Cost Audit can be defined as a searching examination of cost records made by a competent person. It is a system of identification and communication which signals – (i) whether there are errors in cost accounts, cost statements and cost data, and (ii) whether the procedure laid down is adequately followed.
A cost audit, therefore, includes verification of correctness of the cost accounts, cost statements, cost reports, costs data, and costing techniques applied, and finally checking these data to see that they adhere to cost accounting principles, plans, procedures, and objectives.
Contents
- Meaning of Cost Audit
- Definitions of Cost Audit
- Objects of Cost Audit
- Objectives of Cost Audit
- Features of a Cost Audit System
- Aspects of the Scope of Audit
- Types of Cost Audit
- Preliminaries to be Followed by the Cost Auditor before Commencement of Cost Audit
- Functional Audits
- Functions of a Cost Auditor
- Areas Need to be Examined by a Cost Auditor
- Powers and Duties of a Cost Auditor
- Value of Costing Records to the Auditors of the Financial Account
- Cost Audit Report
- Cost Audit Programme
- Differences between Cost Investigation and Cost Audit
- Introduction to Statutory Cost Audit in India
- Features of Cost Audit in India
- Scope and Legal Provisions in India
- Advantages of Cost Audit
- Criticisms of Cost Audit
What is Cost Audit: Meaning, Definitions, Objectives, Features, Types, Preliminaries, Functions, Cost Audit Report, Differences, Advantages and More
Cost Audit – Meaning
Cost Audit is a critical review undertaken for the purposes of – (i) verification of the correctness of cost accounts, and (ii) checking that cost accounting plan is adhered to.
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Cost Audit can be defined as a searching examination of cost records made by a competent person.It is a system of identification and communication which signals – (i) whether there are errors in cost accounts, cost statements and cost data, and (ii) whether the procedure laid down is adequately followed.
In the terminology of CIMA. London cost audit has been defined as “The verification of cost records and accounts and a check on adherence to the cost accounting procedures and their continuing relevance”.
‘Audit’ may be described as a systematic examination of the books, vouchers and records of a business to enable the auditor to satisfy himself and to report whether the accounts thereof are properly drawn up so as to exhibit a true and fair view of the state of affairs of the business.
Initially, the scope of audit was limited to the verification of the transactions of financial nature but in the recent times, it has been extended to other fields also. Cost audit is one of them. Cost audit is concerned with the verification of the correctness of the cost records or cost accounts maintained in a business concern.
Cost Audit – Definitions
CIMA defines cost audit as – ‘the verification of cost accounts and a check on the adherence to the cost accounting plan.’ Cost audit system is employed for the verification of cost accounting records according to the cost accounting system and checking on the adherence to the cost accounting plan.
A cost audit, therefore, includes verification of correctness of the cost accounts, cost statements, cost reports, costs data, and costing techniques applied, and finally checking these data to see that they adhere to cost accounting principles, plans, procedures, and objectives.
According to the Institute of Cost and Works Accounts of India (ICWAI), cost audit checks the minute details when the work is still in progress. It is a preventive measure, a barometer of performance, to guide management policies and decisions. Cost audit is the process of detecting errors and faults in the cost accounts, thereby preventing possible frauds and misappropriations.
The Institute of Cost & Works Accountants of India defines ‘cost audit’ as “an audit of efficiency of minute details of expenditure while the work is in progress and not a post-mortem examination. Financial audit is a ‘fait accompli’.
Cost Audit is mainly a preventive measure, a guide for management policy and decision, in addition to being a barometer of performance”. The Institute of Cost and Management Accountants, U.K., has defined ‘Cost Audit’ as “the verification of the correctness of cost accounts and a check on the adherence to the cost accounting plan”.
According to Smith and Day “By the term ‘Cost-Audit’ is meant the detailed checking of the costing system, techniques and accounts to verify their correctness and to ensure adherence to the objective of cost accounting”.
In the words of R.W. Dobson “Cost Audit is the verification of the correctness of cost accounts and of the adherence to the cost accountancy plans”.
On the basis of the analysis of the above definitions, it can be said that cost audit is the detailed checking as well as the verification of the correctness of costing techniques, system and cost accounts. In any manufacturing concern or in a service organisation, it is generally felt necessary to compute the correct cost of products or services so as to charge the customers correctly. For this purpose, cost accounts or costing records are maintained.
But, only the maintenance of cost accounts is not sufficient. In order to ascertain the true and accurate cost of products and services, it is necessary to ensure that these records are accurate and correct. As such there is a need to get the costing records properly audited and checked by a properly qualified and trained professional.
9 Main Objects of Cost Audit
The main objects of cost audit are:
(i) To verify that the cost accounting records (or costing books) are accurate.
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(ii) To certify that costing principles have been fully adhered to in maintaining cost accounts.
(iii) To find out whether the predetermined cost accounting procedures and processes have been strictly followed by the management.
(iv) To detect errors and frauds, which might have been committed intentionally or otherwise in preparing cost accounts.
(v) To check whether each item of expenditure involved into the relevant components of goods manufactured has been properly incurred.
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(vi) To see how far the existing practices of cost records are helpful for the management to take decisions.
(vii) To disclose the deficiencies or inefficiencies in the use of material, labour and machines with a view to assist the management.
(viii) To assist the external auditor in conducting detailed checking by reducing the volume of audit work through the use of internal cost audit system.
(ix) To exercise moral check on the cost accounting staff and to attain efficiency in cost accounting systems and procedures.
Top 12 Objectives of Cost Audit
1. Examine whether proper cost accounting records in the manner as required under the Companies Act in regard to various elements of cost as raw materials, labour, overheads, etc., are being maintained by the company.
2. To ascertain whether company’s cost accounting records so maintained give a true and fair view of the cost of production, processing and manufacturing of the product covered under cost audit.
3. Verification of cost accounts and other relevant data.
4. Comparison of the actual cost for the year with the cost pertaining to previous two years.
5. Comparison of actual cost with the standard cost and finding out reasons for variances.
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6. Inculcate habit of cost consciousness in the minds of those who are responsible for incurring the cost.
7. Bring to light the abnormal costs and extraneous costs so that management may take suitable remedial measures in this direction in the years to come.
