Cost Audit

Q. Definition of cost audit

Cost Audit is the detailed checking of the costing system, technique, and accounts to verify their
correctness and ensure adherence to the objective of cost accountancy. Cost audit is the
verification of cost records and accounts, a check on adherence to the prescribed cost
accounting procedures, and the continuing relevance of such procedures. Cost auditing checks
and verifies cost accounts’ accuracy, actuality, authenticity, and overall adherence to the
company’s cost accounting plan. This involves not only the examination of cost accounts but
also the fact that the plan prepared in this connection has been duly executed.
According to ICMA London
"Cost audit is the verification of cost accounts and a check on the adherence to the cost
accounting plan".
According to Smith and Day
"By 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
accounting".
A cost audit is 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 a cost audit is verifying cost accounting records according to the cost
accounting system, and
 The second is checking on adherence to the cost accounting plan
A cost audit, therefore, includes verifying the correctness of the cost accounts, cost statements,
cost reports, cost data, and costing techniques applied and checking these data to see that they
adhere to cost accounting principles, plans, procedures, and objectives.

Q. Features of cost audit

The main features of cost audit in India are summarized as follows :
Cost audit is a detailed examination of a company's cost accounting records, systems,
procedures, and practices to ensure their accuracy and compliance with applicable laws and
regulations. The primary purpose of cost audit is to verify the accuracy of cost accounting
information, assess cost control mechanisms, and provide recommendations for improvement.
Some of the key features of cost audit include:
1. Verification of Cost Accounting Records: Cost auditors examine the company's cost
accounting records to ensure they accurately reflect the cost of production, operations,
and other activities. This involves checking the accuracy of cost data, allocation methods,
and adherence to accounting standards.

2. Compliance Check: Cost audit ensures that the company complies with relevant legal
and regulatory requirements concerning cost accounting standards and practices. It
helps in detecting any discrepancies and ensures adherence to laws related to cost
accounting.

3. Identification of Cost Inefficiencies: Cost audits identify areas of inefficiencies in cost

control, cost management, and resource utilization. It helps in pinpointing areas where
costs can be reduced or controlled without compromising quality or efficiency.

4. Evaluation of Cost Control Mechanisms: Cost auditors assess the effectiveness of the
company's cost control mechanisms. They review budgeting processes, cost reduction
strategies, and cost monitoring systems to determine their efficiency and suggest
improvements if necessary.

5. Recommendations for Improvement: Based on the findings from the audit,

recommendations and suggestions are provided to management for improving cost
control, cost management practices, and overall operational efficiency.

6. Enhanced Decision-Making: The insights obtained from cost audits help management in
making informed decisions regarding pricing strategies, product mix, cost-saving
initiatives, and resource allocation.

7. Enhanced Credibility: Cost audits enhance the credibility of a company's financial

statements by ensuring the accuracy and reliability of cost-related information
presented to stakeholders, including shareholders, regulators, and creditors.

8. Risk Management: Cost audit assists in identifying and mitigating risks associated with
inaccurate cost data, inefficient resource allocation, or inadequate cost control
measures.
 9. Continuous Improvement: It promotes a culture of continuous improvement by
highlighting areas for enhancement in cost accounting processes and practices.

10. Independent Review: Cost audits are often conducted by independent professionals or
firms, ensuring an unbiased evaluation of the company's cost accounting systems and
practices.
Cost audits play a crucial role in ensuring transparency, accuracy, and efficiency in a company's
cost accounting practices, ultimately contributing to improved financial management and
decision-making.

Q. Objectives of cost audit

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

 To establish the accuracy of costing data. This is done by verifying the arithmetical
accuracy of cost accounting entries in the books of accounts.
 To ensure that cost accounting principles are governed by the management objectives
and these are strictly adhered to in preparing cost accounts.
 Ensure that cost accounts are correct and detect errors, fraud, and wrong practices in
the existing system.
 To check up on the general working of the cost department of the organization and to
make suggestions for improvement.
 To help the management make correct decisions on certain important matters
 To determine the actual cost of production when the goods are ready.
 To reduce the amount of detailed checking by the external auditor, its effective internal
cost audit system is in operation.
 To determine whether each item of expenditure involved in the relevant components of
the goods manufactured or produced has been properly incurred.

