FOR

(CMA FINAL)

MOHIT
AGARWAL
 CONTENTS

1. BASICS OF COST AND MANAGEMENT AUDIT 01 - 06

2. COMPANIES Cost Records and Audit RULES 2014 As Amended Upto 15th October 2019 07 - 10

3. COST AUDIT DOCUMENTATION AND AUDIT PROCESS 11 - 14

4. COST AUDITOR PROFESSIONAL ETHICS, RESPONSIBILITIES AND PUNISHMENT 15 - 20

5. OVERVIEW OF COST ACCOUNTING STANDARDS AND GACAP 21 - 40

6. COST AUDITING AND ASSURANCE STANDARDS 41 - 46

7. COST AUDIT PROGRAMME 47 - 56

8. PREPARATION AND FILING OF COST AUDIT REPORT 57 - 60

9. MANAGEMENT REPORTING ISSUES UNDER COST AUDIT 61 - 66

10. BASICS OF MANAGEMENT AUDIT 67 - 74

11. MANAGEMENT AUDIT IN DIFFERENT FUNCTIONS 75 - 82

12. EVALUATION OF CORPORATE IMAGE 83 - 90

13. INTERNAL CONTROL, INTERNAL AUDIT UNDER THE COMPANIES ACT, 2013 AND OPERATIONAL AUDIT 91 - 128

14. AUDIT OF SERVICE ORGANISATIONS/INTERNAL AUDIT IN DIFFERENT SECTORS 129 - 154

15. ANALYSIS ON MANAGERIAL PERFORMANCE/CASE STUDIES ON PERFORMNACE ANALYSIS 155 -176

BASICS OF COST AND
MANAGEMENT AUDIT

01
Basics of Cost and Management Audit

Meaning of Cost Accounting

It is the process of identification , classification, measurement and assignment of cost to various

cost objects.

Meaning of Cost Audit

According to Chartered Ins tute of Cost Audit is independent examina on of cost

Management Accountants (London) statements, cos ng records and other related
Cost audit is the verifica on of informa on of an en ty with an objec ve to form
correctness of cost accounts and an independent opinion thereon. Cost Audit is
adherence to cost accoun ng plan. done by complying the standards on cost audit.
 Cost and Management Audit

Ensuring that costing

records have been
prepared by complying
Verification of cost accounts. costing rules. Detection of fraud and error.

Objective of Cost Audit

Facilitating fixation of price. Reconciliation Verification of cost allocated to

between costing and each cost unit and cost centre.
financial records.

Cost Accounting Standards

These are the standards which lays down costing rules to achieve uniformity and consistency in
cost accounting principles and practices. Institute of Cost Accountants of India has constituted Cost
Accounting Standard Board (CASB) for making cost accounting standards.

The Objectives of Cost Accounting Standards are:

Provides a structured approach

to cost ascertainment. Enables the cost auditors to
provide attestation services.

Promotes uniformity. Gives basis for computing cost of

product/ activity/ service.

Promotes harmonisation and

standardisation of costing practices.

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Utility/ Advantages of Cost

Enables the organisation to

structure its cost properly. Reduces manipulation and
detects the frauds and errors.

Improves organisation’s
Helps in both routine and non-
performance by reducing wastages.
routine decision making.

Improves efficiency and helps in

optimum utilisation of resources.

Eligibility criteria of Cost Auditor

Cost Auditor has to be a cost accountant. However, persons who are disqualified u/s 141(3) of The
Companies Act 2013 cannot become cost auditor.

DISQUALIFICATION OF AUDITOR U/S 141(3)

a. Body corporate except LLP.

(This is because law makers wanted guilty auditors to be personally liable which is not possible
in case of body corporate, so body corporate is disqualified.)

b. Officer or employee of company: Independence

c. Partner/employee of officer/employee of company: Independence

d. If a person is disqualified or his partner or relative.

(i) Holds shares in the company or its holding or its subsidiary or its associate or subsidiary
of holding (Fellow subsidiary).

Provided that relative may hold shares in the co. UPTO FACE VALUE not exceeding Rs 1000 or
such higher sum as may be prescribed (currently face value prescribed is Rs 1 lakh).
If relative is holding face value more than 1 lakh then corrective action to be taken within
60 days.

(ii) Indebted for an amount exceeding Rs 5 lakh in company/holding/ subsidiary/associate/

fellow subsidiary.

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 Cost and Management Audit

(iii) Given any guarantee or security to company/holding/ subsidiary/associate/ fellow

subsidiary more than Rs 1 lakhs for any third party.

e. A person/firm is disqualified if it has direct or indirect business relationship with company/

holding/ subsidiary/associate/fellow subsidiary.

f. A person is disqualified if his relative is either a director or in employment as a KMP of the

company.

g. A person/firm is disqualified to conduct more than 20 audits in a year.

h. A person is disqualified for 10 years from the date of conviction for an offence involving fraud and
imprisoned.

i. A person is disqualified if he renders services u/s 144 to company/holding/subsidiary.

Discuss ceiling limit.

Ceiling limit on the number of audits is 20 or partner who is not in full time employment elsewhere.

Example: A, B and C are partners in a CA firm

A B C
(In full me (Part me) (Is also a partner
employment = 0 + 20 + 8 (20-12) in another CA firm
elsewhere) having 12 audits in his
= 28 audits
name there)

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Following audits are not counted in ceiling limit

Branch audit Private company

having PUSC
less than 100 Cr
Tax audit (As per
ICAI’s notification its
limit is 60 per partner) Dormant company

Internal audit
Small company

OPC

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 Cost and Management Audit

NOTE

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Companies (Cost Records and Audit)
Rules 2014

02
COST AUDIT U/S 148

1. Meaning

It means auditing of cost records by a cost accountant (CMA in practice).

2. Applicability of If aggregate turnover of company (whether in regulated sector i.e., Type A or

maintaining cost unregulated sector i.e., Type B) in immediately preceeding financial year is
records minimum 35 crores.
 Cost and Management Audit

3. Applicability of cost audit

Regulated sector Unregulated sector

(Type A) (Type B)
Aggreagate turnover in Aggreagate turnover in
immediately preceeding immediately preceeding
financial year minimum 50 Cr financial year minimum 100 Cr
and from individual product and from individual product
minimum 25 Cr. minimum 35 Cr.

Power Petroleum Drugs

4. Type A i.e., Regulated Sector

Telecommunication Sugar Fertilizer

5. Type B i.e., Unregulated Sector Rest

6. Example Suppose A ltd is a petroleum company manufacturing three products

A, B and C whose turnover of immediately preceeding
financial year given below :-
Situations Cost Record Applicability Cost Audit Applicability
1. Products
A : 20 Cr
Yes No
B : 20 Cr
C : 20 Cr

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7. Cost Record are maintained in CRA 1.

Situations Cost Record Applicability Cost Audit Applicability
2. Products
A : 30 Cr
Yes No
B : 20 Cr
C : 20 Cr
3. Products
A : 30 Cr
B : 10 Cr Yes No
C : 5 Cr

8. Appointment of Cost Auditor

If Audit Committee (AC)

exists AC shall recommend If Audit Committee (AC)
the name of the cost done not exists
auditor. BOD shall appoint on its
own.
BOD shall appoint.

9. Remuneration of Cost Auditor

If Audit Committee (AC|) If Audit Committee (AC|)

exists AC will recommend. does not exists

BOD shall fix. BOD shall fix.

Shareholder shall approve. Shareholder shall approve.

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 Cost and Management Audit

10. Time limit of Appointment

Cost auditor shall be appointed within 180 days from the commencement of financial year
and company shall inform about its appointment in form CRA 2 to CG (ROC) within 30 days of
appointment or 180 days of commencement of financial year whichever is earlier.

11. Casual Vacancy

All the casual vacancy shall be filled up by BOD withinh 30 days of such casual vacancy and
company shall inform to CG (ROC) within 30 days of filling of such casual vacancy by submitting
Form CRA 2.

12. Removal of Cost Auditor

BOD may remove the cost auditor without any prior approval of CG.

13. Qualifications, Powers and Duties of Cost Auditor

Same as company auditor mutatis mutandis (with necessary changes).

14. Can company auditorbe appointed as Cost Auditor?

No

15. Can the internal auditor be appointed as cost auditor?

No

16. Time limit of completing Cost audit

Cost audit shall be completed within 180 days from the end of financial year and cost auditor
shall issue his cost audit report in Form CRA 3 to company and within 30 dyas company shall
along with explanation to adverse remarks if any submit to ROC in Form CRA 4.

17. Exemptions from Cost Audit : (No exemptions in cost record|)

Unit in SEZ Company whose Unit for cap ve

revenue from export consump on
in foreign exchange
more than 75%
of total revenue.

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COST AUDIT
DOCUMENTATION AND
AUDIT PROCESS

03
3 Stages of cost audit or overview of cost audit

Planning
1. Understanding the entity and its environment including internal environment
2. Risk identification and strategy.
3. Risk and materiality assessment

Performing
1. Audit execution
2. Audit procedures
3. Obtain audit evidences or audit findings.

Reporting
1. Audit conclusion
2. Issuing an audit report

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 Cost and Management Audit

Practical steps of audit process

Step 1 : Objective of Audit and management Outlook

Auditor should understand from management of the entity whether management is looking for a cost
audit just to satisfy the statutory requirement or also to fulfil other objectives like.

Cost Suggesting Suggesting

reduction product marketing
diversification strategies

Checking Define profit Complete

parameters of making and review of
operational loss making business
efficiency products strategies

Step 2 : Preconditions
1. Cost auditor should understand the following :-

Objective of Number of Reporting

cost audit. cost auditors period
appointed.

Area, nature Applicable Statutory

and scope of reporting deadlines.
cost audit. famework.

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2. Cost auditor should ensure that managment understands its responsibilities :-

To maintain To give To give

cost records. unrestricted access necessary.
to cost auditor
to its books and
persons.

To present cost To give additional To select an

statement. information is apply cost
required by cost accounting
auditor. principles.

