Cost Audit

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.”

Smith and Day in their book ‘Advanced Cost Accountancy’ define it, “the term ‘Cost Audit’ is meant the detailed checking of the costing system, technique and accounts to verify their correctness and to ensure adherence to the objective of cost accountancy.”

R.W. Dobson Smith and Day in their book Introduction to Cost Accountancy’ defines it, “Cost audit is the verification of the correctness of cost accounts and the adherence to the cost accountancy plan.”

Cost audit is the verification of the correctness of cost accounts and a check on the adherence to the cost accounting plan.

This is, it not only involves the examination of cost accounts but also the fact that the plan prepared in this connection has been duly executed. Cost audit as an audit of the efficiency of minute details of expenditure in which the work is in progress and not a post-mortem examination.

The first function of cost audit is the verification of cost accounting records according to the cost accounting system and the second function is the 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, cost data and costing techniques applied and finally checking these data to see that they adhere to cost accounting principles, plans, procedures and objectives.

Objectives of Cost Audit

The following are some of the objectives for which cost audit is undertaken:

1. To establish the accuracy of costing data. This is done by verifying the arithmetical accuracy of cost accounting entries in the books of accounts.
2. To ensure that cost accounting principles are governed by the management objectives and these are strictly adhered to in preparing cost accounts.
3. To ensure that cost accounts are correct and also to detect errors, frauds and wrong practice in the existing system.
4. To check up the general working of the cost department of the organization and to make suggestions for improvement.
5. To help the management in taking correct decisions on certain important matters
6. To determine the actual cost of production when the goods are ready.
7. To reduce the amount of detailed checking by the external auditor its effective internal cost audit system is in operation.
8. To find out whether each item of expenditure involved in the relevant components of the goods manufactured or produced has been properly incurred or not.

Advantages of Cost Audit

The important advantages of cost audit are briefly discussed as follows:

1. Advantages to the Management

• It provides necessary information for prompt decision decisions.
• It helps management to regulate production.
• Errors, omission, fraud, and mistakes can be detected and prevented due to the effective auditing of cost accounts.
• It reduces the cost of production through plugging loopholes relating to wastage of material, labor, and overheads.
• It can fix the responsibility of an individual wherever irregularities or wastage are found.
• It improves the efficiency of the organization as a whole and costing system in particular by constant review, revision and checking or routine procedures and methods.
• It helps in comparing actual results with budgeted results and points out the areas where management action is more needed.
• It also enables comparison among different units of the factory to find out the profitability of the different units.
• It exercises a moral influence on employees which keeps them efficient and alert.
• It ensures that the cost accounts have been maintained under the principles of costing employed in the industry concerned.
• It ensures effective internal contr
• It helps to increase the overall efficiency of productivity.
• Inefficiency can be eliminated by suitable corrective actions.
• It facilitates cost control and cost reduction
• It assists in the valuation of stock of materials, works in progress and finished goods.
• It ensures maximum utilization of available resources,
• It enables the management to choose economic methods of operations and thus earn profits to satisfy the shareholders and the investing public.
• It enables the management to chalk out the future policy based on the report by the cost auditor especially regarding labor, raw material, plant, etc. to maximize production and reduce the cost of production.
• It tests the effectiveness of cost control techniques and to evaluate their advantages to the enterprise.

2. Advantages to the Shareholders

• It ensures that proper records are maintained as to purchases, utilization of materials and expenses incurred on various items i.e. wages and overheads, etc. It also makes sure that the industrial unit has been working efficiently and economically.
• It enables shareholders to determine whether or not they are getting a fair return on their investments. It reflects managerial efficiency or inefficiency.
• It ensures true picture of the company’s state of affairs. It reveals whether resources like plant and machinery are being properly utilized or not.
• It creates an image of the creditworthiness of the concern.
• Advantages to the Society
• It tells the true cost of production. From this, the consumer may know whether the market price of the article is fair or not. The consumer is saved from exploitation.
• It improves the efficiency of industrial units and thereby assists in the economic progress of the nation.
• Since the price increase by the industry is not allowed without justification as to an increase in the cost of production, consumers can maintain their standard of living.