8. It helps in price fixation of goods and services of national importance.
9. Cost Audit in an industry is the prerequisite for inter-firm and intra-firm comparison. This type of comparison is very important for the health of the weak and unhealthy units of the industry.
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10. It determines whether the company is making optimum use of resources for each line of activity.
11. Cost audit generates very useful information to the various Government departments for taking decision on price fixation, negotiating long-term contracts and export incentives.
12. It brings to light excessive profits made by companies on products covered under cost accounting records rules.
Main Features of a Cost Audit System
The following are the main features of a cost audit system:
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(a) Examination of the operation of the system, to discover where it is being handled differently from the way originally intended.
(b) Verification of fixed charges, as equipment may have been added or disposed of without charging depreciation; insurance or tax rates or amounts may have charged; or depreciation rates may not be correct.
(c) Study of distribution of expenses to departments and of apportionments of service departments cost to producing departments to discover errors in principle of methods.
(d) Examination of payrolls, time reports, clock cards, and methods of posting labour cost to orders.
(e) Investigation of the classification of departments to find whether departments have been consolidated or sub-divided in such manner as to distort costs.
(f) Examination of purchasing, receiving, storing, and issuing of materials, to see that the necessary routine is followed correctly.
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(g) Tests of the method of costing used to discover variations from correct methods.
Aspects of the Scope of Audit – Propriety and Efficiency Audit
The scope of audit has two important aspects viz.-
1. Propriety Audit.
2. Efficiency Audit.
Aspect # 1. Propriety Audit:
This aspect of audit is concerned with actions and plans of management which affect the finance and expenditure of the business concern. Under this aspect, the cost auditor is required to ensure that an item of expenditure is sanctioned or approved by the proper authority.
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It is done with the help of documents and vouchers. In addition, the cost auditor has to ensure that the item of expenditure is proper and reasonable on the grounds of propriety.
Thus, the cost auditor has to report:
(a) Whether or not the planned expenditure could give optimum results.
(b) Whether or not the size or channels of investment were designed to produce the best results.
(c) Whether the return from investment in certain channels could be bettered by some alternative plan of action.
Aspect # 2. Efficiency Audit:
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This aspect of cost audit is concerned with the evaluation of performances. It covers the verification of the facts that the expenditure has been incurred according to the plan and the results obtained have also been according to the plan.
It covers the examination of the plan prepared in the form of budgets (financial and functional) and the comparison of the actual performance with the budgeted performance and analysing the reasons for variances.
Thus, efficiency audit ensures that:
(a) Every rupee invested in capital or in other fields gives the optimum return; and
(b) Investment in different spheres of the business has been so balanced that it gives maximum results.
Therefore, the cost auditor plays the role both as consultant and financial advisor. He assists the Chief Executive of the business concern in judging the soundness of the financial plans and performances by coordinating the results of actions of heads of various departments.
Cost Audit Types: Managerial Purposes, Individual Customers, Government, Required by a Statute and Trade Association
Cost audit is not always conducted at the instance of management or at the initiative of Government. Taking, therefore, the person or persons at whose instance cost audit is taken up, we may distinguish the following types of cost audit.
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Type # i. Cost Audit for Managerial Purposes:
This type of cost audit is conducted for and on behalf of managerial personnel of a particular undertaking. Like financial audit, the objective is to ensure that cost accounting records are maintained according to the existing procedures.
Besides, the objective is also to satisfy management whether the accounting records reflect a true and fair view of cost which is so important for price fixation, policy formulation and decision making by management.
Type # ii. Cost Audit for Individual Customers:
Cost audit maybe conducted on behalf of a customer also. This happens when price is to be fixed on cost-plus contract basis. In cost-plus contracts, the customer may insist on cost audit for the purpose of ascertaining the actual cost for fixation of price.
If a clause to that effect is inserted in the contract itself, the contractor has to get his cost accounting records audited so that the agreed margin of profit may be added to the cost ascertained by cost audit.
Type # iii. Cost Audit for Government:
Sometimes, the Government may insist on cost audit for satisfying itself that the undertaking which has approached it for financial assistance is really in need of it and, in fact, deserves it.
This happens when the Government whether, Central or State, encourages industrial development by providing financial assistance of the nature of bounties and subsidies to individual units.
Type # iv. Cost Audit as Required by a Statute:
In some countries as in India, for instance, the law may require a particular class of undertakings to maintain the requisite cost accounting records and get the same audited year after year.
The Central Government in India is empowered by the Companies Act, to order audit of cost records of only certain classes of companies for which maintenance of cost accounts has been prescribed.
Type # v. Cost Audit for a Trade Association:
One of the objects of a trade association is the regulation of price of the product produced by its members. Should that be so, cost audit may be conducted at the instance of such a trade association also.
The association may require its members to see that the cost accounting records of its members are audited to ensure accuracy of cost data and information pooled by them.
Preliminaries to be Followed by the Cost Auditor before Commencement of Cost Audit
Before the commencement of cost audit, a cost auditor has to be busy with the following preliminaries:
1. The cost auditor should get thoroughly acquainted with the Cost Accounting Records Rules relating to the industry. This should be followed by the process of ‘planning’ the cost audit. The process of planning the cost audit involves decisions on the areas of cost audit, quantum to be covered, types of checks to be used, methodology of collection of facts, etc.
A checklist in planning the cost audit is given below:
(i) System of production.
(ii) Accepted accounting and cost accounting concepts.
(iii) Cost behaviour of the products under cost audit during the past two years.
(iv) Discussion with persons in the organisation connected with cost audit.
(v) Efficacy of existing control measures and efficiency measures.
(vi) Follow-up of earlier cost audit report, if any.
2. The cost Auditor should try to get general idea about that industry.
For this purpose, he should try to acquaint himself with following details relating to that industry:
(i) Other units in the industry;
(ii) Total production;
(iii) Market potential; and
(iv) Input performance.
This type of study will help the cost auditor to form a relative view of the company being cost audited and other units in the industry. This type of information relating to industry is available in various financial journals and publications of Government, Chambers of Commerce and Manufacturers’ Associations.
