CHAPTER 30

Cost Audit
Meaning

Cost Audit is the verification of the cost accounts and of the adherence to the cost accounting plan. That is, it not only involves the examination of cost accounts but also the fact that plan prepared in this connection has been duly executed. The Indian Companies Act has made provisions to perform cost audit to certain categories of companies engaged in the production processing, manufacturing and mining activities under section 209 and 233 B. It has however not been made compulsory for all the companies. The duties and powers of the Auditor are set out under section 227 of the said Act. Cost Auditor will not submit his report to the members of the company but will have to submit to the Company Law Board.
Definition

Cost Audit may be defined as "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."
Difference between Financial Audit and Cost Audit
Financial Audit
(1)

Cost Audit
(1)

It is statutority compulsory under Companies Act.

It is not compulsory except in certain cases as provided under section 233B. It covers only cost records and cost accounts.
It aims to verification of cost accounts and

(2) (3)

It covers all the financial transactions recorded in financial books and financial records.
It aims to examine that the business transactions have been recorded correctly.

(2) (3)

ensures the plan prepared in this connection has been duly executed. (4) (5) It concerned with forward looking approach. Cost Auditor is required to report to the management except statutory audit.

(4) (5)

It is concerned with the past and historical in nature. Reporting the true and fair view of the company's earnings and state of affairs.

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Financial Audit

Cost Audit

(6) (7)

Financial aspect of the accounts is a matter of concern. It is concerned with the scrutiny of reliability or otherwise of transactions.

(6) (7)

Cost aspect of account is of main concern. It is concerned with the propriety and efficiency of the transactions.

Proposes or Objectives of Cost Audit The purpose of Cost Audit is to examine whether the methods laid down for ascertaining costs and other decisions are being properly implemented and whether the cost accounting plan is being adhered to or not. The purposes can, therefore, be classified under two heads, namely :
(1)

Protective Constructive

(2)

(1) Protective Purpose: Under protective purpose, it aims to examine that there is no undue wastage or losses and costing system brings out the correct and realistic cost of production or processing. (2) Constructive Purpose: Cost Audit has a constructive purpose as well. Cost Audit plays a constructive role by providing management of the company with information useful in regulating production, choosing economical methods of operation, reducing operation costs and reformulating plans etc. on the basis of his findings during the course of Cost Audit. Circumstances Under Which Cost Audit is Desirable The following are the circumstances under which cost audit is ordered :
(1)

Price Fixation Cost variation within the industry Inefficient Management Tax Assessment Trade Disputes

(2) (3) (4) (5)

Types of Cost Audit The following are the important types of Cost Audit:
(1)

Efficiency Audit Propriety Audit Statutory Audit

(2) (3)

(1) Efficiency Audit: Efficiency Audit is directed towards the measurement of whether corporate plans have been effectively executed. It is concerned with the utilization of resources in economic and most remunerative manner to achieve the objectives of the concern. For example, the effective utilization of capital in an organization can be gauged by determining return on capital employed. (2) Propriety Audit: Propriety Audit is concerned with executive actions and plans be~ring on the finance and expenditure of the company. The auditor has to judge whether the planned expenditure is designed to give optimum results.

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(3) Statutory Audit: This type of audit is conducted in accordance with the provisions of Section 233B of the Companies Act 1956. It is the compulsory audit which required to maintain the related books and accounts of specified establishments. The chief aims of this types of audit is that the government wants to ascertain the relationship of costs and prices. Advantages or Usefulness of Cost Audit Besides the chief merit of detecting and preventing errors and frauds as in the case of audit in general. cost audit secures the following advantages to the management. shareholders and Government. I. Usefulness to the Management:
(1)

It ensures effective internal control. It provides necessary information for prompt decision making. It facilitates inter firm comparison. It helps to increase the overall efficiency of productivity. Inefficiency can be eliminated by suitable corrective actions. Errors. omission, fraud and mistakes can be detected and prevented due to effective auditing of Cost Accounts. It facilitates cost control and cost reduction. It creates cost consciousness among employer and employees. It assists in valuation of stock of materials. work in progress and finished goods.
It ensures maximum utilization of available resources.

(2) (3) (4) (5) (6) (7) (8) (9) (10)

II. Usefulness to the Government: (1) (2) (3) (4) (5)

(6)

Cost Audit helps in fixing contract price in cost plus contract. Helps in fixing of selling price for essential commodities. Enables Government to focus attention on inefficient work. Enables Government to give protection to certain industries. Facilitates settlement of trade disputes.
It imposes an automatic check on inflation.

III. Usefulness to the Shareholders:

(1)

It ensures more profit and high return to the shareholders. It creates an image of creditworthiness of the concern. It reflects a high degree of reliability to cost data. It ensures efficient management in utilization of plant and machinery, land and building, worker and employees etc.

(2) (3) (4)

Cost Audit Programme A suitable programme for cost audit should be drawn out in detail. specifying each item of audit work to be carried out. An audit programme is a written plan prepared by the Cost Auditor showing the following salient features :

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how much work is to be done? who is going to do a particular portion of work? and what is the duration of time by which the work is to be finished? Prof. Meig defines "An audit programme is the detailed plan of auditing work to be performed specifying the procedures to be followed in verification of each item in the financial statements and giving the estimated time required."

Areas of Cost Audit Programme is Carried Out

The areas which a cost audit programme should include are as below :
(1)

Inventory of stores and work in progress Labour Overheads Selling, Distribution, Office and Administrative expenses Capital expenditure Utilization of capacity, plant and equipments

(2) (3) (4) (5) (6)

Advantages of Cost Audit Programme

The following advantages will accrue, if a cost audit is carried out with the help of a cost audit programme:
(1)

It helps the auditor to know about the progress of audit. It increases the efficiency of the cost audit associates. It facilitates the uniformity in work. It helps to safeguard against omission. It guides for proper distribution of works and fixing responsibility. It serves as a defense against charge of negligence. It serves as a reference for the future audit of the same concern.

(2) (3) (4) (5) (6) (7)

Disadvantages of Cost Audit Programme

There are certain disadvantages, if the cost audit work is carried out with the help of cost audit programme. They are as follows:
(1)

For small concern, it would be unnecessary to prepare a programme. Audit associates have no interest and initative since, they perform their work mechanically. As each business has its own problems and procedures, a rigid audit programme cannot be laid for all types of business.

(2) (3)

Cost Accounting Records

The areas of activity in respect of which cost accounting records are to be maintained under Cost Accounting Record Rules are :

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(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15)

Raw Materials, Components, Stores and Spare Parts Salaries and Wages Service Department Expenses Utilities Depreciation Other Overheads Conversion Cost Research and Development Expenses Interest Joint Products and By-products Work in Progress and Finished Goods Stock Cost Statements Records of Physical Verification Packing Production Records

QUESTIONS 1. 2. 3. 4. 5. 6. 7. Define Cost Audit. Explain the purposes of Cost Audit. Explain the types of Cost Audit. What are the advantages of Cost Audit? What do you understand by Cost Audit Programme? Explain the difference between Financial Audit and Cost Audit. Mention the areas of activity in respect of which cost accounting records are to be maintained. What are the circumstances under which cost audit is ordered?

DOD