3. Advantages to the Government

• It assists the tariff board in deciding whether tariff protection should be extended to a particular industry or not.
• It helps to ascertain whether any particular industry should be given any subsidy to develop that industry.
• It provides reliable data to the government for fixing up the selling prices of the various commodities.
• It helps in fixing contract prices in a cost-plus contract.
• It determines whether differential pricing within the industry is desirable.
• It helps the government to take necessary measures to improve the efficiency of sick industrial units.
• It can reveal the fraudulent intentions of the management.
• Cost statements may be helpful to authorities in imposing tax or duty at the cost of finished products.
• It facilitates settlement of trade disputes of the companies.
• It imposes an automatic check on inflation.
• It assists the Tariff Board to consider the extension or removal of protection.

Disadvantages of Cost Audit

Cost audits verify expense records and accounts. Audit also ensures that accounts and bookkeepers comply with ethical practices.

Effective cost audits provide a complete breakdown of expense that gives a company financial clarity about accounts. Although they provide such transparency “there are many disadvantages to conducting cost audits.

1. Expensive

One primary disadvantage associated with cost audits is the excessive fees. Auditors are typically independent contractors who can charge relatively high prices for services rendered.

In addition to initial charges, auditors may increase fees in the middle of the project if companies fail to prohibit such action in the contract. A person or corporation can essentially go from paying $4,000 to $6,000 for an audit.

2. Lengthy

Cost audits are also lengthy processes that require employee devotion.

Although the auditor may be an outside contractor, employees must provide requested information and be accessible in case further explanation of documents is necessary.

3. Lost Time

Although thorough an auditor’s report is usually given three to five weeks after the balance sheet is released. This means people who have been stealing from an establishment have nearly a month to form an excuse or leave the company.

4. Uncertainty

Because a major part of the process involves estimating there’s the possibility of numerical figures being wrong.

Besides, if receipts and other forms of record-keeping are skewed an auditor relying on such documents may produce an inaccurate report.

Types of Cost Audit

The main types of Cost audit are the following:

1. Cost Audit as an Aid to Management

The aim is to see that all information placed before management is relevant, reliable and prompt so that management can discharge its duties well. It must also be seen that no relevant or pertinent information is suppressed.

2. Cost Audit on Behalf of a Customer

Often contracts are placed on “Cost Plus” basis. In other words, the customer will determine the final price to be paid on the basis of exact cost plus an agreed margin of profit. The customer, in such a case, usually gets cost accounts of the product concerned audited to establish correct cost and, therefore, price.

3. Cost Audit on Behalf of Government

Sometimes the Government is approached with request for financial help or protection. Before taking a decision on the request, the Government may choose to get cost accounts of the applicant audited to establish whether the need for help is genuine or is a result of mere inefficiency.

4. Cost Audit under Statute

The Amendment Act of 1965 has inserted a new section, 233B, in the Companies Act, 1956 whereby the Central Government may order that certain classes of companies will get their cost accounts audited by a member of the Institute of Cost and Works Accounts of India. Only such companies as are required to maintain proper records regarding materials consumed, labour and other expenses under Section 209 (as amended to date) and may be required to get their cost accounts audited.

The powers and duties and manner of appointment of the cost auditor are the same as that of external financial auditor and the same disqualifications will apply. The cost auditor will submit his report to the Company Law Board with a copy to the company. The right to investigate all aspects of cost accounts is presumably granted to the cost auditor.

The aim of cost audit under statute seems to be that the Government wishes to know, as an instrument of control, the costs of various goods. Government has the power to prescribe the forms in which cost audit reports are to be made out. These are designed not only to verify information, but also to convey good deal of information to Government.

5. Cost Audit on Behalf of the Trade Association

Sometimes trade associations seek to maintain prices at a certain level. For this purpose, the accuracy of costing information submitted by various concerns has to be checked. The trade associations may seek to have full information about production capacity and the relative efficiency of productive processes.