3. After having formed the idea relating to the relevant industry, the cost auditor should get to know the company being cost audited.
For this purpose, reference should be made to the following:
(i) Memorandum of Association and Articles of Association
(ii) Organisational chart of company.
(iii) Details relating to factories, regional offices and their location.
(iv) Product profile of the company.
(v) Licensed capacity.
(vi) Installed capacity.
(vii) Number of employees,
(viii) Main raw material used.
(ix) Pattern of collecting information for financial accounts and cost accounts, i.e., Management Information System.
(x) Inter-control procedures laid out in different manuals.
4. The cost auditor should get acquainted with manufacturing process relating to different products. Visit to factories, where manufacturing process is actually carried on, will be essential for this purpose.
Functional Audits – Efficiency Audit, Propriety Audit, Operational Audit, Voucher Audit, Regulation Audit and Statutory Audit
Cost audit is mainly concerned with propriety and efficiency audit. It, therefore, covers all the areas of production, sales, and other management functions.
The main functional audits are as follows:
1. Efficiency Audit:
Efficiency or performance audit is the appraisal of performance to ascertain whether the plan has been effectively and efficiently executed. It is also called profitability audit. It starts with the study of the plan and extends to the comparison of the actual performance against the budgeted performance and the investigation into the reasons for variances.
Efficiency audit ensures the application of basic economic principle that resources flow into the most remunerative channels. The main purposes of efficiency audit are to ensure that every rupee invested in capital or in other fields gives the optimum return, and that the balancing of investment between different functions and aspects is designed to give maximum results.
It also checks up whether job evaluation and merit rating have been introduced on correct lines and are being rigidly adhered to or not.
2. Propriety Audit:
Propriety audit scrutinizes the executive actions and decisions bearing on the financial and profit and loss situation of the enterprise with special regard to public interest, commonly accepted customs, and standards of conduct.
While carrying out a propriety audit, the auditor would judge whether the standards of propriety is a significant consideration because of deployment of public fund and a set of standards of propriety has been formulated for adherence. The audit conducted by the Comptroller and Auditor General of India is essentially propriety based.
Propriety audit is a higher audit. In propriety audit, a cost auditor has to judge – (a) whether the planned expenditure would give maximum results, and (b) whether the return from expenditure on capital as well as current operations could not be bettered by some other alternative plan of action.
3. Operational Audit:
Operational audit is a comprehensive examination and appraisal of business operations by an independent person for the purpose of informing the management whether or not the various operations are performed in a manner which complies with established policies directed towards management’s objectives. Included in the audit is an appraisal of the efficient use of both human and physical resources as well as an appraisal of various operating procedures.
Examples of operational audit include investigations into such matters as the profitability of stock retention, capital locked up, buying outright, transport facilities (whether to hire or to maintain a fleet), and other matters within the operational areas of the business.
The specific phases of an operational audit depend upon the nature of the company, the nature of operational area being audited, and the size and expertise of the auditing team.
Typical phases of an operational audit are –
(i) selection of the operational area for audit,
(ii) advance preparation,
(iii) initial survey,
(iv) audit programme,
(v) investigation and analysis,
(vi) evaluation and recommendations, and
(vii) final reporting.
4. Voucher Audit:
Voucher audit is primarily an integrity or honesty audit carried out with reference to vouchers. This is the basic routine check which ensures that the transactions of a business are correct and truthful and are duly supported by vouchers and receipts. A transaction is considered to be valid only if it is supported by a voucher which should be in the proper form drawn in a proper manner and properly authenticated.
5. Regulation Audit:
In government departments and statutory bodies, sets of rules and regulations are prescribed which govern the day-to-day operation of these organizations.
In private sector too, manufacturer lays down the detailed procedure to be followed in respect of items and transactions which are not already covered by government legislations like the Companies Act, various Labour Laws, etc. Regulation audit ensures that these rules and procedures are correctly and faithfully adhered to.
6. Statutory Audit:
Audit conducted in accordance with the provisions of any act or statute laid down by the government is termed as statutory audit. The Companies Act (Sec. 224) requires that the prescribed books and accounts maintained by a company be audited by specially appointed auditors.
The statutory auditor ensures and satisfies himself that the company’s accounts have been correctly compiled so as to exhibit a fair and true view of the affairs of the company. This audit is normally confined to the audit of the financial accounts of the company, i.e., its P&L A/c and balance sheet and the accounts and documents leading to their compilation.
According to an amendment of the Companies Act, 1956 (Sec. 233 B), audit of the cost accounts of certain establishments (to be notified by the central government from time to time) is compulsory. Statutory audit of companies now, therefore, covers the financial as well as the cost accounts of these companies.
Statutory audit of the accounts of the government departments and statutory bodies is conducted by the representatives of the Comptroller and Auditor General [CAG] who is directly responsible to the Parliament.
Functions of a Cost Auditor
The cost auditor has to plan his activities and his work is to be based on a proper audit programme. The Institute of Cost and Works Accountants of India, has brought out a booklet, ‘Cost Audit,’ its significance, which spells out the functions of a cost auditor in relation to different items, which are summarised as under.
Function # 1. Inventory:
The cost auditor should examine the following regarding inventory:
(i) Is the size of the inventory excessive or adequate in view of the production plan?
(ii) Is the drill of providing it economical?
(iii) Does it take into account the cost of storage vis-a-vis the cost of carrying?
(iv) Does it ensure optimum order size for each item?
(v) Does it take into account lead time of different items or groups of items?
(vi) Are there too many forms and records?
(vii) Are bottlenecks in production caused by the receipt and issue system?
(viii) Is there a possibility of reducing inventory cost consistent with production needs?
(ix) Is the inventory as certified by the management physically correct and priced as per the stores ledger?
(x) Are the expenditures on consumable stores within the standards? If not, why so?
(xi) Are the raw material issues as per production schedule and standards, or covered by authorised schedules?
(xii) Is the same type of attention and care given to money changed into inventory and tangibles as is given to cash?
Function # 2. Opening and Closing Stocks:
The cost auditor should examine the following regarding opening and closing stocks:
i. Opening Stocks:
(a) Its volume should be consistent with the volume of output during the year.