Q. Advantages of cost audit

Advantages of Cost Audit to the Management
1. It provides necessary information for prompt decision decisions.
2. It helps management to regulate production.
3. Errors, omissions, fraud, and mistakes can be detected and prevented due to the
effective auditing of cost accounts.
4. It reduces the cost of production by plugging loopholes relating to wastage of material,
labor, and overheads.
 5. It improves the organization’s efficiency and the costing system by constantly reviewing,
revising, and checking routine procedures and methods.
6. It helps compare actual results with budgeted results and points out the areas where
management action is more needed.
7. It also enables comparison among different factory units to determine the profitability of
the different units.
8. It ensures effective internal control.
9. It facilitates cost control and cost reduction.
10. It assists in the valuation of stock of materials, works in progress, and finished goods.

Advantages of Cost Audit to the Shareholders

1. 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 ensures
that the industrial unit has been working efficiently and economically.
2. It enables shareholders to determine whether or not they are getting a fair return on
their investments. It reflects managerial efficiency or inefficiency.
3. It ensures a true picture of the company’s state of affairs. It reveals whether resources
like plants and machinery are properly utilized or not.
4. It creates an image of the creditworthiness of the concern.

Advantages of Cost Audit to the Society

1. 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.
2. It improves the efficiency of industrial units and thereby assists the nation’s economic
progress.
3. 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.

Advantages of Cost Audit to the Government

1. It helps to ascertain whether any particular industry should be given any subsidy to
develop that industry.
2. It provides reliable data to the government to fix the selling prices of various
commodities.
3. It helps the government to take necessary measures to improve the efficiency of sick
industrial units.
4. It can reveal the fraudulent intentions of the management.
5. Cost statements may be helpful to authorities in imposing taxes or duties at the cost of
finished products.
6. It imposes an automatic check on inflation.
7. It assists the Tariff Board in considering the extension or removal of protection.
Q. Disadvantages of cost audit
Although they provide such transparency, there are many disadvantages to conducting cost
audits.
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.
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
if further explanation of documents is necessary.
Lost Time
Although thorough, an auditor’s report is usually given three to five weeks after the balance
sheet is released. This means people stealing from an establishment have nearly a month to
form an excuse or leave the company.
Uncertainty
Because a major part of the process involves estimating, numerical figures can be wrong.
Besides, if receipts and other record-keeping forms are skewed, an auditor relying on such
documents may produce an inaccurate report.

Q. Procedures of cost audit

The procedure of cost audit involves the following steps:

1. Audit of Materials: The cost auditor should observe the following while auditing materials:

 Check the materials ledger, ensuring that the correct bin card, note receipt, and issue of
material are present.
 All payments related to materials must be vouched from material receipt vouchers.
 Check the purchase of materials, receipts, wastage, and return of materials, if any.
 Evaluate practices for defective and outdated materials.
 Check whether the cost calculation for the output is made after due note of defective
materials.
 Check whether the materials issue price exceeds the prescribed level.
 Analyze procedures for purchase and issue.
  Ensure that there is no misappropriation or theft of materials.

2. Audit of Labor: Cost auditors should note the following points when conducting an audit of
labor:

 Check the work attendance register, supervisor records, and gatekeeper records.
 When wages are paid according to piece rate, the cost auditor should complete the record
of each worker's output and the same should be vouched from the job card.
 When the time rate for wage payment is used, the cost auditor should check the
procedure for recording overtime (this should be sanctioned by the responsible officer).
 Check incentive plans for wage payment, if they are used.
 Verify the total direct cost from labor cost tables.
 Audit the wages record (its payments are subject to internal audit).
 The cost auditor should check that the wages record is satisfactory.

3. Audit of Overheads: Overhead refers to the ongoing costs of running a business such as
electric bills, gas, coal, rent, and salaries (excluding costs that are directly related to creating or
selling a product or service). The cost auditor should check the distribution of overhead
expenses for each department. Alongside this, the following actions should be taken into
consideration:

 Check whether expenditure is desirable from the production and sales perspectives.
 Ensure that expenses do not exceed the proportionate output.
 Check whether actual expenditure exceeds standard expenditure.
 Check plant capacity (i.e., whether full capacity is used).
 Check the method of depreciation to evaluate whether it is desirable.
 Calculate the daily plant expenditure.
 Check the plant's present position physically.
 Determine plant sales.

