Capex Procurement Audit: Where the Big Cheques Go Wrong

Most owner-managed businesses have tightened their routine buying. Purchase orders need approval, quotes sit on file, the three-way match runs. Then a Rs 15 crore production line is bought on the strength of a board resolution and a vendor presentation, and nobody looks at it again for eighteen months, until the asset is capitalised and depreciation begins. Capex is where the largest single cheques in the business are written under the weakest controls.

Why a capex procurement audit begins after sanction, not before

Routine controls are built for repetition. Capex is a one-off. There is no rate contract to compare against, no historical price, no reorder pattern. The buyer cannot benchmark, so the technical team decides, and that team is measured on plant uptime, not on price. Capex approval also stops at sanction: the board approves an amount, not a process. The result is a Rs 15 crore commitment carrying the scrutiny of a Rs 5 lakh one.

Ask for one report: sanctioned amount, committed amount and final capitalised cost for every project of the last three years. If the third column routinely sits 15 to 25 per cent above the first, that is not an estimation problem. It is a control problem.

The specification is often written by the vendor

The costliest failure happens before the tender is floated. A supplier is invited to help scope the requirement, and the specification that emerges quietly matches exactly one machine. Three quotes are then obtained, and two of them cannot comply.

• Who drafted the technical specification, and does that name also appear on the winning vendor's correspondence?

• Do rejected bids fail on a commercially irrelevant clause, a brand of controller or a plate thickness, rather than on output or price?

• Was the comparison made on landed cost, including freight, insurance, customs duty, erection, commissioning and spares, or only on ex-works price? Two quotes on different Incoterms are not comparable.

What happens after the order is placed

Sanction discipline collapses at the variation order. The machine arrives, foundation work costs more, an extra conveyor becomes essential. Each variation is small, each is approved by whoever is available, and together they eat the contingency and more. Three exceptions worth pulling:

• Variation orders as a percentage of original order value, vendor by vendor. A vendor consistently 20 per cent above order value is bidding low on purpose.

• Retention money and bank guarantees. Retention of 5 to 10 per cent is normally held until commissioning. Check whether it was released before the performance test was actually run, and whether guarantees are live. Ask the CFO for the register of guarantees held from capex vendors, with expiry dates.

• Aged advances against capex orders. Money paid for equipment that arrived a year ago is a recovery problem, not a balance sheet line.

Where the cost finally lands

Two errors, both expensive. On capitalisation, AS 10 and Ind AS 16 permit only costs directly attributable to bringing the asset to working condition for its intended use: site preparation, freight, installation, professional fees. General administrative overheads do not qualify. Companies err in both directions, loading routine repairs into capital work-in-progress, or expensing genuine erection cost. Both distort depreciation, and CARO 2020 requires reporting on whether proper records with quantitative and situation-wise particulars exist and whether physical verification is done at reasonable intervals.

On GST, credit on plant and machinery is available, but Section 17(5) of the CGST Act blocks credit on works contract services and on goods used for construction of immovable property on own account, other than plant and machinery. On a factory expansion, the civil portion and the machinery portion must be separated in the contract itself. A single lump-sum turnkey invoice usually puts the whole credit at risk.

The bottom line

• Approving the amount is not approving the spend. Control has to continue after sanction.

• Compare on landed cost, never on quoted price. The cheapest machine at the gate is often the costliest on the floor.

• Track sanction to final capitalised cost, project by project. That one variance tells you more than the tender file does.

• Separate civil from machinery in every contract, and verify retention and guarantees before release, not after.

By CA Dhruv Seth, Seth & Associates, Chartered Accountants, Lucknow | dhruv@sethspro.com

This article is for general information and does not constitute audit, legal or tax advice. Regulations change; please verify the current position or speak to a qualified adviser before acting.