(b) The opening stock against different jobs physically exists in the shops and is not merely an accounting figure.
(c) The shop foreman/supervisor/engineer maintains proper account of consumption vis-a-vis withdrawals from the stock, and he is personally responsible for every aspect of stock in the shop.
ii. Closing Stocks:
The cost auditor should consider the following:
(a) The physical verification is carried out correctly,
(b) The valuation is correct vis-a-vis actual production and accepted method for valuation.
(c) The volume of unmoved stores is not abnormal as compared to the normal rate of yearly consumption. The unmoved stores should be recommended for disposal so that capital is not locked up unnecessarily.
(d) The volume of closing stock is commensurate with the volume of output, and it indicates that there is no bottleneck of any kind in the Sales and Production Budgets.
Function # 3. Stores Issue Procedure:
The cost auditor should consider the following:
(i) The withdrawal of materials from stores to production shops/ departments is scientific or covered by authorised schedule and permits issues to be located,
(ii) It is not possible for the stock to be lost or pilfered in the production department.
(iii) Where stores are transferred to other jobs, proper transfer voucher has been prepared and copies sent to stores, accounts, etc.
Also if surplus materials are there, they should be returned to the stores, forthwith and credits given to unit of production. Similarly scraps should also be returned to the stores and accounted for.
Function # 4. Work-in-Progress:
The cost auditor should consider the following:
(i) The work-in-progress is physically verified and that it agrees with the balance in the incomplete cost cards,
(ii) The valuation of the work-in-progress is correct with reference to the stage of finishing of each job/process and the value booked in the job cost cards or process cost sheet.
(iii) There is no under-valuation of opening or closing work-in-progress and thus artificially bringing down or pushing up of net assets or net profits as the case may be.
(iv) The value and volume of work-in-progress is not disproportionate when compared with the finished product, and is as planned.
Function # 5. Labour:
The following are to be considered:
(i) The cost of labour is allocated to different jobs with reference to job or time cards.
(ii) Productivity of groups, sections, or departments matches with the standards set so that labour cost is the least.
Function # 6. Capacity Utilisation:
The cost auditor should consider the following:
(i) The idle capacity in a shop/department is not excessive; or transport facilities for distribution are not excessive.
(ii) Over-all machine time utilised is commensurate with the volume of production so that machine hours utilised give the maximum output.
Function # 7. Overheads:
The cost auditor will consider and certify the following:
(i) The allocation of overheads between finished and unfinished products is according to the correct costing principles.
(ii) The actual indirect expenditure is not significantly excessive compared with the standards or budgets, and the variations are explained and accounted for.
(iii) The overheads are not excessive as compared to the volume of output in a shop/section/department.
(iv) The allocation of indirect expenditure over production, distribution, sales is done correctly and logically.
5 Important Areas Need to be Examined by a Cost Auditor
Although a cost audit may cover the entire costing system, some important areas need to be examined by the cost auditor more thoroughly than others.
These may be stated thus:
Area # 1. Materials:
The auditor will usually examine the following things:
(a) Procedures involved in purchase and stores routine (purchasing, receiving, inspecting issuing, returning of materials and the documents involved therein).
(b) Fixation of stock levels and economic order quantity.
(c) Analysis of scrap, wastage or loss of materials in the manufacture and in storage.
(d) Suitability of pricing methods followed.
(e) Accounting for material cost.
(f) Verification and valuation of physical stock and its reconciliation with book stock; and adjustment of discrepancies.
(g) Valuation of work in progress.
(h) Verification of paper work and forms involved in maintaining inventory records.
Area # 2. Labour:
The important points to be considered are:
(a) Procedure of labour requirement and training.
(b) Verification of job time with gate time and identifying idle time.
(c) The system of classifying into direct and indirect.
(d) Labour cost and checking as to its accuracy.
(e) Verification of overtime cost, its calculation, its authorisation and its reasonableness.
(f) Suggesting ways and means to reduce idle time.
(g) Analysis of labour turnover cost.
(h) Labour variance analysis.
(i) Checking the internal control to prevent fraud in payment of wages.
Area # 3. Overheads:
The auditor should find out:
(a) Classification of overheads, and accumulation of overheads.
(b) Basis of allocation and apportionment of overheads to cost units or cost centres.
(c) Method of overheads absorption adopted.
(d) Treatment of under or over-absorption of overheads.
(e) Checking of actual expenses with budgeted ones.
(f) Inclusion of overheads in stock or work-in-progress.
(g) The preparation of budgets.
Area # 4. Capital Expenditure:
The auditor should look into the:
(a) Propriety of a capital investment.
(b) Treatment of expenses incurred in acquisition of a fixed asset.
(c) Depreciation methods and rates.
(d) Evaluation of profitability of a project.
(e) Records relating to fixed assets.
(f) Physical verification and valuation of fixed assets.
Area # 5. Capacity Utilisation:
The cost auditor should consider the following:
(a) The idle capacity in a department is not excessive; or transport facilities for distribution are not excessive.
(b) Over-all machine time utilised is in tune with the volume of production so that machine hours utilised give the maximum output.
Powers and Duties of a Cost Auditor
Section 227 deals with rights, powers, and duties of auditors. The rights and duties are interrelated. The several rights conferred upon an auditor are related to the matters in respect of which he has to make a report to shareholders on the annual accounts of the company.
Powers of Cost Auditor:
The cost auditor has the following rights and powers:
(a) The auditor of a company has a right of access, at all times, to the books and accounts and vouchers of the company, whether kept at the head office of the company or elsewhere.
(b) He is entitled to enquire from the officers of the company such information and explanations as he thinks necessary for the performances of his duties as auditor.
(c) Where the accounts of any branch office are audited by a person other than company’s auditors, the company’s auditor is entitled to visit the branch office, if he deems it necessary to do so, for the performance of his duties as auditor.
(d) He has a right to receive notice of and other communications relating to any general meeting of the company. He has also a right to attend any general meeting and to be heard on any part of the business which concerns him as auditor.
(e) He has the right to receive remuneration for auditing the cost accounts of the company.