3. Auditor and cost auditor should agree on audit fees and payment schedules and sign the
engagement letter.

Step 3 : Understanding the company’s in business (key inputs to make audit plan)
Cost auditor before making an audit plan should understand the following relating to company’s
business :-
1. Nature of companies activities, ownership and management structure.
2. Nature of industry in which it operates.
3. Applicable reporting framework.
4. Companies production process.
5. Details of subsidiaries, associates and joint ventures.
6. Purchase and sales policy.
7. Inventory Policy.
8. Internal Control system.
9. Internal audito system.
10. Previous year’s audit report.

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 Cost and Management Audit

Step 4 : Planning the audit

Audit plan should include the following
1. Timings (dates) and duration (number of days) of audit.
2. Level and number of audit personnel required.
3. Determining the audit engagement partner.
4. Deciding materiality level.
5. Drawing and overall audit plan and strategy.
6. Formulating audit procedures like.
7. Formulating risk assessment procedures.

Formulating audit procedures like

Test of Test of details Analytical Management Assertion

controls procedures representation

Step 5 : Executing the audit

Performing the Collecting the audit Preparing Preparing final

audit procedures as evidences and draft audit and audit report.
planned. checking. discussion.

Relevance and Sufficiency and Source of such

reliability evidences

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Cost Auditor Professional
Ethics, Responsibilities and
Punishment

04

COST AUDITOR – DEFINITION

“Cost auditor” means a Cost Accountant in practice
 Cost and Management Audit

Code of Professional Ethics

The objectives of the accountancy profession require four basic needs to be met :
(a) Credibility in information and information systems;
(b) Professionalism identified by employers, clients and other interested parties;
(c) Quality of service carried out to the highest standards of performance; and
(d) Confidence
Cost accountants have to observe fundamental principles, which are :
(a) Integrity - A cost accountant should be straightforward and honest in performaing his services.
(b) Objectivity
(c) Competence
(d) Confidentiality
(e) Professional Behaviour

Duties of a Cost Auditor to Report Fraud – (Section 143 of the Companies Act, 2013)
(i) According to Section 143(12) of the Companies Act 2013, if an auditor of a company, has reason
to believe that an offence involving fraud is being or has been committed against the company
by officers or employees of the company, he shall immediately report the matter to the Central
Government within such time and in such manner as may be prescribed.
(ii) Sub-Section specifies that no duty to which an auditor of a company may be subject to shall be
regarded as having been contravened by reason of his reporting the matter referred to in sub-
section (12) if it is done in good faith.
(iii) Sub-Section 14 makes it clear that the provisions of this section shall mutatis mutandis apply to
the cost accountant in practice conducting cost audit under section 148.
(iv) According to Sub-Section 15 if any auditor, cost accountant or company secretary in practice do
not comply with the provisions of sub-section (12), he shall be punishable with fine which shall
not be less than one lakh rupees but which may extend to twenty-five lakh rupees.
(v) Matter are required to be reported immediately but not later than 2 days of his knowledge
specifying:
(a) Nature of Fraud with description;
(b) Approximate amount involved; and
(c) |Parties involved.
(vi) Following disclosures are required to be made in Board’s Report :
(a) Nature of Fraud with description;
(b) Approximate Amount involved;
(c) Parties involved, if remedial action not taken; and
(d) Remedial actions taken

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Professional and Other Misconducts

The First Schedule
Part I
Professional Misconduct in Relation to Cost Accountants in Practice
A cost accountant in practice shall be deemed to be guilty of professional misconduct, if he :-
(1) allows any person to practice in his name as a cost accountant unless such person is also a cost
accountant in practice and is in partnership with or employed by himself;
(2) Pays or allows or agrees to pay or allow, directly or indirectly, any share, commission or brokerage
in the fees or profits of his professional work, to any person other than a member of the Institute
or a partner or a retired partner or the legal representative of a deceased partner.
“Partner” includes a person residing outside India with whom a cost accountant in practice has
entered into partnership.
(3) accepts or agrees to accept any part of the profits of the professional work of a person who is not
a member of the Institute :
Provided that nothing herein contained shall be contrued as prohibiting a member from entering
into profit sharing or other similar arrangements, including receiving any share, commission
or brokerage in the fees, with a member of such professional body or other person having
qualifications, as is referred to in item (2) of this Part;
(4) enters into partnership, in or outside India, with any person other than a cost accountant in
practice or such other person who is a member of any other professional body having such
qualifications as may be prescribed.
(5) Secures, either through the services of a person who is not an employee of such cost accountant
or who is not his partner or by means which are not open to a cost accountant, any professional
business :
(6) Solicits clients or professional work, either directly or indirectly, by circular, advertisement,
personal communication or interview or by any other means :
Provided that nothing herein contained shall be construed as preventing or prohibiting -
(i) Any cost accountant from applying or requesting for or inviting or securing professional work
from another cost accountant in practice;
(ii) A member from responding to tenders or enquiries issued by various users of professional
services or organisations from time to time and securing professional work as a consequence;
(7) Advertises his professional attainments or services, or uses any designation or expressions other
than cost accountant on professional documents, visiting cards, letter heads or sign boards,
unless it be a degree of a University established by law in India or recognised by the Central
Government or a title indicating membership of the [Institute of Cost Accountants of India] or of
any other institution that has been recognied by the Central Government.

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 Cost and Management Audit

Part II
Professional Misconduct in Relation to Members of the Institute in Service
A member of the Institute (other than a member in practice) shall be deemed to be guilty of professional
misconduct, if he being an employee of any company, firm or person –
(1) Pays or allows or agrees to pay, directly or indirectly, to any person any share in the emoluments
of the employment undertaken by him;
(2) Accepts or agrees to accept any part of fees, profit or gains from a lawyer, a cost accountant or
broker engaged by such company, firm or person or agent or customer of such company, firm or
person by way of commission or gratification.
Part III
Professional Misconduct in Relation to Members of the Institute Generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional
misconduct, if he –
(1) not being a fellow of the Institute acts as a fellow of the Institute;
(2) does not supply the information called for, or does not comply with the requirements asked
for by the Institute, Council or any of its Committees, Director (Discipline), Board of Discipline,
Disciplinary Committee, Quality Review Board or the Appellate Authority;
(3) while inviting professional work from another cost accountant or while responding to tenders or
enquiries or while advertising through a write up, or anything as provided for in items (6) and (7)
of Part I of this Schedule, gives information knowing it to be false.
Part IV
Other Misconduct in Relation to Members of the Institute Generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of other misconduct,
if he –
(1) He is held guilty by any civil or criminal court for an offence which is punishable with Imprisonment
for a term not exceeding six months;
(2) In the opinion of the Council he brings disrepute to the profession or the Institute as a result of
his action whether or not related to his professional work.
THE SECOND SCHEDULE
Part I
Professional Misconduct In Relation To Cost Accountants In Practice
A cost accountant in practice shall be deemed to be guilty of professional misconduct, if he:—
(1) discloses information acquired in the course of his professional engagement to any person other
than his client so engaging him, without the consent of his client, or otherwise than as required
by any law for the time being in force;
(2) certifies or submits in his name, or in the name of his firm, a report of an examination of cost
accounting and related statements unless the examination of such statements has been made by
him or by a partner or an employee in his firm or by another cost accountant in practice;

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(3) permits his name or the name of his firm to be used in connection with an estimate of cost or
earnings contingent upon future transactions in a manner which may lead to the belief that he
vouches for the accuracy of the forecast;
(4) expresses his opinion on cost or pricing statements of any business or enterprise in which he, his
firm or a partner in his firm has a substantial interest;
(5) fails to disclose a material fact known to him in a cost or pricing statement, which is not disclosed
in a cost or pricing statement but disclosure of which is necessary in making such statement
where he is concerned with such statement in a professional capacity;
(6) fails to report a material mis-statement known to him to appear in a cost or pricing statement
with which he is concerned in a professional capacity;
(7) does not exercise due diligence, or is grossly negligent in the conduct of his professional duties;
(8) fails to obtain sufficient information which is necessary for expression of an opinion
(9) fails to invite attention to any material departure from the generally accepted procedure of
costing and pricing applicable to the circumstances;
(10) fails to keep moneys of his client other than fees or remuneration or money meant to be expended
in a separate banking account or to use such moneys for purposes for which they are intended
within a reasonable time.
PART II
PROFESSIONAL MISCONDUCT IN RELATION TO MEMBERS OF THE INSTITUTE GENERALLY
A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional
misconduct, if he-
(1) contravenes any of the provisions of this Act or the regulations
(2) being an employee of any company, firm or person, discloses confidential information acquired
in the course of his employment, except as and when required by any law for the time being in
force or except as permitted by the employer;
(3) includes in any information, statement, return or form to be submitted to the Institute, Council or
any of its Committees, Director (Discipline), Board of Discipline, Disciplinary Committee, Quality
Review Board or the Appellate Authority any particulars knowing them to be false;
(4) defalcates or embezzles moneys received in his professional capacity.
Part III
Other Misconduct In Relation To Members Of The Institute Generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of other misconduct,
if he is held guilty by any civil or criminal court for an offence which is punishable with imprisonment
for a term exceeding six months.

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 Cost and Management Audit

Penalties Under The Act

Section 24 of the CWA Act, 1959: Penalty for falsely claiming to be a member, etc. Any person who,-
(i) not being a member of the Institute-
(a) represents that he is a member of the Institute; or
(b) uses the designation cost accountant; or
(ii) being a member of the Institute, but not having a certificate of practice, represents that he is in
practice or practices as a cost accountant, shall be punishable on first conviction with fine which
may extend to one thousand rupees, and on any subsequent conviction with imprisonment which
may extend to six months, or with fine which may extend to five thousand rupees, or with both.

Section 25 of the CWA Act, 1959: Penalty for using name of the Council, awarding degrees of cost
accountancy, etc.
(1) No person shall –
(i) use a name or a common seal which is identical with the name or the common seal of the
Institute or so nearly resembles it as to deceive or as is likely to deceive the public;
(ii) award any degree, diploma or certificate or bestow any designation which indicates or
purports to indicate the position or attainment of any qualification or competence in cost
accountancy similar to that of a member of the Institute; or
(iii) seek to regulate in any manner whatsoever the profession of [cost accountants.]
(2) First conviction with fine which may extend to one thousand rupees, and on any subsequent
conviction with imprisonment which may extend to six months, or with fine which may extend to
five thousand rupees, or with both.