Q. Format of cost audit report

The format of a cost audit report may vary based on the industry, specific regulations, or the
company's requirements. However, here is a general structure that a cost audit report might
follow:

1. Title Page:
 - Report title (Cost Audit Report).
- Company name.
- Date of the report.
- Prepared by (name and position).

2. Table of Contents:
- A list of sections and subsections with corresponding page numbers.

3. Executive Summary:
- Brief overview highlighting key findings, conclusions, and recommendations.

4. **Introduction:**
- Background information about the audit purpose, scope, and objectives.
- Explanation of methodologies used in conducting the audit.

5. Audit Findings:
- Details of the audit findings categorized into sections such as:
- Cost Classification and Allocation.
- Cost Control Procedures.
- Costing Methods Used.
- Compliance with Regulatory Standards.
- Comparison with Industry Standards/Benchmarks.

6. Analysis and Interpretation:

- Detailed analysis of the findings.
- Explanation of any significant variations or discrepancies found.
- Identification of strengths and weaknesses in the cost structure.
7. Recommendations:
- Specific actionable suggestions to improve cost efficiency, control, or compliance.
- Suggestions for process improvements or corrective actions.

8. Conclusion:
- Summarization of the main points from the report.
- Emphasis on key takeaways and the overall significance of the audit findings.

9. Appendices:
- Supporting documents, charts, graphs, or additional data used in the analysis.
- Detailed breakdowns of cost calculations, if necessary.

10. References:
- Sources, frameworks, or standards referenced during the audit process.

11. Signatures:
- Sign-offs from the auditing team or responsible individuals validating the report's accuracy
and completeness.

Remember, this is a general guideline. The actual format and content of a cost audit report may
vary based on the industry, company policies, regulatory requirements, and the specific focus of
the audit. It's essential to tailor the report to meet the needs of the organization and the
intended audience.

Q. Cost audit vs Financial audit

Basis for Cost Audit Financial Audit
Comparison
Meaning Cost audit is an independent Financial audit is a systematic
 examination of the correctness of the unbiased examination of a company
cost statements and accounts and its or institution's finance books and
conformity with the cost accounting records, so as to express the opinion
plan. on it.
Audit Performed by a practicing Cost Performed by a practicing Chartered
Accountant. Accountant.
Appointment Board of Directors Shareholders
of auditor
Analyzes Cost records, cost statements and cost
Financial Statement, Books of
accounts. Accounts, Documents, Vouchers, etc.
Emphasis Analysis of the efficiency of operations
Compliance with the accounting
and propriety of actions of the standards and effectiveness of the
management. internal control system.
Compulsion Compulsory for all companies. Compulsory for the companies
engaged in the manufacturing
business.
Report To the Shareholders at the Annual To the Board of Directors at the
submission General Meeting of the company. Board Meeting, which is then
submitted to Central Government.

Q. Cost audit vs Management audit

Basis for Cost audit Management audit
Comparison
Meaning Cost Audit refers to the Management Audit implies a
comprehensive checking and complete examination of the
examination of the correctness of the company to appraise its policies,
cost statements, data, records and plans and structure of the
systems. management, to ascertain its
effectiveness.
Is it Yes, for certain classes of companies, No, it is not mandatory for
mandatory? it is mandatory to perform a cost companies to perform management
audit. audit.
Auditor's The person must be a practicing CMA. Any independent expert or
Qualification management consultant or internal
auditor of the company.
Periodicity It is conducted for every financial It is conducted for more than one
year. financial year.
Audit Report There is a prescribed time limit within No time limit for submission of the
Submission which the report should be management audit report.
submitted.
Accountability The auditor is accountable to the The auditor is accountable to the
shareholders and central company's management.
 government.
Objective To determine the reliability of costTo review management's efficiency,
information. so as to improve it.
Base Cost statements Managerial Activities
Audit Examines and analyses data of Identifies the adequacy and
Techniques material, labor and overheads. reliability of procedures and internal
control systems in operation.
Focuses on Accuracy of costing system and Appraisal of management policies
ascertainment of the actual cost of and activities.
production.