Duties of Cost Auditor:
The cost auditor has the following duties:
Acquaintance with articles and Companies Act – The auditors of a company are to make themselves acquainted with their duties under the articles of the company and under the Companies Act, 1956.
Auditor’s report – The main duty of an auditor is to make a report to the government and the management of the company on the cost accounts examined by him. If, in his opinion and to the best of his information and according to the explanations given to him, the accounts do not give a true and fair view, he must qualify his report.
Value of Costing Records to the Auditors of the Financial Account
The costing records maintained by industrial enterprise are of value to the auditors of the financial account in the following ways:
(a) The valuation of work-in-progress, which in case of manufacturing concerns is an important item, depends on the cost data which can be provided by the costing records. The financial auditor has therefore to refer to the costing records in order to find out whether the work- in-progress has been valued on a proper and consistent basis.
(b) Maintenance of job time records and other cost records relating to workers would provide a greater assurance to the financial auditor that there are no dummy workers.
(c) Cost records also provide a double-check on the accuracy of the entries made in the financial records, since the result show the costing records and the financial records are periodically reconciled.
(d) Maintenance of cost records entails proper and detailed recording of receipts and issue of materials. Therefore, if an effective system exists, the system of perpetual inventory records may also automatically exist. In such cases, the financial auditor can put a greater reliance on the internal control relating to purchase, receipts, and consumption of materials.
(e) A great deal of information, especially quantitative information to be given in the published accounts of companies according to Schedule VI of the Companies Act, 1956, can be given mainly with the help of costing records.
(f) The closing stock of finished goods which is an important item, both in the P&L A/c and the balance sheet, is normally valued at its costs or market value, whichever is lower. The cost of such stocks can be ascertained by reference to the costing records. The financial auditor has to find out whether the basis of valuation of financial stocks is consistent or not.
(g) Cost records are of great help enabling the auditor to discharge his duties under the Section 227 (4A), whereby the auditor has to report on a number of aspects of internal control and audit.
Cost Audit Report (With Time Limit for Submission of Report)
The cost auditor has to prepare a report after he has conducted the cost audit. This report has to be submitted to the Company Law Board and not to the Registrar of Companies. It is not sent to the registrar, as it may contain confidential and secret matters, which if disclosed may prove to be harmful to the company.
The cost auditor has to send the report to the company concerned but not to the members. He is not an employee of the company, nor is he the agent of the shareholders. In spite of the fact that his remuneration is paid by the company, he is not responsible to the company. His position is just like that of a special auditor appointed under Section 233 A.
The report should be precise, concise and clear. There should not be praise for an individual member of the management. Similarly, there should not be any personal criticism against any member of the staff.
The cost auditor should examine the cost records. He should express his independent opinion. He should not be influenced by any person while drafting his report. He should not hesitate to report irregularities, deficiencies, or discrepancies coming to his notice.
The following are the few points which must be stated in the cost auditor’s report:
(a) Whether the machines and labour remained idle during the year because of the shortage of raw materials.
(b) Whether a large quantity of raw materials were stocked which remained unutilized for a long time, thereby locking up the working capital of the company.
(c) He should state whether the cost records maintained by the company were adequate for the purpose of audit.
(d) He should state whether the broad policy laid down by the management was faithfully followed.
(e) The report should concentrate more on the cost of production, comparative profitability, and operating efficiency of different lines in which the company is engaged rather than the routine statistical or financial information.
(f) The cost auditor should state if there has been a rise in the cost of production as compared to that of the previous year. He should analyse the causes of such a rise. He should clearly point out where the problem originates from.
(g) The report should state if there has been any wastage during the process of manufacture and how it could be avoided.
(h) The cost auditor should also mention the areas in which it is possible to reduce the cost of production.
(i) He should state whether or not the cost statement reveals a true and fair view of the cost of production.
Cost audit is a new concept in India. No definite duties of the cost auditor have been laid down by the Companies Act except that he has to submit his report to the Company Law Board and the company concerned. Neither the Institute of Cost and Works Accountants nor the Institute of Chartered Accountants of India has given any guidance in this respect.
In any case, the cost auditor should not hesitate to mention in his report if the management has been at fault which has resulted in a loss to the company. But before submitting the report, he must go through the relative faults and scrutinize them again to find whether the criticism by him is based on correct facts.
Time Limit for Submission of Report:
According to the cost audit rules, a cost auditor is required to submit his report within 120 clays of the expiry of financial year. If he does not do so, he may be fined up to Rs. 500. The cost auditor will have to certify the accuracy of cost records kept by the company. The provisions of Section 233 B of the Companies Act, 1956, are provided with regard to qualifications, disqualifications, powers, and duties of a cost auditor.
Books of account in case of companies engaged in production, processing, manufacturing, or mining activities also include particulars relating to utilization of materials, labour, or other items of cost. The central government may, by order, direct that an audit of accounts of these companies shall be conducted by an auditor who must be a cost accountant within the meaning of the Cost and Works Accountant Act, 1959.
It should be noted that cost audit is in addition to the routine audit. Further, a cost auditor has the same powers and duties in relation to an audit conducted by him and he suffers from the same disqualifications as an auditor of a company appointed under Section 224 or Section 224 A.
He has to report to the central government as well as forward a copy of the report to the company. On receipt of the report of the cost auditor, the central government may take actions as it considers necessary.
Cost Audit Programme (With Points)
A cost audit programme includes a plan of operations to be followed for conducting cost audit.
A cost audit programme will ensure –
(i) that work will be completed in time;
(ii) that nothing relevant for the purpose of cost audit is left out;
(iii) review of work done by juniors, and
(iv) a documentary evidence of work done by the Cost Auditor. Since cost audit is of recent origin, a standard cost audit programme is yet to be developed.
For planning the programme and procedure of cost audit following points should be kept in mind:
1. Whether partial audit or complete audit –
It should be ascertained for preparing a cost audit programme whether cost audit is confined to only some of all items of the system.
2. Periodicity of audit –
In some concerns cost audit may be carried out periodically, while in others it may be continuous cost audit or concurrent audit. A cost audit programme keeps in view periodicity of cost audit.