Section 26 of the CWA Act, 1959: Companies not to engage in cost accountancy.
(1) No company, whether incorporated in India or elsewhere, shall practice as cost accountants.
(2) Any contravention of the provisions shall be punishable on first conviction with fine which may
extend to one thousand rupees, and on any subsequent conviction to five thousand rupees.

Unqualified persons not to sign documents

(1) No person other than a member of the Institute shall sign any document on behalf of a cost
accountant in practice
(2) Any person who contravenes the provisions without prejudice to any other proceedings which
may be taken against him, be punishable on first conviction with a fine not less than five thousand
rupees but which may extend to one lakh rupees, and in the event of a second or subsequent
conviction with imprisonment for a term which may extend to one year or with a fine not less
than ten thousand rupees but which may extend to two lakh rupees or with both.

Section 29 of the CWA Act, 1959: Sanction to prosecute.

• No person shall be prosecuted under this Act except on a complaint made by or under the order
of the Council or of the Central Government.

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OVERVIEW OF
COST ACCOUNTING
STANDARDS AND GACAP

05

COST ACCOUNTING STANDARDS

Defini on:
Cost Accoun ng Standards are guidelines for the companies [for the management] that specify the
cost accoun ng treatment for various cost elements, minimum disclosure requirements and ensure the
comparability, consistency, and completeness of cost records. These standards are designed to achieve
uniformity and consistency in cost accoun ng principles and prac ces.
The Ins tute of Cost Accountants of India, recognizing the need for structured approach to
the measurement of cost in manufacture or service sector and to provide guidance to the user
organiza ons, government bodies, regulators, research agencies and academic ins tu ons to achieve
uniformity and consistency in classifica on, measurement and assignment of cost to product and
services, has cons tuted Cost Accoun ng Standards Board (CASB) with the objec ve of formula ng
the Cost Accoun ng Standards. Keeping in view latest legal and contemporary developments, the Cost
Accoun ng Standards Board develops Cost Accoun ng Standards.
 Cost and Management Audit

UTILITIES OF COST ACCOUNTING STANDARDS

The Cost Accoun ng Standards:
(i) provide a structured approach to measurement of costs in manufacturing process or service
industry;
(ii) integrate, harmonize, and standardize cost accoun ng principles and prac ces;
(iii) provide guidance to users to achieve uniformity and consistency in classifica on, measurement,
assignment, and alloca on of costs to products and services;
(iv) arrive at the basis of compu ng the cost of product, ac vity, or service where required by legal or
regulatory bodies;
(v) enable prac cing members to make use of Cost Accoun ng Standards in the a esta on of General
Purpose Cost statements; and
(vi) assist in clear and uniform understanding of all the related issues by various user organiza ons,
Government Bodies, regulators, research agencies, and academic ins tu ons.
LIST OF COST ACCOUNTING STANDARDS [CASs]
The structure of Cost Accoun ng Standard consists of Introduc on, Objec ves of issuing standards,
Scope of standard, Defini ons and explana ons of the terms used in the standard, Principles of
Measurement, Assignment of Cost, Presenta on and Disclosure.
So far, the Ins tute has released 24 Cost Accoun ng Standards [CASs].
GUIDANCE NOTES ON COST ACCOUNTING STANDARDS
The Ins tute had issued guidance notes on the Cost Accoun ng standards, from me to me, making it
more explicit to understand the standards and for be er applica on of the same in the record keeping
and audit procedures. Normally the guidance notes are greatly required in the respect of the standards
dealing with specific elements of cost, they may also be issued in respect of specific purpose standards
also.
The Guidance Notes deals with principles and methods as provided in the respec ve CASand prac cal
aspects in connec on with the subject ma er of that CAS, as applicable in the determina on of material
cost of a product or service etc. So far the Ins tute has issue 13 Guidance Notes on various issues.
SI. Title
No.
1. Guidance Note on CAS-2 (Revised 2015) Capacity Determina on
2. Revised Guidance Note on Cost Accoun ng Standard on Cost of Produc on for Cap ve
Consump on (CAS-4)
3. Guidance Note on Cost Accoun ng Standard Material Cost (CAS-6)
4. Guidance Note on Cost Accoun ng Standard on Employee Cost (CAS-7)
5. Guidance Note on Cost Accoun ng Standard on Cost of U li es (CAS-8).
6. Guidance Note on Cost Accoun ng Standard on Packing Material Cost (CAS-9)
7. Guidance Note on Cost Accoun ng Standard on Direct Expenses (CAS-10).

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SI. Title
No.
8. Guidance Note on Cost Accoun ng Standard on Administra ve Overheads (CAS-11).
9. Guidance Note on Cost Accoun ng Standard on Repairs and Maintenance Cost (CAS-12).
10. Guidance Note on Maintenance of Cost Accoun ng Records for Construc on Industry Including
Real Estate and Property Development Ac vity
11. Guidance Note on Treatment of Costs Rela ng to Corporate Social Responsibility (CSR) Ac vi es
12. Guidance Note on Cost Accoun ng Standard on Cost of Service Cost Center (CAS-13)
13. Guidance Note on Compila on Engagements by a Cost Accountant
These Guidance Notes explain in detail and clarifies on the various requirements of compliance of the
relevant standards and will have the sec ons of introduc on, scope, defini ons and then the specific
guidance on the treatment and disclosure aspects. Students are advised, like in the case of standards,
to thoroughly go through all the guidance notes on standards, issued by the Ins tute for be er
understanding of the standards and their compliance.
The guidance notes on the standards dealing with specific elements of cost will normally have the
following Chapters / sec ons, elabora ng the contents of the respec ve CAS, in the same logical
sequence, as in the standard:
1. Introduc on
2. Defini ons
3. Principles of Measurement
4. Assignment of Cost
5. Presenta on
6. Disclosures and
7. Annexures, as the need may be.
GENERALLY ACCEPTED COST ACCOUNTING PRINCIPLES (GACAP)
Introduc on
The compila on of Generally Accepted Cost Accoun ng Principles (GACAP) by the Ins tute of Cost
Accountants of India is a unique effort to record principles and prac ces in the discipline of Cost
Accountancy in India.
The Expert Group cons tuted by the Ministry of Corporate Affairs acknowledged the existence of an
un-codified set of generally accepted cost accoun ng principles in use in Indian industries and by the
prac cing cost accountants for a esta on of Cost Statements. The Expert Group suggested that the
principles be codified to provide a formal basis for the prac ce of Cost Accoun ng. The Expert Group
also recommended review of alternate treatment of items in cost accoun ng thus elimina ng needless
diversi es in prac ce leading to the development of cost accoun ng standards.
The Ministry of Corporate Affairs decided to implement the recommenda ons of the Expert Group
and no fied the Companies (Cost Records and Audit) Rules, 2014 on 30th June, 2014. These Rules
introduced a common set of record rules for industries other than regulated industries specified in the
Rules, in place of industry specific rules in vogue earlier. The Rules require every company to which
the rules apply, including all units and branches thereof, to keep cost records in respect of each of its

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 Cost and Management Audit

products and ac vi es on regular basis. The cost records are to be maintained in accordance with the
generally accepted cost accoun ng principles and cost accoun ng standards issued by the Ins tute of
Cost Accountants of India to the extent these are found to be relevant and applicable. The varia ons, if
any, are to be clearly indicated and explained.
GACAP, the Companies (Cost Records and Audit) Rules, 2014 require maintenance of cost records
according to GACAP and Cost Accoun ng Standards gave the mandate for a compila on of GACAP.
Objec ves
The objec ves of this document are:
1. to codify the GACAP as applied in the Indian industry;
2. to narrow down diversi es in cost accoun ng prac ces facilita ng the process of development of
cost accoun ng standards;
3. to provide a reference source to industry and prac oners in prepara on and a esta on of Cost
Statements, where specific cost accoun ng standards are yet to be issued;
4. to provide a reference source to all the stakeholders in the understanding and interpre ng the cost
statement; and,
5. to provide a base for monitoring the evolu on of new concepts and prac ces in cost accoun ng and
to codify them as and when they become generally accepted.
Scope
The scope is to codify the cost accoun ng principles to be followed by business and other en es in India
in preparing and presen ng cost informa on – more par cularly the General Purpose Cost Statements
covered by Cost Audit. This document also encompasses the generally accepted cost accoun ng
prac ces presently being followed by such en es.
Nature of Content and Format
1. This document tled Generally Accepted Cost Accoun ng Principles (GACAP) contains a summary
of the Cost accoun ng principles currently followed by business en es in India in preparing
and presen ng cost informa on in the context of general purpose cost statements for statutory
repor ng and covered by Cost Audit.
2. It explicitly incorporates the principles already contained in the Cost Accoun ng Standards 1-24
issued by the Cost Accoun ng Standards Board (CASB) in India without necessarily repea ng them.
3. In areas not covered by the standards, it reflects the cost accoun ng principles found in the
Companies (Cost Records and Audit) Rules, 2014.
4. Where somewhat conflic ng principles have been laid down by the Companies (Cost Records and
Audit) Rules, 2014 in different industries, a empt has been made to harmonize the principles so as
to evolve a generally acceptable framework. Where use of alternate principles are sanc oned by
the Rules or where alternate principles are applied in prac ce in the absence of explicit guidance in
Rules, the alternates have been men oned with an indica on of the preferred prac ce.
5. Because the Rules were framed at different points of me spread over many years, it is likely
that the principles contained in the Rules and the prac ce based on them do not reflect current
concepts. In such cases, the document reflects the current concepts.

