturing internal audit specialists like PKC Management Consulting. 

Develop Audit Criteria & Checklist

Prepare audit criteria and checklists based on industry standards, regulatory requirements, company policies, and best practices.

Customize your manufacturing checklists for specific audit types (e.g., process, product, system audits).

Plan the Audit

Develop an audit plan detailing the schedule, resources required, areas to be audited, and responsibilities of team members.

Coordinate with key personnel to minimize disruption to production.

Inform department heads (Production, Stores, QA, HR, Finance) well in advance to ensure availability of records and personnel.

Gather Information and Documentation

Collect relevant documents, records, and data such as production reports, quality control records, maintenance logs, and safety protocols.

Review previous audit reports and compliance records.

Interview key personnel involved in manufacturing, including production managers, quality assurance staff, operators, and maintenance teams.

Observe manufacturing operations to assess adherence to procedures, do random stock counts,  check safety equipment, validate calibration tags on equipments

Review Evidence to Identify Nonconformities & Issues

Examine  the evidence collected and records for accuracy, completeness, and compliance with standards and regulations.

Identify discrepancies or gaps in processes or controls.

Document deviations from established procedures, non-compliance with regulations, quality issues, safety hazards, or inefficiencies.

Evaluate the significance of these findings based on their impact on quality, safety, and operations.

Evaluate Findings and Develop Corrective Actions

Identify non-conformances, inefficiencies, and risks. Categorize the findings as Critical, Major, or Minor.

Determine why issues occurred and collaborate with stakeholders to develop corrective and preventive actions.

Assign responsibilities, set timelines, and establish monitoring mechanisms.

Report and Communicate Results

Prepare a comprehensive audit report with executive summary, detailed findings (with evidence references), root causes, risks, and actionable recommendations.

Present the report to management and relevant stakeholders, highlighting areas for improvement and proposed actions.

Follow-Up and Monitoring

Monitor progress through follow-up audits or status reports. Verify evidence of corrections (e.g., updated records, training certificates).

Review the audit process effectiveness with the team for continuous improvement.

Conduct periodic reviews to ensure sustained compliance and continuous improvement.

What Makes PKC The Best for Manufacturing Internal Audits?

✅ Trusted by manufacturing companies nationwide

✅ Specialized team understands complex manufacturing operations 

✅ Expert inventory valuation across raw materials finished goods

✅ Deep knowledge of manufacturing-specific regulations

✅ Supply chain risk assessment vendor management audit capabilities

✅ Revenue recognition expertise for long-term manufacturing contracts

✅ Industry-specific costing systems audit and verification specialists

✅ Comprehensive internal controls evaluation prevents fraud errors

✅ Real-time MIS reporting supports critical manufacturing decisions

✅ Technology integration enhances audit efficiency and accuracy

✅ Competitive pricing without compromising audit quality standards

✅ Post-audit support training ensures continuous improvement

✅ Strategic insights beyond compliance drive operational excellence

✅ Risk identification early protects manufacturing investments

✅ Regulatory compliance across GST TDS EPF manufacturing laws

✅ Detailed attention prevents costly penalties and legal issues

Internal Audit Format for Manufacturing Company

Here’s how an annual internal audit report format for a manufacturing company can look like. 

Remember, this is only a sample. It will vary with your specific industry, audit area, business size and more. 

Reach out to our experts at PKC for Comprehensive Manufacturing Internal Audit Today!

Frequently Asked Questions

1. What is an internal audit in a manufacturing company?

An internal audit for a manufacturer is a regular check to see if the company is following its own rules, Indian laws, and working efficiently. It reviews everything from inventory to payroll, machinery, safety, and legal compliance.

2.  Is internal audit mandatory for manufacturing companies in India?

As per Section 138 of the Companies Act, 2013, internal audit is mandatory for certain classes of companies, including those in the manufacturing sector. For a Private Limited Company, internal audit becomes mandatory if the turnover is ₹200 crore or more or if the outstanding loans or borrowings from banks or public financial institutions exceed ₹100 crore at any point during the preceding financial year.

In the case of an Unlisted Public Company, internal audit is required if any one of the following conditions is met during the preceding financial year:

• Paid-up share capital of ₹50 crore or more
• Turnover of ₹200 crore or more
• Outstanding loans or borrowings of ₹100 crore or more at any point during the preceding financial year
• Outstanding deposits of ₹25 crore or more at any point during the preceding financial year

Even if internal audit is not statutorily mandatory, companies are encouraged to implement it voluntarily, as it offers significant benefits in terms of strengthening internal controls, enhancing operational efficiency, and ensuring regulatory compliance.

3. How often should internal audits be done in manufacturing ?

Usually once every quarter or year is recommended.  High-risk areas may need more frequent audits. Overall, the frequency depends on company size, industry, and legal needs

4. What departments are audited in a manufacturing company?

Common areas include procurement and inventory, finance and tax compliance, compliance,  production and machinery, payroll and HR and safety and environmental systems

5. What is included in a manufacturing sector internal audit report?

The audit report consists of: 

• Audit summary
• Areas reviewed
• Problems found
• Risk level
• Recommendations
• Action plan and timelines