3. General –
Following general points should be kept in view for preparing a cost audit programme:
(i) Administrative set-up of company should be kept in view. Cost auditor should have a list of Directors, Secretary, Financial Auditor, etc. He should also obtain list of different officers in key positions in different functions.
(ii) He should find out raw materials used, manufacturing processes and flow of production.
(iii) He should find out the details of production departments and service departments.
(iv) He should observe the existing system of cost accounting. He should see whether cost accounting rules are adhered to.
(v) He should see whether standard costing and budgetary control are in operation and, if so, whether these systems are adequate.
(vi) He should see whether effective internal control system is in operation.
(vii) He should note the key factors relating to industry.
The study of these general points will facilitate a cost auditor to work out sequential arrangement or his audit activities.
4. Audit Notes –
Cost audit programme should lay down the procedure of keeping written records of queries made, replies received thereto and correspondence, if any, entered into during the course of audit. These note are kept in Audit Note Book. This Audit Notes Book is of great help in preparing Cost Audit Report.
5. Audit Methodology –
Preparation of cost audit programme will take care of the procedure to be adopted for conducting the audit.
Main points in cost audit procedure can be summarised as follows:
(i) Vouching – For vouching, cost auditor inspects the documentary evidence, which substantiates the transaction.
(ii) Checking and tickling – This includes checking of calculations and postings. A cost auditor should mark and initial the records seen in different colour pencils.
(iii) Test checking – A cost auditor has to make procedural tests to determine the extent to which he can rely on internal control in force in a company.
(iv) Questionnaire – A cost auditor has to familiarise himself with systems and procedures followed for preparing his Cost Audit Programme.For this purpose, questionnaires are issued by Cost Auditor to appropriate authorities to obtain clarifications. The answers to various questions are devised generally in the form of ‘Yes’ and ‘No’.
The questions are arranged in such a sequence that Cost Auditor gets sufficient details to get acquainted with various aspects of the organisation. A Cost Auditor may follow standard questionnaires to get familiarised with various aspects of organisation.
6. Audit Report –
While preparing the cost audit programme, the cost auditor should keep in mind that ‘Cost Audit Report’ should be sent to the Department of Company Affairs and to the company within 120 days from the end of company’s financial year.
The cost audit report will include a certificate on proper maintenance of cost accounts, report on operations with suggestions for improvements. Cost audit programme should be arranged in such a manner that complete information to be reported is available in time.
Differences between Cost Investigation and Cost Audit
Cost Investigation refers to a systematic and detailed investigation of cost records of an undertaking with a specific purpose. Cost Audit is a system of audit of cost records which involves checking up the arithmetical accuracy of the books of cost accounts and verifying whether the principles laid down has been followed correctly or not. Cost Investigations totally differs from the cost audit.
The important differences between cost investigation and cost audit are summarised as follows:
Difference # Cost Investigation:
i) It is a systematic and detailed investigation of cost records.
ii) It is a specific exercise conducted with a specific purpose to investigate the matters relating to cost records.
iii) The scope of cost examination is very much narrow and specific.
iv) Cost investigators are interested in conclusive evidence of cost records.
v) Cost investigators are not bound by any accounting conventions and policies.
vi) The Central Government may appoint the cost investigators to examine in detail the cost records of a company.
vii) After the achievement of the specific objective, the cost investigation is completed.
viii) Generally, a well-experienced and professional cost accountant is appointed as a cost investigator.
Difference # Cost Audit:
i) It is the verification of the correctness of cost accounts and of the adherence to the cost accounting plan.
ii) It is a recurring exercise of examination of the costing books and records undertaken to certify their arithmetical accuracy and principles of cost accounting.
iii) The scope of cost verification is very much broad and general.
iv) Cost auditors are interested in persuasive evidence of cost records.
v) Cost auditors are bound by accounting conventions and policies.
vi) It is introduced by the Government of India for the review examination and appraisal of the accounting records.
vii) Cost audit is a continuous process carried out generally on yearly basis.
viii) A cost accountant within the meaning of Cost and Works Accountant Act, 1959 is appointed as a Cost Auditor.
Introduction of Statutory Cost Audit in India
Statutory cost audit was introduced in India in respect of certain specified industries numbering about 40. For making cost audit compulsory in these forty industries, the Companies Act, 1956, was amended in 1974, introducing section 233-B. This section provides for cost audit in respect of companies which are required to maintain cost accounting records under section 209 (1) (d) of the Companies Act.
Accordingly, section 233-B, empowers the Central Government to direct by an order, audit of cost accounts of any company specified therein and is required under section 209 (1) (d), to maintain cost accounts. This power may be exercised if the Central Government is of the opinion that it is necessary to do so. The manner in which cost audit is to be conducted will have to be stated in the order.
Section 233-B, provides for cost audit by a cost auditor who shall be a cost accountant within the meaning of Cost and Works Accountant Act, 1959. The statutory financial auditor himself cannot be a cost auditor of the same company.
The cost auditor has to be appointed by the Board of Directors of the company with the prior approval of the Central Government, i.e., the Company Law Board.It is imperative for the cost auditor to send his report to the Company Law Board as well as the company within 120 days from the end of the company’s financial year to which the cost audit relates. In making the report, it is necessary for the cost auditor to comply with Cost Audit (Report) Rules, 1968.
Within 30 days of receipt of the audit report, the company has to furnish to the Central Government, explanations on every qualification referred to in the report. The Central Government is also empowered to call for any further information or explanation within such time as may be specified, after receiving the report.
Any contravention of any of the provisions of these sections attracts punishment of the nature of fine which may extend to five thousand rupees as well as imprisonment of any officer of the company in default. The term of imprisonment may extend to three years.
Statutory cost audit in India is thus selective in nature. In the first place, it is not applicable to all companies incorporated under the Companies Act. It is restricted only to a company falling under the list of forty companies. Secondly, even in the case of these forty companies, cost audit is applicable only to a company which, in the opinion of the Central Government, requires audit of its cost accounts.
12 Main Features of Cost Audit in India
The main features of cost audit in India may be summarised as under:
(1) The governments has powers to order for the audit of cost account of a company, which fails under the purview of the recorded rules.