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6. It also reflects the Cost Accoun ng Principles contained in the Guidance Notes and other publica ons
issued by ICAI from me to me.
7. Cost Accoun ng principles which are gathering wide spread acceptance in Indian Companies for
management repor ng, even though not adopted for statutory cost repor ng (for example, Ac vity
Based Cos ng),are men oned with suitable caveats regarding their lack of applicability for general
purpose cost statements for statutory repor ng, where applicable.
8. The document s pulates the main principles in bold le ers followed by explana on in normal type.
Conceptual Frame Work
There is a need for a conceptual frame work that underlies the GACAP detailed in the succeeding
sec ons. The conceptual frame work, as the name suggests, is a frame work and not a superset of cost
accoun ng principles. It does not a empt to lay down a principle for any par cular cos ng issue or to
amplify the GACAP. The frame work helps to understand the GACAP that follow, in the appropriate
perspec ve and guides in modifying them or developing new principles;
(a) Focus on drivers of value
Cos ng is necessary for an informed understanding of the organiza onal drivers of cost, revenue,
profits and value. Cos ng has to fulfil this role both in a historical and in a forward looking context.
(b) Cost for a purpose
Over a long me it has been recognized that there is a cost concept relevant for a purpose. Thus
external repor ng requires historical and full absorp on cos ng while performance evalua on
requires a en on direc ng and diagnos c informa on; planning and decision making requires
analy cal and predic ve informa on. It is, therefore, not possible for the same set of cost data to
fit all purposes, thereby resul ng in a wide range of cost concepts from which preparers and users
of cost informa on choose a concept relevant to the purpose.
(c) Reality driven
Cost models must reflect the en ty’s business model, its opera onal processes, its strategy, its
organiza onal structure and its compe ve environment. Organiza onal processes and ac vi es
drive the costs and these are in turn influenced by other factors men oned above.
(d) Materiality and cost effec veness
The selec on of the methods of implemen ng the cos ng principles should have regard to the
issues of materiality and cost effec veness. Materiality of cost informa on is to be judged from
the perspec ve of the user of that informa on. The degree of detail and accuracy required are
governed by the perspec ve of materiality. From the preparers’ viewpoint there is the need to
balance the cost of maintaining a cost accoun ng system with corresponding benefits. This is the
reason why in a number of places, while dealing with methods of implemen ng cost accoun ng
principles, the expression “economically feasible way” has been used in this document.
Hence, for prepara on and disclosure of cost informa on, one is required to judge the materiality
aspect in conjunc on with economic feasibility of maintaining such data and informa on. For
example, maintenance of product/ac vity-wise cost details for each of the ancillary product or
ac vity of an en ty would neither be material nor economically feasible.

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 Cost and Management Audit

Any product or ac vity of an en ty which is incidental to its main opera ons and does not cons tute
its main line of business and whose total turnover from the sale/supply of such product or ac vity
does not exceed 2% of the total turnover of the en ty or ` 20 crores, whichever is lower, should be
treated as an ancillary product or ac vity.
(e) Comparability and consistency
Cost informa on should be prepared and presented in a way which provides for comparability over
me and consistency. The methods used for preparing and presen ng cost informa on should be
changed only where for valid reasons such as those required by law, compliance with new cost
accoun ng standards or on the ground that it would result in a more appropriate presenta on of
cost informa on.
(f) Transparency and auditability
Since cost informa on is used generally by various stakeholders like management, regulators and
Government with a business outlook, there is a need for transparency regarding the defini ons
used and sources of data. It should be possible for those who wish to review such cost informa on
to follow an audit trail. Auditability of cost informa on is a prerequisite to the effec ve use of such
informa on.
PRINCIPLES APPLICABLE TO ELEMENTS OF COST
The compila on of Generally Accepted Cost Accoun ng Principles (GACAP) by the Ins tute of Cost
Accountants of India is a unique effort to record principles and prac ces in the discipline of Cost
Accountancy in India.
The following sec on deal with GACAP applicable to individual elements of cost.
Before proceeding with element-wise principles, it is useful to summarise the principles applicable to
all elements of cost.
1. When an element of cost is accounted at standard cost, variances due to normal reasons are treated
as a part of the element-wise cost. Variances due to abnormal reasons will not form part of the cost.
2. Any Subsidy/Grant/Incen ve and any such payment received/receivable with respect to the input
cost is reduced from cost for ascertainment of the cost of the cost object to which such amount
pertains.
3. Any abnormal cost where it is material and quan fiable will not form part of the cost.
4. Penal es, damages paid to statutory authori es or other third par es will not form part of the cost.
5. Costs reported under various elements of cost will not include imputed costs.
6. Finance costs incurred in connec on with acquisi on of resources such as materials, u li es and
the like will not form part of the cost of such resources.
7. Any credits or recoveries from employees or suppliers or other par es towards costs incurred by
the en ty for a resource will be ne ed against such costs.
8. Except otherwise stated, the measurement of costs for cost accoun ng purposes will follow the
same principles as set out in Generally Accepted Accoun ng Principles, applicable to the concerned
en ty.

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MATERIAL COST
1. Material Cost usually includes all costs required to bring the materials to the present condi on and
loca on.
2. Material receipt is valued at purchase price including du es and taxes, freight inwards, insurance,
and other expenditure directly a ributable to procurement (net of trade discounts, rebates, taxes
and du es refundable or to be credited by the taxing authori es) that can be quan fied with
reasonable accuracy at the me of acquisi on.
3. Procurement costs are not generally included in material cost. However, those costs which can be
directly iden fied with a material are included in the material cost.
4. Development expenses incurred in respect of materials procured is included in the cost of material
to the extent that the material procured is the result of such developments.
5. Where a material is acquired in exchange for other materials or services supplied, the cost of
material acquired is taken as the cost of material supplied or services provided plus other applicable
costs such as freight.
6. Normal loss or spoilage of material prior to reaching the factory or at places where the services are
provided is absorbed in the cost of balance of materials net of amounts recoverable from suppliers,
insurers, carriers or recoveries from disposal.
7. Losses due to shrinkage or evapora on and gain due to elonga on or absorp on of moisture etc.,
before the material is received is absorbed in material cost to the extent they are normal, with
corresponding adjustment in the quan ty.
8. Where the material procured represents an agricultural produce from own sources, the same is
valued at market price or cost where it can be determined with reasonable accuracy.
9. The forex component of imported material cost is converted at the rate on the date of the
transac on. Any subsequent change in the exchange rate ll payment or otherwise will not form
part of the material cost.
10. Self Manufactured Materials (and Self manufactured components and sub assemblies) are valued
at cost including Direct Material Cost, Direct Employee Cost, Direct Expenses, Factory Overheads
and share of Administra ve Overheads rela ng to produc on. Share of other Administra ve
Overheads, Finance Cost and Marke ng Overheads are excluded.
11. The material cost of normal scrap/defec ves, which are rejects, is included in the material cost of
goods manufactured. This cost not exceeding the normal is adjusted in the material cost of good
produc on. Material cost of abnormal scrap/defec ves should not be included in the material cost,
but treated as loss a er giving credit to the realizable value of such scrap/defec ves.
12. Issues of materials are valued using appropriate assump ons on cost flow.
Examples are FIFO, LIFO, and Weighted Average rate.
13. Material Costs are assigned to cost objects on the basis of material quan ty consumed where
traceable and where not traceable on technical norms or es mates.
14. When material is processed or part manufactured by a third party according to specifica ons
provided by the buyer, the processing/ manufacturing charges payable to the third party is treated
as part of the material cost.

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 Cost and Management Audit

15. When the part of the manufacturing opera ons/ac vity is subcontracted, the subcontract charges
related to materials is treated as direct expenses and assigned directly to the cost object.
16. Cost of materials like catalysts, dies, tools, pa erns etc., which are relatable to produc on over a
period of me, is amor zed over the produc on units benefited by such cost. Cost of materials with
life exceeding one year is included in the cost over the useful life of the material.
17. Where the cost of materials is wri en off or wri en down in the financial books as per the accoun ng
policy followed by the en ty, such write off or write down amount is not treated as cost.
18. When the material referred to in paragraph 17 above, is subsequently issued, the issue is valued
at the original cost in cost accoun ng records and the difference between the original cost and the
carrying amount is presented in the reconcilia on statement, wherever, economically feasible.
EMPLOYEE COST
1. Employee cost or Labour cost is ascertained taking into account the gross pay including all allowances
payable along with the cost to the employer of all benefits.
2. Bonus, whether payable as a statutory minimum or on a sharing of surplus and Ex gra a payable in
lieu of or in addi on to Bonus is treated as part of the employee cost.
3. Remunera on payable to Managerial Personnel including Execu ve Directors on the Board and
other officers of a corporate body under a statute is considered as part of the Employee Cost of the
year under reference whether the whole or part of the remunera on is computed as a percentage
of profits.
4. Performance Incen ves must be accumulated over the en re produc on and not recognised a er
the threshold limit for earning the incen ve is reached.
5. Separa on costs related to voluntary re rement, retrenchment, termina on etc. should be
amor zed over the period benefi ng from such costs.
6. Amount payable to employees during the lay off period or for the strike period or during suspension,
is not included in cost.
7. Cost of employee share op ons is treated part of employee cost provided the same is not a no onal
cost and involves an actual cash outlay.
8. Gratuity, pension and other superannua on benefits, measured using actuarial valua on method
or any other methods, are part of Employee Cost.
9. Amor zed separa on costs related to voluntary re rement, retrenchment, and termina on etc. for
the period is treated as indirect cost and assigned to the cost objects. Unamor zed amount rela ng
to discon nued opera ons should not be treated as employee cost.
10. Recruitment costs, Training costs and other such costs is treated as overheads and dealt with
accordingly.
11. Over me premium and idle me cost should be assigned directly to a cost object or treated as
overheads depending on the economic feasibility and the specific circumstance requiring such
over me or idle me.
12. Where the employee service is directly traceable to a Cost object, such cost is assigned on the basis
of me consumed.

