Background

We conducted a SOX (Sarbanes Oxley Compliance) audit for the production processes of a Europe based FMCG – MNC in China. The demand exceeded the production capacity and the Company outsourced its excess demand requirements capacity to third parties (3Ps). The Company supplied product specifications, raw materials and packing materials (RPM) as per the bill of material (BOM) to the 3Ps, who produced finished goods (FG) and despatched them to the MNC’s distribution warehouses.

Observations

• There was no physical verification of stock at the third parties (3Ps) by the MNC. Reliance was placed on the 3P monthly stock reports. The unit of measurement of physical stock followed by the MNC and the 3P was different. For example, whilst the MNC measured in kgs the 3P measured in ‘lots’.

• There was an unexplained book difference of 1.68 million Rmb between the MNC records and the 3P records.

• MNC records showed negative stock at the 3P locations. Upon investigation, it was noticed that some suppliers, directly despatched RPM to 3Ps (without receipt entry of RPM at MNC) and the 3Ps produced and sent the finished goods to the MNC, resulting in excess of FG receipts over the issue of RPM.

• Once the production was completed at the 3P locations, they directly sent the FG to MNC distribution warehouses and faxed a record of the Production to MNC to record the production entries. However, we noticed quantity differences in goods despatched to distribution warehouses and the entries recorded at the MNC. There was no confirmation and reconciliation by the MNC for the FG received at warehouses.

• There was no attempt at identifying normal and abnormal wastages at 3P locations. We noted that normal wastage at 3P was high due to transportation, distant location and different processing methods.

Recommendations

• Monthly physical stock take at 3P locations and adjustment of stock differences on a timely basis, including the unknown difference of 1.68 Million RMB. We advised the 3Ps to follow measurement unit as practiced by the MNC.

• On receipt of RPM from suppliers at 3P locations, 3P locations should confirm to MNC, the receipt of goods at 3P locations. The MNC would record the direct despatch of RPM to 3Ps by its vendors.

• On receipt of FG at MNC distribution warehouses, they would confirm the FG receipts to the MNC, which would compare the statement received from the warehouse with the 3Ps statements.

• Preset the normal wastage limits and enforce the same through contractual agreements.

Value-Add

The benefits of implementing the above recommendations were:



• Physical stock differences were timely identified and adjust and 3Ps were made accountable for stock differences, through contractual obligations.

• Timely recording of RPM directly dispatched to 3Ps by the MNC vendors, which avoided negative stocks at 3Ps.

• Accurate FG production entries were recorded at MNC and timely reconciliation of differences, if any, were done between the statements from warehouse and 3Ps.

• Timely booking of normal wastage (about for 2%) and timely contractual obligation enforcement for abnormal wastages.

• Streamlining of the 3P production process in line with the MNC.