(2) The government of India has framed Cost Accounting (Records) Rules for the maintenance of cost accounts for certain selected industries.
(3) The cost auditor has the powers and duties as the financial auditor.
(4) Copy of cost audit report has to be attached to income tax return.
(5) Cost auditor shall submit a report in triplicate to the central government.
(6) The cost auditor is appointed by the board of Directors of the company.
(7) Statutory cost audit can be conducted by a qualified cost accountant only.
(8) Cost auditor has to submit audit reports in the prescribed proforma.
(9) Time limit prescribed for submission of cost audit reports by the cost auditor is one hundred and eighty days.
(10) Cost audit shall be in addition to the usual financial audit.
(11) The cost audit of a company is a regular feature.
(12) Section 209 of the Companies Act, 1956, 2003, ensures the existence of cost accounts.
Cost Audit – Scope and Legal Provisions in India
The scope of audit has expanded at a very rapid rate in recent times. The frontiers of audit have covered not only financial audit, performance audit, efficiency audit, management audit, but also cost audit within its fold.
The government of India has also introduced Cost Audit by Cost Accountants in public interest by an amendment under Section 233 (B) of Indian Companies Act, 1956. It authorizes the central government to direct an audit of the cost accounts of a company engaged in production, processing, manufacturing, and mining activities.
The scope of cost audit will depend upon the terms of reference as may be specified by the management, for example, an in-depth analysis of the present system of accounting for materials or examining the adequacy of the method of overhead recovery in vogue.
Where the cost audit has been undertaken for reviewing the costing system as a whole, the cost auditor examines the following aspects of the system and offers his suggestions for improvement –
(a) Method of costing employed – job costing or process costing or any variant of the methods.
(b) Method of accounting for raw materials and stores.
(c) Method of accounting for wastages, spoilages, and defectives.
(d) System of recording wages, salaries, and overtime.
(e) Incentive schemes.
(f) Basis of apportionment of overheads to cost centers.
(g) Basis of reapportioning service center overheads and the absorption of overheads into product costs.
(h) Treatment of interest on borrowings – whether it is to be included as an element of cost.
(i) Method of accounting for R&D expenses.
(j) Method followed for providing depreciation,
(k) Valuation of work-in-progress and finished goods.
The relevant legal provisions regarding cost audit are discussed hereunder:
1. Maintenance of Cost Books:
It is required that every company keeps a proper book of accounts at their registered offices.The central government has now acquired powers to order cost audit in case of those companies which are required to maintain cost accounts under Section 209 (1) (d) and which are engaged in production, processing, or mining activities, etc.
But it should be noted that all the companies which are engaged in such types of business are not subject to cost audit, but only those companies which may be specifically ordered by the central government will have to get their cost accounts audited by competent cost accountants.
The central government has notified 28 industries so far for cost audit. The government has also prescribed rules regarding maintenance of cost accounting records separately for many industries like cycle, caustic soda, cement, electric pumps, refrigerators, tyres, aluminum, vanaspati and sugar, etc. The cost auditor should study these rules before starting his work.
2. Appointment of Cost Auditor:
A cost auditor may be appointed by the board of directors of the company with the prior approval of the central government. The cost auditor will enjoy the same right and powers which can be enjoyed by an auditor appointed under Section 227 (i) of the Companies Act. He has to submit his audit report to the central government and Company Law Board in such form and within such time as may be prescribed.
A copy of his report may be sent to the company. It may be noted here that a person appointed under Section 224 of Companies Act, as an auditor of a company cannot be appointed or reappointed to conduct cost audit of the company. If any auditor earns any disqualification after his appointment as cost auditor, he will cease to work as cost auditor automatically.
3. Qualifications of Cost Auditor:
As per Section 233 B of the Companies Act, 1956, a cost auditor must be a cost accountant within the meaning of Cost and Works Accountant Act, 1956.
But after the Companies (Amendment) Act, 1974, a chartered accountant possessing the prescribed qualification have been permitted to do cost audit only for such period notified by the central government, if the central government feels that sufficient number of cost accountants are not available to conduct the cost audit.The qualifications and disqualifications applicable to statutory auditors are applicable to cost auditors too.
4. Disqualification of a Cost Auditor:
Certain persons, even if they are otherwise qualified, are disqualified from being appointed as auditors of a company.
They are:
(a) A body corporate.
(b) An officer or employee of the company.
(c) A person who is a partner, or who is in employment, of an officer of employee of the company.
(d) A person who is indebted to the company for an amount exceeding Rs. 1,000.
(e) A person who is disqualified for appointment as auditor of any other body corporate which is that company’s subsidiary or holding company, or a subsidiary of that company’s holding company.
If an auditor becomes subject, after his appointment, to any of the disqualifications, he is deemed to have vacated his office as such.
5. Procedure for Cost Audit:
The type and size of the cost audit depends upon the size of the organization. The cooperation of the staff is required for conducting the audit. Before the audit work is taken up, all books and records should be posted up-to-date, vouchers for the various transactions filled serially, and all working sheets made available to the auditors.
This information is made available in advance to the auditor to save time and reduce cost.
Generally, the following principles and factors are considered while conducting cost audit:
i. Vouching:
Vouching means the inspection which is made by the auditor, the documentary evidence which substantiates a financial transaction. In vouching, the auditor notes the correctness of each individual transaction posted from the supporting documents.
ii. Checking and Ticking:
It includes the totals of each page, document or ledger, checking of arithmetical accuracy of bills, vouchers, records, reports, etc. All checking of calculations or postings are suitably marked with the help of coloured pencils, ink, or by rubber stamp.
iii. Test Checks:
This method is employed to check the arithmetical accuracy of figures. Test check method is employed where the transactions are numerous and the audit checks are few. Only selected items will be checked and statistical techniques may also be employed. The various rates may be ascertained and compared with suitable norms.
iv. Audit Notes and Questionnaire:
During the course of audit, the auditor records on working papers the material facts observed by him. This also includes queries and questionnaires issued by him to the management for eliciting clarification and final answers. These questionnaires may be regarding material control, labour, machine utilization, etc., and are collected by the auditor.