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13. When employee costs are not directly traceable to a Cost object, they are assigned on a suitable
basis like es mates of me based on me study.
DIRECT EXPENSES
1. The iden fica on of Direct Expenses is based on traceability in an economically feasible manner.
2. Similarly if an item of the expense does not meet the test of materiality, it can be treated as part of
overheads.
3. Expenses incurred for the use of bought out resources are determined at invoice or agreed
price including du es and taxes, and other expenditure directly a ributable thereto net of trade
discounts, rebates, taxes and du es refundable or to be credited.
4. Other Direct Expenses other than those referred above are determined on the basis of amount
incurred in connec on therewith.
5. Expenses paid or incurred in lump sum or which is in the nature of ‘one- me’ payment, is amor zed
on the basis of the es mated output or benefit to be derived from such expenses.
6. Direct Expenses are by defini on directly traceable to cost objects and hence no special principles
are involved for them to be assigned to cost object.
UTILITIES
1. The cost of u li es purchased is measured at cost of purchase including du es and taxes,
transporta on cost, insurance and other expenditure directly a ributable to procurement (net of
trade discounts, rebates, taxes and du es refundable or to be credited.
2. The cost of generated u li es includes direct materials, direct labour, direct expenses and factory
overheads.
3. Cost of U li es generated for the purpose of inter unit transfers is arrived as Cost of self generated
u li es with Distribu on cost added.
4. Cost of U li es generated for Intercompany transfer is arrived as Cost of self generated u li es
plus Distribu on cost plus share of administra ve overheads.
5. Cost of U li es generated for sale to outside par es is arrived as Cost of self generated u li es plus
Distribu on cost plus share of administra ve overheads plus marke ng overheads.
6. The Cost of U li es includes Cost of distribu on of such u li es.
7. Cost of produc on and distribu on of u li es is determined based on the normal or actual capacity
whichever is higher and unabsorbed cost, if any, is treated as abnormal cost.
8. Cost of stand by u lity includes the commi ed costs of maintaining such u lity.
9. While assigning cost of u li es, traceability to a cost object in an economically feasible manner is
the guiding principle.
10. The most appropriate basis for distribu on of cost of a u lity to the departments consuming
services is to be derived from usage parameters.

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 Cost and Management Audit

REPAIRS AND MAINTENANCE COST

1. The cost of Repairs and Maintenance is the aggregate of direct and indirect cost rela ng to repairs
and maintenance ac vity.
2. Cost of in-house Repairs and Maintenance ac vity will include cost of materials, consumable stores,
spares, manpower, equipment usage, u li es and other resources used in the ac vity.
3. Cost of Repairs and Maintenance ac vity carried out by outside contractors inside the en ty will
include the charges payable to the contractor apart from the above in-house cost.
4. Cost of Repairs and Maintenance ac vity carried out by contractors at his premises is determined
at invoice or agreed price including du es and taxes and other expenditure directly a ributable net
of discounts (other than cash discount), taxes and du es refundable or to be credited. It will also
include the cost of other resources provided to the contractors.
5. Each type of Repairs and Maintenance is treated as a dis nct ac vity, if material and iden fiable.
6. The cost is measured for each major asset category separately.
7. Cost of spares replaced which do not enhance the future economic benefits of the exis ng asset
beyond its previously assessed standard of performance is included under Repairs and Maintenance
cost, when Repairs and Maintenance is considered as a separate cost centre, the cost of which is
appor oned to user centres.
8. Where a high value spare is replaced, and the replaced spare is recondi oned and such spare is
expected to result in future economic benefits, it is taken into stock. Such a spare is valued at an
amount that measures its service poten al in rela on to a new spare, the amount of which will not
exceed the cost of recondi oning the spare. The difference between the total of the cost of the new
spare and the recondi oning cost and the value of the recondi oned spare should be treated as
Repairs and Maintenance cost.
9. Cost of major overhaul is amor zed on a ra onal basis.
10. Repairs and Maintenance cost is traced to a cost object to the extent economically feasible.
11. Where the Repairs and Maintenance cost is not directly traceable, it is assigned based on either of
the principles of Cause and Effect or Benefits Received.
PRODUCTION OVERHEADS
1. Overheads comprise of indirect material cost, indirect employee cost and indirect expenses. They
are termed indirect because they are not directly iden fiable or allocable to the ul mate cost object
– usually a product or service – in an economically feasible way.
2. Produc on Overheads are indirect costs involved in the produc on process or in rendering
services. Produc on Overheads include administra on cost rela ng to produc on, factory, works
or manufacturing. Produc on related expenses incurred at corporate office, e.g. design office
expenses, materials management and industrial rela ons will also be covered by the term.
3. The terms Produc on Overheads, Factory Overheads, Works Overheads and Manufacturing
Overheads denote the same meaning and are used interchangeably.
4. Since overheads cannot be economically traced to products and services, they are assigned to them
on some equitable basis.

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5. While assigning overheads, traceability to a cost object in an economically feasible manner shall
be the guiding principle. The cost which can be traced directly to a cost object shall be directly
assigned.
6. Assignment of overheads to the cost objects shall be based on either of the following two principles;
(i) Cause and Effect – Cause is the process or opera on or ac vity and effect is the incurrence of
cost.
(ii) Benefits Received –Overheads are to be appor oned to the various cost objects in propor on
to the benefits received by them.
7. Secondary assignment of overheads may be done by following either Reciprocal Basis or Non-
Reciprocal Basis. While reciprocal basis considers the exchange of service among the service
departments, non- reciprocal basis considers only one direc onal service flow from a service cost
centre to other produc on cost(s).
8. It is not a good prac ce to allocate overheads to Cost Centres/ Cost Objects on the basis of “what
the traffic will bear” – that is by size of the user.
9. There is a dis nct preference for alloca ng overheads on the basis of “cause and effect” analysis.
What or who causes the costs to be incurred is a more ra onal criterion to assign costs rather than
size or benefits received.
10. In case of facili es created on a standby or ready to serve basis, the cost shall be assigned on the
basis of expected benefits instead of actual.
11. Produc on Overheads are usually accumulated under produc on cost centres to facilitate
absorp on by products or services.
12. These costs are absorbed by the products on the basis of resources used by the product at the
produc on centre.
13. The overheads assigned to the produc on cost centres are charged to products/ services through
an overhead absorp on rate for each cost centre.
Common bases for assignment of Produc on overheads to Cost Objects are:
Bases of denominator Applicability
Unit of Produc on When single product is produced or various products are
similar in specifica ons.
Material Cost Where the overheads are mostly related to material.
Direct employee cost When conversion process is labour intensive and wage
rates are substan ally uniform
Direct employee hour When conversion process is labour intensive
Machine Hour or Vessel Occupancy or When produc on mainly depends on performance of the
Reac on Hour or Crushing Hour etc. base
A preferred approach for assignment of overheads to cost objects is to use mul ple drivers instead
of a single driver such as machine hour, where feasible.
14. A preferred approach to assignment of overheads is the assigning of cost of resources to ac vi es
and assigning the cost of ac vi es to Cost Objects through use of cost drivers, wherever feasible.

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 Cost and Management Audit

15. Also there are service cost centres through which the product does not pass through but which
provide a support func on to the produc on cost centres.
16. Where the cost of services rendered by a service cost centre is not directly traceable to a cost
object, it shall be assigned on the most appropriate basis.
17. The most appropriate basis of distribu on of cost of a service cost centre to the cost centres
consuming services is to be derived from logical parameters which could be related to the usage of
the service rendered. The parameter shall be equitable, reasonable and consistent.
18. Charging overheads on the basis of “benefits received” by the various users is preferred. This
requires some measure of “receipt of benefit” to be developed.
19. Some mes capacity in a service department is created in an cipa on of demand for services. It is
appropriate to allocate such capacity costs on the basis of “capacity to serve” rather than actual
usage of services.
Ul mately all overheads must be charged to products of services. Hence the total produc on
overheads of Produc on Cost Centres are applied to products passing through them using a suitable
absorp on base.
20. Before the final step of absorp on, produc on overheads of produc on cost centres have to be
segregated between fixed overheads and variable overheads. The fixed overheads are absorbed
by products based on normal capacity or actual capacity u liza on whichever is higher. Variable
overheads are absorbed by products based on actual capacity u liza on. This treatment is in line
with Accoun ng Standard 2 as well.
21. Normal capacity is defined in Cost Accoun ng Standard 2 as the produc on achieved or achievable
on an average over a period or season under normal circumstances taking into account the loss of
capacity resul ng from planned maintenance. It is prac cal capacity minus the loss of produc ve
capacity due to external factors.
22. Under-absorbed fixed overheads are charged off to Cos ng Profit & Loss Account and shown as an
item of Reconcilia on with financial accounts.
DEPRECIATION
1. Deprecia on, though part of overheads, generally appears as a separate line item in the cost
statements instead of being grouped under overheads. This is because of its size in the technology
driven business of today and its unique characteris c of being non-cash cost.
2. Amor za on of intangible assets tends to be grouped with deprecia on because intangible assets
themselves are grouped with Fixed Assets in the presenta on under Schedule III of the Companies
Act 2013.
3. The measurement of deprecia on in Cost accounts tends to mirror the prac ces in financial
accounts.
4. However the treatment of deprecia on in Cost Accounts must address the following issues:
- Deprecia on not calculated on period of use basis.
- Deprecia on an idle assets
- 100% of deprecia on on certain class of assets

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- Write-off of small value assets

- Deprecia on on fully depreciated assets
- Deprecia on on revalued assets
5. Some mes deprecia on in books is not calculated on period of use, for example 50% of annual
deprecia on is taken for an asset put into use for a day in financial accounts keeping in mind Income
Tax provisions. Cost accounts will always use the deprecia on computed on period of use basis
and take the balance to Cos ng P & L or reconcilia on with financial accounts.
6. Even where 100% of the deprecia on is allowed in the first year for income tax purposes, companies
are required to use regular rates of deprecia on for cost accoun ng purposes. Even where an en ty
uses 100% deprecia on rates in financial books of accounts, deprecia on based on es mated life
is used for cos ng purposes with the difference taken to cos ng Profit & Loss or Reconcilia on
with Financial Accounts.
7. Where small value items are wri en off fully at the me of purchase in financial accounts, the
same is generally adopted for cost accounts.
8. In the case of old plants, there is the special case for fully depreciated assets which however
con nue in regular service. Some en es con nue to provide a no onal deprecia on on such
assets for decision making purposes.
9. Deprecia on on the amount by which the asset is wri en up on Revalua on is charged to Revalua on
Reserve in financial books. Some en es compute the deprecia on on the revalued figure for
cos ng purposes to reflect the true cost of deprecia on.
10. It goes without saying that the cumula ve deprecia on charged in the Cost Accounts against any
individual item of fixed asset will not exceed the original cost of the asset.
11. The assignment of deprecia on to various cost centres should not pose a problem so long as
detailed Fixed Asset records are maintained by the Company. However there are some common
items of fixed assets between cost centres e.g. yard piping carrying products from one process to
another, common storage tanks and the like. Deprecia on on common assets are appor oned
to individual cost centre on some suitable basis e.g. yard piping is assigned to the cost centre
receiving the material.
ADMINISTRATIVE OVERHEADS
1. Administra ve overheads are the aggregate cost of resources consumed in ac vi es rela ng to
general management and administra on of an organisa on.
The principles of measurement of Material Cost, Employee Cost, U li es, Repairs & Maintenance
and Deprecia on found in the respec ve standards will apply if included in administra ve overheads.
2. In case of leased assets, if it is an opera ng lease – the en re rentals will be treated as a part
of administra ve overheads, while in case of a financial lease – the finance cost por on will be
segregated and treated as a part of finance cost.
3. The cost of so ware (developed in house, purchased, licensed or customized), including up-
grada on should be amor zed over its useful life.
When hardware requires up-grada on along with the so ware, it is recommended to use compa ble
es mated lives for the two sets of cost.

