Cost Audit

Unit-I

Nature , Objectives & Scope

Cost Audit:
It is an audit process for verifying the cost of manufacture or production of any
article, on the basis of accounts as regards utilisation of material or labour or
other items of costs, maintained by the company. In simple words the term cost
audit means a systematic and accurate verification of the cost accounts and
records and checking of adherence to the objectives of the cost accounting.

As per ICWA London’ “cost audit is the verification of the correctness of cost
accounts and of the adherence to the cost accounting plan.”

The ICWAI defines cost audit as “system of audit introduced by the government
of India for the review, examination and appraisal of the cost accounting records
and attendant information required to be maintained by specified industries"

From above definition of cost audit, it is clear that cost audit is a systematic
examination of cost accounts to verify correctness of cost accounting records.

As per the section 233 B of Company Law 1956, there is the provision for cost
audit. Under this section, cost audit is compulsory for all the public and govt.
companies which are associated with the processing and production. If there
aggregate value of net worth exceeds 5 crores or total sale exceeds 20 crores,
the cost audit is must.

Objectives of Cost Audit

The following are some of the objectives for which cost audit is under taken:
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 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 costing department of the organization
and to make suggestions for improvement.

5. To help the management in taking correct decisions on certain important

matters i.e. to determine the actual cost of production when the goods are ready.

6. To reduce the amount of detailed checking by the external auditor if effective

internal cost audit system is in operation.

Advantages of Cost Audit:

To The Management
1. Cost audit helps in detection of errors and frauds.
2. The management gets accurate and reliable data based on which they can
make day-to-day decisions like price fixation.
3. It helps in cost control and cost reduction.
4. It facilitates the system of standard costing and budgetary control.
5. It helps the management in inter-unit / firm comparison.
6. It enables the management to identify loss making propositions.

To The Government
1. Cost audit ensures efficient functioning of the industry. This in turn, nurtures a
healthy competition among the different companies and paves a path for fast
progress.
2. It helps in identification of sick units and enables the Government to make
relevant decisions.
3. It helps in fixing prices in the case of essential commodities and checking
undue profiteering.
4. It enables to take decisions as to granting of subsidies, incentives and
protection to various industries.
5. It helps to take decisions as to levies, duties and taxes.

To the Society
1. Cost audit enables the Government to fix prices of essential commodities. This
safeguards the interests of the society.
2. Cost audit enables the Government to keep a check on undue profiteering by
the manufacturers and avoids artificial price rise due to monopolistic tendencies.

To the Shareholders
1. Cost audit reveals whether any of the products of the company are making
losses. Thus though the company making an overall profit, a loss making line
may eat up the company’s profits. This is brought to the notice of the
shareholders and the management is forced to take remedial measures, thereby
making optimum utilisation of resources.
2. Cost audit ensures that the shareholders get a fair return on their investments.

Disadvantages of Cost Audit:

1. Holding a Cost Audit can be expensive. This is because a company will often
bring in an independent auditor who are normally charging higher price.
2. A Cost Audit can be a long process which will likely involve more time. This
extra time and effort can impact an employee's day to day routine work.
3. If a Cost Audit is carried out in order to find fraudulent activity it can take a long
time by which time people stealing could have covered their tracks.
4. Cost Audits involve a large amount of estimation and so there is the possibility
that figures will be incorrect and if record keeping from the company is not good
to start with then inaccuracies will be arises.

Nature of Cost Audit

1. Engagement letter – Auditor should send all clients an engagement letter

setting out the auditor’s duties and responsibilities.
2. Planning – Planning and controlling audit work is essential to performing
work to the required high standard of skill and care.
3. Ascertain accounting systems – auditors enquire into and ascertain the
client’s system of accounting and internal controls in order to understand
how accounting data is prepared and to gain an impression as to whether
systems are reliable.
4. Test controls and transactions – Controls must be tested if the auditor
intends to rely on them. Records must be tested to obtain evidence that they
are a reliable basis for the preparation of accounts.
5. Verify assets and liabilities – Figures appearing in financial statements must
be verified.
6. Review financial statements – To see if, overall, they appear sensible.
7. Obtain management representations – The auditor asks management to
confirm formally the truth and fairness of certain aspects of financial
statements.
8. Sign auditor’s report – After the directors have approved the accounts.

Scope of Cost Audit

The cost audit extents to the verification and checking of the following areas:

1. Services
Utilization of power, fuel, water, steam and electricity and that of material, labour and other costs
like overheads allocated to the service department.
2. Wages and Salaries
Maintenance of employment and attendance records, overtime and idle time records, allocation of wages
and salaries among various departments and those connected with the capital work.
3. Overhead
The overheads like production, administration, selling and distribution should be allocated on a
reasonable basis. The cost auditor ensures a fair and equitable distribution of overheads between various
departments, reconciliation of the cost records with that of financial records, overhead recovery rates, and
basis for allocation of cost between fixed and variable.

4. Depreciation
Maintenance of fixed assets registers with quantitative details, situation, method of calculating
depreciation, allocation of depreciation in respect of the common assets.

5. Production
Daily production reports, summaries from daily to monthly, monthly to yearly and comparison with past
records and budgeted targets including abnormal losses, work in-progress, etc.

6. Work-in-Progress
Maintenance of records viz., job cards, work order, cost ledger, etc. and their valuation method.

7. Stock Verification
Inventory records for stock – both finished and unfinished products, spares and stores, tools, machinery
spares, etc, their values, issue procedure and balances.

8. Utilization of Capacity
Plant utilization and capacity utilization are not considered in detail in financial audit. Under this
category the cost auditor’s examination covers the following aspects – total available hours, standards
hours, planned hours, and actual hours worked. Practical capacity, standard capacity, expected capacity,
and actual capacity utilized.
Besides, the cost auditor’s examination covers various other aspects viz., royalty payments, company
policies with regard to inventory management, productivity, internal control, internal audit, cost
reduction, export performance, bottlenecks in the production process, inter-company transactions, etc.
Hence, from the practical utility point of view, the scope of cost audit is much wider than the financial
audit.
Difference between Financial Audit and Cost Audit

Financial Audit Cost Audit

Only in case of companies involved into

1. Financial audit is mandatory for all
manufacture or mining business and required
companies registered under Companies Act,
to maintain Cost Accounts as per Section 209.
1956.

2. The financial audit is done to report on the Cost audit is done to certify after careful
financial data, consisting of a statement of examination or checking of reports on
balance sheet and profit and loss to ensure expenditure made on production of intended
fairness of business perspectives. items.

Cost Auditor is appointed by the board of

3. Financial Auditor is appointed by
directors with the previous approval of the
shareholders.
Central Government.

4. Financial audit is mandatory to be Cost Audit is conducted in a year in which

conducted every year. audit is required by the government.

Cost audit is done when government or

5. Financial audit is done or conducted as per
industrial organization proposes to make an
the demand of the shareholders.
audit.

6. Financial auditor has to check or examine

In cost, audit the auditor has to see whether
carefully and in detail the exact value of
there is sufficient stock maintaining in order
closing the stock for the purpose of balance
to fulfill the needs of the business concern.
sheet.

7. The financial auditors have to give their The cost auditors have to give their remarks
remarks about the exact expenditures shown about how correctly or wisely the decisions
on the record. have been taken in production of items.

8. The finance auditor submits the report in Cost auditor submits the report to the
annual general meeting organized by company and central government within 180
shareholders. days from the end of financial year.