6. Records of Overhead Charges:
After having examined the relevant records relating to the materials and wages directly applicable to each job, the cost auditor should now proceed to examine the overhead expenses like power consumed, rent, salaries, etc., in order to ensure that they have been correctly allocated to the jobs concerned.
Overheads relating to factories, administrative and selling and distribution activities should be distinguished from each other, as he has to certify that overhead charges have been properly and correctly allocated to each job or unit.
- Production Overhead:
The main points should cover the following:
i. Classification and collection – A cost auditor should ensure that collection of expenses is according to the original plan.
ii. Apportionment and allocation – The basis of apportionment of expenses must be examined. A great bulk of overhead expenses is from service departments like maintenance, store, purchase, etc., and the cost auditor should ensure that these service department expenses are appointed to production departments on scientific and reliable basis.
iii. Absorption of overhead – A cost auditor should ensure that the method of absorption of overhead is reliable, and the under- or over-absorption of overhead is as minimum as possible.
iv. Overhead budgets – Where standard costing has been established in conjunction with budgetary control, a cost auditor should examine the budget variances and the steps taken to remove the budget variances.
- Selling, Distribution, and Administration Overhead:
The main points to be covered are as follows:
i. Evaluation of sales performance – A cost auditor has to see whether the budgets were prepared after a proper market survey. Moreover, he has to scrutinize the data to make sure the actual costs have not deviated from the budgeted costs.
ii. Size of advertising expenses, after sales service and other promotional expenses – A cost auditor must ensure that the expenses are within reasonable limits and have been necessarily incurred.
iii. Productivity of Men, Machines, and Materials – A cost auditor has to report on the overall productivity and business efficiency, and he should indicate –
(a) Reasonableness of idle capacity.
(b) Optimum utilization of resources and explanation for repair, replacement of plant and machinery.
Cost Audit appears that it not only serves the management of the company and the shareholders but it serves the customers as well as the nation also.
1) To the Management:
i) It provides reliable cost data for managerial decisions.
ii) It helps the management in finding out the correct cost of production.
iii) It helps the management to regulate production.
iv) It helps in obtaining licences for either expansion or diversification of the various product-lines of the business.
v) It is a basis in evaluating the internal-divisional performance.
vi) It acts as an effective managerial tool for the detection of errors, frauds, inconsistencies and irregularities so that reliable and smooth functioning of the system is continued.
vii) It reduces the cost of production, through plugging loopholes relating to wastage of material, labour and overheads.
viii) It can increase the productivity by pin-pointing the weak area of cost of production.
ix) It can fix the responsibility of an individual wherever irregularities or wastage is found. The inefficiencies of the personnel’s working in the cost department may be revealed.
x) It can measure the profitability of the organisation.
xi) It helps in comparing actual results with budgeted by means of various analysis and points out the areas where management action is more essential.
xii) It exercises moral influence on employees which keeps them efficient and alert.
xiii) It ensures that the cost accounts have been maintained in accordance with the principles of costing employed in the industry concerned.
xiv) It can ensure accurate determination of profit for tax purposes.
xv) It can stop the capital erosion by constant watch on the better plant utilisation, discontinuing uneconomic product-lines and elimination of wastage.
2) To the Shareholders:
i) The cost audit enables shareholders to determine whether or not they are getting a fair return on their investments. It reflects the managerial skill and efficiency or inefficiency of those who are at the helm of the affairs of the company i.e., Board of Directors, General Manager and other senior officials.
ii) It ensures a true picture of company’s state of affairs. It reveals factual information by comparing resources and their proper utilisation. It enables the shareholder whether the plant and equipments are properly utilised or not by adopting several methods and techniques.
iii) It ensures that proper records are maintained as to purchases, utilisation of materials and the expenses incurred on various items. It also makes sure that the industrial unit has been working accurately, economically and efficiently.
3) To the Society:
i) It can bring about an overall improvement of the community by drawing up plans and programmes relating to cost for the part of the natural resources which are still unutilised.
ii) It indicates the true cost of production. From this the consumer may aware, whether the market price of the article is fair or not. It means the cost audit try to save the consumer from the exploitation.
iii) It improves the efficiency of industrial units and thereby assists in economic growth of the nation.
iv) Since price-increase by the industry is not allowed without justification as to increase in cost of production, consumers can maintain their standard of living.
v) It can control different elements of cost viz., materials, labours and overheads, which help to the society at large.
vi) It serves an important task in holding the price-line and serves the interest of the society, (means whether factors of the society).
4) To the Government:
i) It helps the Government in fixing and regulating prices, tariff protection.
ii) It facilitates settlement of trade disputes of the companies.
iii) Cost Statements may be helpful to authorities in levying tax or duty on the cost of finished products.
iv) It enables the Government to ascertain the cost of work under “cost plus, percentage contract”, if it is done by the proper examination of cost record.
v) It can also reveal the fraudulent intentions of the management.
vi) It helps the Government to take necessary steps to improve the efficiency of sick industrial units.
vii) It provides factual information to the Government for fixing up ceiling prices of the various commodities and to curb profiteering by the manufacturing concerns.
viii) It also helps in ascertaining whether any particular industry should be given any subsidy in order to develop that industry.
ix) It forms a basis for assessment of income tax.
x) It can also check some extent the high inflationary trend.
xi) It helps in promoting export.
xii) It helps to have better inter-firm comparison.
Cost Audit – Criticisms
Cost Audit should have no limitation of its own. If there be any intimation, it does not relate to the objectives for which it has been introduced. Sometime, it may arise due to its limited scope of application in the related fields of operation.
However, it is found to be criticised on the following ground only:
i) It involves maximum amount of cost for the jobs which can be done by the internal auditor.
ii) It becomes very difficult to quantify responsibility of the accountants, chartered accountant and cost accountant, in case of the company which goes into liquidation.
iii) The cost audit reports are not published regularly for the protection of the interest of the shareholders.
iv) It has been superimposed on the financial audit.
v) It deters the progress of the organisation by interfering the work of the organisation by talking about efficiency and propriety.
vi) The Cost Audit staffs in actual practice do not perform any important function except gossiping.
vii) Cost Auditors are not always above frauds, errors and misappropriation and manipulation.