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 Cost and Management Audit

4. The cost of the administra ve services procured from outside is determined at invoice or agreed
price including du es and taxes, and other expenditure directly a ributable net of discounts
(other than cash discount), taxes and du es refundable or to be credited. The assignment of
administra ve overheads to cost objects is based on either of the principles of Cause and Effect
or Benefits received, if it is not directly traceable.
The cost of shared services is best assigned to user ac vi es on the basis of actual usage,
infrastructure costs on the basis of readiness to serve and general management costs on a ra onal
basis. For e.g.: Number of employees, turnover, investment size etc.
5. Since most administra ve costs are fixed in nature, it is preferable to change them to users
on “readiness to serve” basis such as installed capacity, budgeted sales etc. rather than actual
produc on or actual sales. Even the drivers men oned in (9) above can be on the basis of expected
driver quali es rather than actual.
SELLING AND DISTRIBUTION OVERHEADS
1. Selling costs can be recorded in a manner which will facilitate customer / product profitability
analysis, as appropriate. Thus selling costs can be iden fied to markets, distribu on channels,
territories, salesman etc., before being assigned to customer / product as applicable.
2. The acceptable bases for appor onment of common selling costs to customers / products are:
a. Weight
b. Units / equivalent units
c. Value of goods
d. Any other appropriate and equitable basis
3. The acceptable bases for assigning common transport costs to products are:
a. Weight
b. Volume of goods
c. Tonne km
d. Units / equivalent units
e. Value of goods
4. The transporta on costs assigned to products are charged to units based on some measure which
factors in the distance e.g. tonne km.
INTEREST AND FINANCE CHARGES
1. Interest and Finance Charges have come to be included in cost of sales though not in cost of
produc on. Such costs are also assigned to products before arriving at margins by product.
2. For the purpose of assignment, Interest charges are grouped under
- interest on long term funds
- interest on working capital funds
3. The former is assigned to product lines based on fixed capital investment (including fixed assets
and mould and dies) in such product lines. A por on of the interest is also charged to outside

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investments, if they exist, and excluded from cost of sales. For this purpose, it is usual to develop
an average cost of long term funds and apply it to fixed capital investment in each product line.
4. It is not the accepted prac ce to charge imputed interest on owners’ funds in cost accoun ng.
SALES
1. Cost of sales statements lead right up to margin and hence sales also have to be handled in Cost
Accoun ng.
2. Since cos ng is always by product, cost accoun ng requires product wise analysis of sales. This is
usually produced by other modules of the enterprise system.
3. What is cri cal is the value of sales produced by such analysis. O en sales analysis produce invoiced
value of sales. What is required for cost accoun ng is net value of sales net of trade discounts,
returns, allowances, volume discounts, special discounts based on market condi ons etc.
4. Many of these deduc ons from sales are transacted through credit notes which also must be
processed through the sales analysis to arrive at product wise break up.
5. Some of these deduc ons from sales may be available only in total and hence may have to be
allocated to products on a suitable basis, say, sales value.
6. It is not unusual for businesses to focus on net realiza on from sales ex-factory gate. This means
that freight (both primary and secondary), transit insurance, loading and unloading charges,
handling charges and the like are deducted from net sales as arrived at in 3 above to arrive at net
sales realiza on ex-factory gate. This also entails freight and other transport costs not being shown
under the head Distribu on costs. So long as these costs are shown separately as deduc ons from
net sales value, the prac ce is acceptable.
7. Companies (Cost Records and Audit) Rules, 2014 require gross sales to be shown in addi on to net
sales in cost statement. This requires that excise duty, sales tax (VAT) etc is added to net sales to
arrive at gross sales by product. However, in view of applica on of GST, w.e.f. 1/7/2017, the Gross
sales becomes Net Sales.
JOINT COSTS
1. Joint Costs are the costs of a produc on process that yields mul ple products simultaneously, for
example, in the refining of Petroleum which yields Petrol, Kerosene, Diesel, Naphta, Grease, Tar
and several other products or the dis lla on of coal, which yields coke, natural gas, and other
products.
2. The costs of the common process are the joint costs.
3. Joint costs are allocated
(a) Based on a measure of the number of units, weight, or volume of the joint products, or
(b) Based on the values a ributed to the joint products.
4. By-product is a special case of Joint Product where one or more of the joint product has minor value
compared to others.
5. Such by-products are generally valued at their value at the split-off point with such value being
credited to the costs of the main product. The split-off point value is arrived at on the basis of the
ul mate realizable value of the by-product less the post split-off costs.

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 Cost and Management Audit

COMMON COSTS
1. A common cost is the cost of opera ng a common facility, ac vity or service or that is shared by two
or more cost objects.
2. The common cost is generally lower than the stand-alone individual cost to each cost object was
the facility not shared.
3. Common costs are therefore allocated to each cost object based on the individual costs of the cost
object.
PRESENTATION AND DISCLOSURE
Generally the presenta on requirements of cost informa on for statutory purposes are laid down in
the respec ve rules. Similarly the requirements of repor ng for regulatory purposes are laid down by
the regulatory agencies. Managements s pulate the presenta on formats for managerial purposes. It
is therefore not considered necessary to lay down any model statements or formats in this document.
However it is considered appropriate to stress certain disclosure prac ces which are generally applicable.
1. Cost Statements must contain, besides total cost, unit cost per unit of output.
2. Output quan es with unit of measure must appear in the Cost Statements.
3. Input costs are best broken up as quan ty and rate.
4. The basis of valua on of inputs must be stated.
5. The basis of distribu on of costs to cost objects or cost centres must be disclosed.
6. Costs incurred in foreign currency must be stated separately.
7. Any costs excluded must be disclosed.
8. Any credits or recoveries ne ed against cost must be disclosed separately.
9. Transac ons with related par es must be highlighted or disclosed separately.
10. Cost elements, which are material for a product or ac vity, must be disclosed separately.
11. Cost details of all ancillary products or ac vi es may be maintained under a miscellaneous group
and disclosed appropriately.
12. Changes in the cos ng principles and methods applied must be disclosed with the effect.
Conclusion
This document contains a discussion of the generally accepted cost accoun ng principles in the context
of today and the mes gone by. It must be understood that cost accoun ng principles and methods
of applying them are in a constant flux influenced by fresh thinking by experts, regulatory influences,
parallel developments in financial accoun ng standards and the like. Professional accountants will be
well advised to use this document as a guide and not as a set of rules.

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Corporate Social Responsibility u/s 135

1. Applicability :- Any Co(including foreign Co)
satisfying any of the 3 conditions in immediately
preceeding FY

T/O Min100 Cr or
Net Profit Min 5Cr
NW Min 500 Cror

Provided that if the above Co ceases to satisfy the

above 3 limits for continuous 3 FYs then CSR
shall not apply unless limit is attracted again.

What are the obligations if Sec 135 attracted?

Constituteof CSR committee Spendatleast2%*Aug NPof

1. havingatleast3directoroutofwhich/ immediatelypreceeding3FYs.
shallbeIndDir. 1. NP is computed u/s198.
2.Conot readtoappointIndDirshall 2. 2itemsshallbeexcludedfromNP.
constituteCSRcommitteewithonly2 a. Profitsfromoverseas branches.
Dir. b. Dividend receivedfromcompanies
3.PvtCoshallconstituteCSRcommittee onwhichsec135is applicable.
withonly2Dir.
4.Foreign CoshallconstituteCSR
committeewithonly2personsoutof
whichshallberesidentinIndia.

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 Cost and Management Audit

Functions/ Role of CSR Committee

Recommend CSRpolicy
havingactivities of Schedule Recommendtheamountof Monitor CSR Policy
VII CSRexpenditure

Role of BOD

ApproveCSR policy MakenecessaryCSR

recommendedby CSR expenditure
committee

What activities will not continue CSR?

Any activityundertakenin
theordinarycourseof
ActivitiesoutsideIndia
businessexceptpharma
Companiesfor COVID19
Activitiesdone for
vaccination/drugs
employees& their
family members
Politicalcontribution
u/s182

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How to do CSR/ Mode of CSR

By contributingto are registered

Co can directlydo CSR society/trusthavinggood track
expenditureor recordin last3 FYs.
By openinga Sec 8
Company or

Disclosure of CSR

Board Report Company’sWebsite

8. Schedule VII Activities of CSR (Acronym + HEEENAS)

1. Eradication of hunger poverty, malnutrition.

2. Promotion of Education.
3. Promotion of Gender Equality.
4. Protection of Environment.
5. Protection of National Heritage.
6. Measures for the benefits of Armed Forces Veterans, war widows.
7. Promotion of Rural Sports, naturally recognized sports, Paralympic & Olympics sports.
8. Contribution to PM National Relief fund or PM CARES (Citizen’s Assistance & Relief in Emergency
situation) fund.
9. Contribution to technology incubators or R&D projects related to development of COVID 19
vaccination/drugs.
10. Rural Area development.
11. Slum Area development(slum areas is areas notified by CG/SG/Local Authority as slum).

