Cost Audit

Cost Audit Functions, Objectives, Advantages, Limitations, Report

Table of Contents:-

  • What is Cost Audit?
  • Functions of Cost Audit
  • Forms of Cost Audit
  • Objectives of Cost Audit
  • Advantages of Cost Audit
  • Limitations of Cost Audit
  • Satutory Provisions of Cost Audit
  • Cost Audit Report
  • Cost Audit Programme
  • History of Cost Audit

What is Cost Audit?

Cost Audit is an independent examination of an entity’s cost statements, cost records, and other related information to express an opinion thereon. Standards on Cost Auditing guide the cost auditor through each step of the audit process regarding the audit procedures to be followed, the responsibilities of the cost auditor, and cost reporting.

Cost audit is the verification of cost records and accounts and a check on the adherence to the prescribed cost accounting procedures and the continuing relevance of such procedures.

It is often stated that auditing begins where accounting ends because accounting records serve as the basis for verification. The audit ensures that the corresponding accounts provide an accurate and fair view of the affairs. When the concept of audit is applied to cost accounting records, it means a more specific and specialized activity.

Functions of Cost Audit

On interpreting the above definition, we may outline the following four primary functions of cost audit:

1. Verification as a process of audit;
2. Examination of the correctness of cost records and accounts;
3. Analysis of whether the prescribed procedures of cost accounting have been appropriately followed or not; and
4. Evaluation that the prescribed cost accounting procedures remain relevant to the organization under audit.
This involves an assessment of:

(a) adequacy of cost accounting systems, records, and procedures,
(b) their correct maintenance,
(c) their useful compilation in the form of cost statements and
(d) adherence to the prescribed accounting procedures.

Forms of Cost Audit

Cost audits are conducted in addition to the audits of financial accounts by the statutory auditors appointed by the company. It usually addresses two significant aspects of a business: protective and constructive, known as Propriety Audit and Efficiency Audit, respectively.

Propriety Audit

From a protective point of view, cost audit:

1. It detects errors,

2. It verifies that the cost accounts are maintained correctly in accordance with generally accepted cost accounting principles adopted in the industry, and

3. It ensures that the prescribed system of cost accounting is appropriately carried out.

Efficiency Audit

From the constructive point of view, a cost audit examines the following:

1. The adequacy and effectiveness of existing procedures regarding managerial decisions.

2. The possibilities of drawing optimum results through the projected expenditure.

3. There are opportunities for a more profitable investment of money in another area.

4. The rate of return on capital employed.

Objectives of Cost Audit

The main objectives of a cost audit are as follows:

1. To serve as a valuable tool of control.
2. To safeguard the interests of the company’s members, consumers of its products, and the government.
3. To verify the precision of cost data.
4. To ensure that the principles of cost accounting have been appropriately adapted and applied.
5. To assist in the process of decision making based on cost considerations.
6. To offer suggestions for a more efficient organization of the costing operations.
7. To ensure that a suitable system of costing has been maintained by the needs and characteristics of the industry and that the supporting procedures help in attaining the organisation’s goals.
8. To examine whether the cost statements give an accurate and fair view of the cost information.
9. To help ascertain quotations for future contracts based on correct cost estimates.
10. To look into cost practices to aid pricing decisions effectively.
11. To act as a moral appraisal of the employees associated with cost accounts.

Cost audit, thus, is a valuable tool for verifying cost information and its control.

Advantages of Cost Audit

Let us now discuss the advantages of cost audit from the viewpoints of:

(a) The  management,
(b) The shareholders,
(c) The society, and
(d) The government.

Cost Audit and Management

1. It guides managerial decisions through relevant cost data.
2. It assists in the regulation of the level of production.
3. It detects and prevents errors and fraud.
4. It checks wastage and minimizes costs.
5. It fixes accountability for poor performance.
6. It helps in improving procedures and their efficiency.
7. It compares actual costs with estimated costs and analyzes causes of variance.
8. It evaluates the comparative profitability of different units.
9. It extends moral influence on staff.
10. It ensures the application of proper principles of costing.

Cost Audit and Shareholders

1. It ensures a system of accounting for expenses.
2. It ensures a method of proper utilization of resources.
3. It ensures an efficient process of production.
4. It ensures an adequate return to investors.

Cost Audit and Society

1. It aids in ascertainment of true cost and fair selling price.
2. It aids in determination of the level of industrial efficiency and its contribution to economic development.
3. It aids in the adoption of a proper standard of living due to a fixed price level.

Cost Audit and Government

Cost audit is a tool for:

1. Tariff policy on different industrial units.
2. Subsidy decisions in respect of industrial functions.
3. Regulated prices and profits.
4. Controlled industrial sickness.
5. Enforcement of fair trade practices.
6. Finding out future project costs.
7. Guidance to proposed levy of duties and taxes.
8. Improved efficiency of industrial operations.
9. Quicker settlement of industrial disputes.

