Cost Audit

The Institute of Cost and Management Accountants of England defines Cost Audit as follows - "the verification of cost records and accounts and a check on adherence to the cost accounting procedures and their continuing relevance".

Thus, cost audit involves the following

  1. Examination of correctness of cost accounts : This involves verification of the cost accounting system, the methods and techniques of costing; the accuracy of the cost accounts and the reports generated

  1. Ensuring that the Cost Accounting Plan has been adhered to : This involves checking whether the objectives/policies laid down by the management are in accordance with the Cost Accounting Plan.
Objectives of Cost Audit :

The objectives of cost audit can be summarized as follows -

  • Protective Objective

  • To examine whether proper cost accounting records as per the provisions of the Companies Act have been maintained.

  • To check whether the records maintained as above give a true and fair view of the cost of production.

  • To verify the cost data and the reports generated there from.

  • To reduce wastage of materials and labour.

  • To maintain internal check and internal control in the various areas of operation.

  • Constructive Objectives

  • To make available accurate and timely information to the management.

  • To generate useful information for the Government so as enable it to fix prices, to give concessions to industries etc.

  • To help the management in the decision making process.

  • To reduce cost of production by making maximum utilisation of resources and to increase the level of efficiency by choosing the most beneficial method of operation.

  • To enable fixation of prices.

  • To promote cost-consciousness

  • Other Aspects of Cost Audit :
    Apart from the aspects discussed above, cost audit also covers the following:

  • Efficiency Audit: Efficiency audit involves measurement of the efficiency of the performance of a company. Efficiency audit means comparison of actual performance with the set target, ascertaining the variances, investigating the reasons for the variances and instituting remedial action for the same.

Thus, the main purpose of efficiency audit is to ensure that -

  • There is most optimum utilisation of resources.

  • The resources are channelised in the most profitable lines.

  • Propriety Audit :
    It means the audit of executive actions and plans bearing on the finances and expenditure of the company.
    The cost auditor has to check the following aspects while conducting a propriety audit –

  • Whether the existing procedures aid the management in decision making

  • Whether the planned expenditure would give optimum results

  • Whether the return on investment could be improved by some other alternative plan of action

Thus, a propriety audit aims at supporting a reasonably high standard of financial prudence, so as to look after the interests of the shareholders.

Annexure to the Cost Audit (Report) Rules specifically provide for the cost auditor’s comments on "cases where the company’s funds have been used in a negligent or inefficient manner".

Types of Cost Audit :

  • Statutory Cost Audit :
    Following are the features of statutory cost audit –

  • Section 233B of the Companies Act, 1956,empowers the Government to bring any industry under the purview of cost audit.

  • A statutory cost audit is not an annual feature like the statutory financial audit. It is to be conducted only when an order for the same is made by the Government.

  • Normally, a statutory cost audit is ordered for a particular industry and not for a particular company. Thus, if a company manufactures say , three products, only one product may be covered under statutory cost audit.

  • Section 209(1)(d) of the Companies Act, 1956, prescribes the cost records to be maintained for the purpose of cost audit.

  • The cost auditor is appointed by the Board of Directors of a company with the previous approval of the Central Government. A cost accountant or a chartered accountant may be appointed as a cost auditor. However an auditor appointed under Section 224 of the Companies Act, 1956, cannot be appointed as the cost auditor of the same company. Powers and duties of the cost auditor with respect to access to books of accounts and records and obtaining information and explanations from the officers of the company are the same as under Section 227(i) if the Companies Act, 1956.

  • The company should make available to the cost auditor, within 90 days from the end of the financial year, all the cost accounting records as would be required for conducting the cost audit.

  • The cost auditor is required to submit his report in triplicate to the Central Government within 120 days from the end of the financial year of the company. A copy of the report should be sent to the company also. The report should be in the form laid down in the Cost Audit (Report) Rules, 1968 and the subsequent amendments to the same.

  • The company should furnish to the Central Government, within 30 days of the receipt of the cost audit report, all information and explanations on every reservation and qualification contained in the report. The Central Government is empowered to call for further information/explanations, if required and may take the requisite action on the report.

  • Cost Audit on behalf of the Management :
    The management establishes a costing system so as to facilitate intelligent decision-making. The correctness of the decisions depends upon the reliability of the costing system and the accuracy of the cost data generated based on which such decisions are based.
    A cost audit enables the management to –

  • Establish the reliability of the cost accounting system Establish the accuracy of the cost data generated

  • Verify whether the objectives for installing the cost accounting system are being met.

  • Ascertain whether the existing targets fixed can be upgraded or whether the existing cost accounting system can be improved.

  • Cost Audit on behalf of the Customer :
    In the case of a "cost-plus contract" the contractee (or the customer), may insist on a cost audit so as to ascertain the correctness of the "cost". Normally, the contract stipulates this facility for the contractee.

  • Cost Audit on behalf of the Government :
    Such an audit is conducted under the following circumstances :

  • When the Government wants to fix a fair price for essential commodities

  • When the Government is approached for concessions, subsidy, protection to a particular industry / company.

  • When the Government wants to fix duties on certain products.

  • Cost Audit on behalf of the Trade Association :
    When a company becomes a member of a trade association, it may have to fulfill certain requirements of the trade association, one of which may be cost audit.
    Such an audit helps the trade association to ascertain the reliability of the data submitted by the member company. It also facilitates the following -

  • The trade association may negotiate with the Government for subsidies, concessions etc.

  • Cost audit may be useful in settling trade disputes on account of demand for higher wages, bonus etc.

  • In case of major cost variations within the industry, the respective company’s costs can be verified.

Circumstances Under Which a Cost Audit is Ordered:

With reference to "Types of Cost Audit"  above, following are the circumstances under which a cost audit is ordered -

  • When a company or a product incurs continuous losses.

  • In case of cost-plus contracts

  • For price fixation.

  • In case of major cost variations within the different units of the industry

  • In case of granting subsidy by the Government

  • In case of fixation of levies and duties on products by the Government

  • For settling trade disputes on account of higher wages, bonus etc.

When a trade union wants to negotiate with the Government for certain benefits.

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