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NOTE

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COST AUDITING AND
ASSURANCE STANDARDS

06
Sub-section (3) of section 148 prescribes that the auditor conducting the cost audit shall comply with
the cost auditing standards. This proviso to be read with the following explanation:
“cost auditing standards” mean such standards as are issued by the Institute of Cost Accountants of
India, constituted under the Cost and Works Accountants Act, 1959, with the approval of the Central
Government..
The Institute of Cost Accountants of India is a founder member of the International Federation of
Accountants (IFAC). The International Auditing and Assurance Standards Board (IAASB) established
under the authority of IFAC have issued series of International Standards on Auditing (ISAs).
 Cost and Management Audit

Government of India, Ministry of Corporate Affairs, vide their letter no. 52/33/CAB/2013 dated 10th
September, 2015 has, under section 148(3) of the Companies Act, 2013, granted Central Government’s
approval to the following Cost Auditing Standards:
1. Cost Auditing Standard-101 on Planning an audit of Cost Statements;
2. Cost Auditing Standard-102 on Cost Audit Documentation;
3. Cost Auditing Standard-103 on Overall objectives of the independent cost auditor and the conduct
of an Audit in accordance with Cost Auditing Standards
4. Cost Auditing Standard-104 on Knowledge of business, its processes and the business environment

Cost Auditing Standard on Planning an Audit of Cost Statements - 101

1. Objective - The objective of this Standard is to guide the members in planning for the audit of cost
statements so that it is performed in an efficient and effective manner. Audit planning shall also
include establishing the overall audit strategy and audit plan for the conduct of the audit.
2. Definitions
• Audit: Audit is an independent examination of financial, cost and other related information
of an entity whether profit oriented or not, irrespective of its size or legal form, when such
an examination is conducted with a view to expressing an opinion thereon.
• Audit Plan: A record of the planned nature, timing and extent of risk assessment procedures
and further audit procedures at the assertion level in response to the assessed risks.
• Audit Risk: Audit risk is the risk that the cost auditor expresses an inappropriate audit opinion
on the cost statements that are materially misstated.

2. Requirements
1. Prior to entering the planning phase, the Cost Auditor shall ensure that:
(a) the appointment as cost auditor is proper, he has received the letter of appointment
(b) the ethical requirements
(c) an understanding of the terms of reference , scope of coverage
2. At first Audit Strategy is made and then the plan and then the audit programme
3. In formulating the Overall audit strategy, the Cost Auditor shall consider all relevant factors.
(a) results of preliminary activities
(b) knowledge from previous audits
(c) knowledge of business
(d) nature and scope of the audit
(e) statutory deadlines and reporting format
4. The Cost Auditor shall develop an audit plan.
5. The Cost Auditor shall update the Overall audit strategy and the audit plan as required during the
course of audit.
6. The Cost Auditor shall document the overall audit strategy, the audit plan and any significant
changes made therein during the audit engagements and the reasons for the changes.

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3. Application Guidance
1. The nature and extent of planning activities will vary according to the:
(a) size and complexity of the entity’s activities, the number of products to be covered, the
processes and operations involved
(b) the audit team members’ previous experience
2. Planning is not a discrete phase of an audit, but rather a continuous and iterative process.
3. In audits of small entities where the entire audit may be conducted by a small audit team
comprising the audit partner working with say one team member .

Cost Auditing Standard on Cost Audit Documentation – 102

Covered in Chp – 3
The Cost Audit Documentation should be retained for at least ten years
from the date of the Cost Audit Report.

Cost Auditing Standard Overall Objectives of the Independent Cost Auditor and
the Conduct of an Audit in Accordance with Cost Auditing Standards - 103
Objectives
The Cost auditor‘s overall objectives are:
1. to obtain reasonable assurance about whether the cost statements as a whole are free from
material misstatement, whether due to fraud or error
2. Where reasonable assurance cannot be obtained, the cost auditor should qualify the opinion and
in extreme cases disclaim an opinion.
Professional Judgment: The application of relevant training, knowledge and experience, within the
context provided by cost auditing standards, cost accounting standards and ethical requirements, in
making informed decisions about the courses of action that are appropriate in the circumstances of
the audit engagement.
Professional Skepticism: An attitude that includes
(1) a questioning mind,
(2) being alert to conditions which may indicate possible misstatements due to error or fraud, and
(3) a critical assessment of audit evidence.

Requirements
1. The cost auditor shall comply with the relevant ethical requirements including those pertaining to
independence in respect of cost audit engagements.
2. While conducting an audit, the cost auditor shall comply with each of the Cost Auditing Standards
relevant to the audit.
3. The cost auditor shall plan and perform an audit with an attitude of professional skepticism
4. The auditor shall obtain sufficient appropriate audit evidence
5. The cost auditor shall exercise professional judgment

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 Cost and Management Audit

Application Guidance
Audit and Ethics: The cost auditor should comply with relevant ethical requirements as per Code of
Ethics issued by the Institute of Cost Accountants of India. The fundamental principles with which the
auditor is required to comply are Independence, Integrity, Objectivity, Professional competence and
due care, Confidentiality and Professional conduct.
Conduct of audit – By applying Relevant Cost Auditing Standard
A cost auditor cannot obtain absolute assurance because there are inherent limitations in an audit
that affect the cost auditor’s ability to detect material misstatements. These limitations result from
factors such as the following:
(1) The use of sample testing.
(2) The inherent limitations of internal control (for example, the possibility of management override
or collusion).
(3) The fact that most audit evidence is persuasive rather than conclusive.

Audit Risk and Materiality: Inverse Relationship

Responsibility for the Cost Statements: The cost auditor is responsible for forming and expressing an
opinion on the Cost Statements.
The Cost auditor is not responsible for preparing and presenting the cost statements in accordance
with the applicable Cost reporting framework

Cost Auditing Standard on Knowledge of Business, its Processes

and the Business Environment - 104
The following is the Cost Auditing Standard (Cost Auditing Standard - 104) on “Knowledge of Business,
its Processes and the Business Environment”.
Objective
The objective of this standard is to enable the cost auditor to have knowledge of the client’s business

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Requirements
1. The Cost Auditor shall have adequate level of understanding of the knowledge of Business, its
Processes and the Business Environment to develop a reasonable assurance in order to express
an opinion on the cost statements
2. The Entity and Its Environment: The cost auditor should obtain an understanding of the following:
(a) The nature of the entity, (including its operations covering Business processes, major inputs,
Joint & By- Products and Wastages and major outputs etc) and the entity’s ownership and
governance structure.
(b) Relevant industry, regulatory, and other external factors including the applicable cost and
financial reporting framework.
(c) The entity’s selection and application of cost accounting policies.
(d) The measurement and review of the entity’s performance.
The Entity’s Internal Control:
(a) Control Environment: The cost auditor shall evaluate whether management has created and
maintained a culture of honesty and ethical behaviour.
(b) The entity’s risk assessment process: The cost auditor shall obtain an understanding of whether
the entity has a process for
(1) Identifying business risks relevant to cost reporting objectives;
(2) Assessing the likelihood of their occurrence;
(3) Estimating the significance of the risks; and
(4) Deciding about actions to address those risks.
c) Cost Information System/ Management Information System:
(1) The classes of transactions and their analysis, that are significant to the cost statements;
(2) The procedures, by which those transactions and their analysis are initiated, recorded,
processed, and reported in the management information systems and cost statements;
(3) The related cost accounting records
(d) Control Activities: The auditor shall obtain an understanding of the control activities, relevant to
the audit.
(e) Monitoring of controls

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NOTE

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COST AUDIT
PROGRAMME

07
FACTORS IN PLANNING COST AUDIT ASSIGNMENT
In planning the audit assignment certainimportant factors are taken into consideration viz.
(a) Requirement of audit personnel for the assignment
(b) Documentation of the audit procedures and of evidences
(c) Quality control exercised over performance of the assignment etc.

Audit personnel for the assignment

The cost audit team to whom the assignment is to be delegated need appropriate direction and
supervision. It is therefore, essential that they accomplish the following tasks:
(i) Physical inspection of the activities and the area where they are performed;
(ii) Knowledge of the key personnel responsible for the activities and for the maintenance of cost
records;
(iii) Physical inspection of the cost accounting records and other records relating to activities;
(iv) Study of the statements of budgets, plans and strategies relating to activities;
(v) Study of the Cost Accounting system.
 Cost and Management Audit

Documentation of the audit procedures and of evidences

Chap - 3

Quality control over performance of the assignment

(a) Monitoring the progress of the preparation / maintenance of cost accounting records;
(b) Reviewing that the audit assistants do have necessary skill and competence
(c) Modifying the plan and programme, as considered necessary; and
(d) Removing the differences of professional judgement between the personnel and deciding the
level which is appropriate for reference purpose

CHECKLIST TO AUDIT VARIOUS COST ELEMENTS

1. Audit of production - Product wise
2. Audit of raw material cost
3. Audit of key raw materials inventory status
4. Audit of electricity cost
5. Audit of cost of electricity generated by DG set
6. Audit of demineralised water cost
7. Audit of steam cost
8. Audit of stores and spares cost
9. Audit of repairs and maintenance cost
10. Audit of employee cost
11. Audit of insurance cost
12. Audit of depreciation cost
13. Audit of administrative overhead cost
14. Audit of selling and distribution overhead cost
15. Audit of packing material cost
16. Audit of sales value

Audit of Production - Product Wise

Following checklist should be considered to audit production - product wise:
• Ensure that there is proper inventory balancing for each of the finished product, for example,
Opening Stock + Production = External Sales + Internal Transfers + Closing Stock
• Ensure that closing stock of previous year is correctly considered as opening stock of current year
• Check the capacity utilisation of previous 5 years - product wise
• For any abnormal under utilisation of production capacity the auditor should seek the reasons
from the management and what steps management has proposed to undertake to overcome
under utilisation of capacity.
• Check whether there is any circumstance where there is addition to capacity for any product
during the year but actual production achieved is either equal to or less than that of previous
year. Reasons for the same should be sought from the management

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Audit of Raw Material Cost

• Ensure that proper quantitative inventory balancing is carried
Opening Stock + Purchases – Consumption = Closing Stock
• Work out Input / Output Ratios for key raw materials for previous 3 to 5 years.
• In case of chemical based industries, some chemicals tend to evaporate during their storage.
Being normal loss, it should be shown as consumption for that product.
• In some cases it may happen that residue of some particular raw material is not reusable but has
to be sold out in the market, say for example In such case, sale value of residue of raw material X
will be reduced from raw material consumption of X for Product A only.
• FIFO & Weighted Average rates can be applied
• FIFO & Weighted Average rates can be applied
• If some raw material is produced in-house, then the company would have created separate cost
centre for that raw material.
• Sometimes a company may keep rented storage tank at port to store the material which is
subsequently brought to the company premises. This rent will form part of cost of material
• Demurrage or detention charges or any penalty levied should not form part of landed cost of raw
material
• R & D department should suggest how to reduce/eliminate wastages
• Check the trend of rates of key raw materials for previous 4 years

Audit of Key Raw Materials Inventory Status

• Obtain information about current stock position
• Assess how the stock position is keeping pace with consumption pattern
• Check whether unnecessary increase in the volume of inventory results in more and more cost
locked up in inventory

Audit of Electricity Cost

Following checklist should be kept in view to audit electricity cost during cost audit:
• Focus on A Category cost centres
• Any increase in consumption without any corresponding increase in output requires explanation
from the management as it is a matter of concern
• Check the trend of electricity cost for previous 5 years
• Check whether proper meters are installed
• Check whether meters are regularly calibrated
• A company may have more than one source of electricity.