Limitations of Cost Audit

Cost audit also has its limitations. These are as follows:

1. Cost audit is an unnecessary interference in the internal operations of the management.
2. Cost records are essential for facing market competition, and the relevant information must be treated as trade secrets.
3. Cost audit verifies accounts of estimated figures, which are invariably different from actual expenses.
4. It is a very time-consuming exercise. Verification spreads over the entire field activity and deals with numerous items of the production process, ranging from the first purchase of raw materials to the last sale of the finished product.
5. Cost audit may take much time to complete, and its reports may need to be updated. They may be mere history when they come up for consideration.

Despite such limitations, cost audit is a recognized control and industrial efficiency technique. Its importance and scope of application, therefore, have been constantly growing.

Satutory Provisions of Cost Audit

In respect of cost audit, the significant provisions of Section 233B of the Companies Act, 1956 (as amended) are as follows:

1. When Cost Audit is Required?

If deemed necessary, the Central Government may direct, through an order, that an auditor conducts an audit of costs (records kept by a company under Section 209(1)(d)) in such a manner as specified in the order. Cost audit is in addition to the statutory financial audit.

2. Who can Conduct Cost Audit?

The auditor shall be a cost accountant under the Cost and Works Accountant Act 1959. Suppose the Central Government thinks that a sufficient number of cost accountants are not available to audit companies’ cost accounts generally. In that case, the government may allow, for a specified period, duly qualified chartered accountants to also conduct the cost audit.

3. How to Appoint Cost Auditor?

A cost auditor is to be appointed by the company’s board of directors with the previous approval of the government.

4. Is Cost Audit an Additional Audit?

A cost auditor is distinct from a financial auditor. A cost audit is conducted in addition to the audit performed by an auditor under section 224 of the Act.

Cost Audit Programme

A Cost Audit Programme is a coordination of:

(a) the work to be done,
(b) distribution among the audit staff, and
(c) the time frame to complete the assignment.

However, the Companies Act has yet to lay down any specific method for cost audit. The only provision is that under directed circumstances, the cost auditor must submit his report to the Central Government with a copy to the company under audit. However, a cost audit programme must have a systematic plan of action so that it is concluded within the schedule and at minimum cost. The cost audit programme includes the following verifications:

1. Whether the policies followed by the company are in its interest.
2. Whether the cost accounts maintained by the company are in order.
3. Whether the management has been efficient enough to generate adequate profit for the company or to control its cost of production.
4. Whether the audit opinion will be based on facts duly supported by proper examination of relative records.

Besides, the cost audit programme should also take note of:

(a) audit methodology to be applied,
(b) audit notes prepared,
(c) questionnaire issued,
(d) queries made,
(e) replies received,
(f) explanations collected,
(g) additional information required,
(h) discussions held,
(i) follow-up measures needed, etc.

Cost Audit Report

The Cost Audit (Report) Rules, 1968 (as amended from time to time) incorporate the following significant provisions:

1. Submission of Report

 Every cost auditor conducting an audit of the company’s cost accounting records must submit a report to the central government in the prescribed form and according to the procedure. Simultaneously, a copy of the report must be forwarded to the company.

2. Powers and Duties of Cost Auditor

The company and every officer shall make available to the cost auditor such cost accounting records, cost statements, and other books and papers required for conducting the cost audit. They shall provide necessary assistance to the cost auditor to enable the audit within the specified time limit.

3. Time Limit for Report

The cost auditor must send the report to the Central Government and the company within 180 days from the end of the financial year to which the cost audit report relates.

The form prescribed for the Cost Audit Report is as follows.


I/We……….. having been appointed as auditor(s) under section 233-B of the Companies Act, 1956, of M/S………………. Ltd., have examined the books of accounts and other relevant records for the year ended…………… [mention the specific date] relating to maintained by the company and report, subject to my/our comments under the heading “Auditor’s conclusions and observations contained in the Annexure to this Report.”

(a) I/We have obtained all the information and explanations which, to the best of my/our knowledge and  belief, were necessary for this audit;

(b) The company has kept proper cost accounting records;

(c) Proper returns adequate for my/our cost audit have been received for branches not visited by me/us;

(d) The said books and records give the information required by the Act in the manner so required and

(e) In my/our opinion, the company’s cost accounting records have been adequately kept to give an accurate and fair view of the cost of production, processing, manufacturing, or mining activities, as the case may be, and marketing of the product under consideration.

The content found in the Annexure to this report is an integral part of this report and is also subject to the observations made by me/us therein.

Dated this…………….[mention the day] day of…………….[mention the month], 20………..[mention the year], at [mention the place].

Cost Auditor(s)

History of Cost Audit

– 1965: Cost Audit was first introduced in India with the enactment of Sec 233B of the Companies Act 1956 for Cost Audit and Sec 209 (1) (d) for the maintenance of Cost Records.

– 1965-2008: Forty-four industries were covered under cost record maintenance, and cost audit was on a company-specific basis.

– 2008: An Expert Group was set up to study the existing cost audit mechanism.

– 2009: The Expert Group submitted its report to the Central Government.

– 2011: The mandatory Cost Audit of Cost Records maintained by the Companies under the Companies Act 1956 was introduced for Manufacturing, Mining, and processing operations depending on the limits of Turnover and Net Worth. Additionally, the issue of a Compliance Certificate by the Cost Accountants was mandated.

– 2014: The New Companies (Cost Records and Audit Rules), 2014 were issued under the Companies Act, 2013.

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