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 Cost and Management Audit

Audit of Cost of Electricity Generated by DG Set

Following checklist should be remembered to audit the cost of electricity generated by DG set:
• Monthly report of Diesel Generating Set prepared by officer in-charge of DG set should be the
basis for ascertainment of cost of electricity generated
• Ensure that monthly report contains the following information:
(a) No of hours DG set is operated
(b) Quantity of high speed diesel used
(c) Total units generated
• Proper meters should be in place to quantify the total units generated
• Meters should be regularly calibrated
• There should be proper system to quantify quantity of diesel used
• Ensure the correctness of depreciation and insurance booked against DG set

Audit of Demineralised Water Cost

Following checklist should be kept in view to audit demineralised water cost during cost audit:
• Proper cost centre should be allocated to DM water plant
• Monthly report prepared for demineralised water plant should form the basis for ascertainment
of cost of demineralised water plant
• Ensure that monthly report so prepared contains the following data
(a) Quantity of filtered water used
(b) Quantity of chemicals used
(c) Electricity units used (Kwh)
(d) Quantity of demineralised water generated
(e) Quantity of demineralised water allocated to production cost centres, boiler etc
• There should be proper system in place to quantify quantity of demineralised water generated
and quantity allocated to various cost centres
• It is recommended to have proper meters which should be regularly calibrated
• Ensure correctness of depreciation and insurance
• Cost of electricity
• Cost of chemicals consumed

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Audit of Steam Cost

• Generally boiler house prepares monthly report which becomes the basis for ascertainment of
cost of steam. Ensure that monthly report for boiler contains the following information:
(a) Running hours of boiler
(b) Quantity of steam generated (MT)
(c) DM water consumption (KL)
(d) Electricity consumption (Kwh)
(e) Fuel consumption
• The cost auditor should check the following ratios for previous 5 years:
(a) Cost of steam generated for previous 5 years
(b) Quantity of steam generated per unit of fuel used
• Focus on A category cost centres
• Ensure that cost of consumable stores and repairs is properly booked against boiler
• Ensure that depreciation and insurance are correctly worked out
• Cost auditor should go through steam cost of previous 5 years

Audit of Stores and Spares Cost

• If there is any substantial increase in expenditure with respect to any particular cost centre/cost
centres then reasons for the same should be discussed with the head of that cost centre(s) so that
appropriate action can be taken to prevent such recurrences.
• The cost auditor can pick up few major items of stores & spares and ensure that they have been
booked against correct cost centres
• The cost auditor should also go through expense control chart

Audit of Repairs and Maintenance Cost

• If there is any substantial increase in expenditure with respect to any particular cost centre / cost
centres then reasons for the same should be discussed with the head of that cost centre(s) so that
appropriate action can be taken to prevent such recurrences.
• The cost auditor can pick up few major items of repairs & maintenance and ensure that they have
been booked against correct cost centres
• The cost auditor should also go through expense control chart

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Audit of Employee Cost

Following checklist should be kept in view to audit employee cost during cost audit:
• The cost auditor should verify the following information:
(a) Employee cost for previous 5 years – cost centre wise
(b) Number of employees for previous 5 years - cost centre wise
(c) Employee cost per employee for previous 5 years - cost centre wise
• The cost auditor should also verify the following information:
(a) Employee cost for previous 5 years – product wise
(b) Number of employees for previous 5 years – Product wise
(c) Employee cost per employee for previous 5 years – product wise
• The cost auditor should verify that cost centre wise list of employees is regularly updated in
employee payroll so that cost centre wise employee cost gives correct reflection of employee
cost
• Generally, employees are transferred from one cost centre to another cost centre. The cost
auditor should ensure that pay roll of employees reflect all such transfers correctly and timely
• Increase in number of employees for particular cost centres or product should be looked into. The
reasons and justification should be obtained from the management

Audit of Insurance Cost

The insurance premium paid by company may cover various kinds of insurances. Insurance of plant &
Machinery, buildings and equipments, furniture & fixtures usually covers risks of general loss and fire.
• The cost auditor should obtain information from either CMA department/Finance department
• product wise expenses on insurance.

Audit of Depreciation Cost

Same as Insurance

Audit of Administrative Overhead Cost

A cost auditor should ask for the following information:
(a) Trend of administrative expenses (`/Lacs) – year wise
(b) Administrative expenses (`/MT) – year wise product wise
• The auditor should see that basis of allocation/apportionment
• For any abnormal increase in any expenses, the cost auditor should ask for cost centre wise
break up discuss with the management
• He should see that donations and penalties are not charged to products but shown as items
of reconciliation
• If there is any substantial increase/decrease in per MT administrative expenses as compared
to any of 4 years, he should seek the reasons for the same

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Audit of Selling and Distribution Overhead Cost

1) Determination of the costs of sales of products and the extent of profitability of each.
2) Control of selling & distribution costs
3) Price fixation
• A cost auditor should ask for the following information:
(a) Trend of selling & distribution expenses (`/Lacs) – year wise
(b) Selling & distribution expenses (per/MT) – year wise product wise
• He should see that basis of allocation/apportionment
• For any abnormal increase in any expenses and discuss with the management

Audit of Packing Material Cost

• Efforts should be made to negotiate the rate of high value consumption packing materials
• Steps should be taken to reduce handling losses, wastages, etc
• Ensure that proper quantitative inventory balancing is carried out for all the packing materials i.e.
opening stock + purchases – consumption = closing stock
• For charging packing material cost to product/products, both FIFO and weighted average rates
can be applied.
• a company prepares expense control chart
• If some packing material is produced in-house then the company would have created separate
cost centre for that packing material.

Audit of Sales Value

• More focus should be on products of A category and B category in terms of sales value
• Check whether efforts have been made to increase sales realisation
• Check whether efforts have been made to procure more orders for product/products having
higher contribution
• Check whether company has diverted resource allocation from high volume/low contribution
products to high contribution products
• Check that there is a proper balance between the opening stock, production, sales and closing
stock in order to ensure no unnecessary locking up of working capital in terms of closing stock
• Check that any increase in production capacity has resulted in increase in sales quantity without
affecting corresponding sales realisation

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An overall checklist of the programme is drawn up for reader’s guidance:

SI. Planning Phases Ac on to be taken

No.
1. Familiarisa on with the company:
(a) Nature of business and industry Acquire the previous
years’ Annual Reports and
Accounts (at least 5 years)
(b) Objec ves of the company, e.g., maximisa on of profits, Keep notes
cost reduc on, quality improvement, customised
produc on etc. Strategies of the company like market
expansion, market diversifica on including mergers/
acquisi ons, research including innova on, product
diversifica on including product mix etc.
(c) Ownership, e.g. public or private, domes cally controlled Iden fy and keep notes on
or MNC, major shareholders, management posi on of legal forms.
shareholders
(d) Corporate structure, subsidiaries and affiliates ownership Keep notes
percentage and dates of acquisi on
2. Company records: Obtain copies.Keep notes
Memorandum and Ar cles of Associa on, foreign technical
collabora on &agreement, other agreement deeds or contracts
including that of inter- company transac ons, secretarial
records and registers.
3. Familiarisa on with the Organiza on of the Company: Keep notes
(a) Head of Finance/ Accounts/Cos ng
(b) Other Directors & Key Managerial Personnel
(c) Delega on of Financial and Administra ve Authori es;
Organisa on control systems in existence including MIS,
and cost controlprocesses
4. Familiarity with organisa on profile: Obtain detailed
Main or Central or Head Office Administra on Offices other organisa onchart showing
func onal managements, e.g. Purchase, Sales, Produc on, func onal rela onships.
Finance, etc. Backgroundof Key personnel
5. Familiarity with the company policies: Keep notes and Iden fy
(a) Capitalisa on
(b) Products or Services
(c) Inter-company transac ons policies
(d) Other important policies
6. Sales policy and sales management: Pricing Policies – Home and Keep notes and Iden fy
export sales
7. Produc on planning and control: Obtain the process
Manufacturing process, factory layout, Product details flowcharts

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SI. Planning Phases Ac on to be taken

No.
8. Accoun ng systems:
Financial accoun ng, Cost accoun ng, Integrated accounts
9. Management informa on systems: Obtain an outline of the
• Budgets schemes adopted, if any
• Standard cos ng
10. Internal audit system and Internal control: Systems/Internal Obtain Internal Auditor’s
Audit Programmes Manual and reports on
areas covered.
11. Cost records, statements and reports: Obtain them from the cost
(a) Cost accoun ng records and other related records department.
(b) Cost Statements and related Statements & documents
(c) Cost Accounts Manual
(d) Previous cost auditor’s reports (if any)

An Illustrative check-list of information to be obtained

A. One Time Information:
1. Organization chart
2. Process of manufacture with Flow Chart
3. Blue print of production area with machine locations
4. List of cost centres
5. Machine details
6. Product details
7. Details of any product manufactured under any technical collaboration, licence agreement,
Terms of payment of royalty if any
8. Details of process chemicals
9. Details of packing materials

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PREPARATION AND FILING
OF COST AUDIT REPORT

08

Introduction
A Cost Auditor is required to submit his report in Form CRA-3 which is required to be prepared on the
basis of data and information available in the cost accounting records and other data maintained by
the company in accordance with CRA-1 of the rules.

Qualified Audit Report

• A qualified audit report is given by the cost auditor
• when the cost statements are materially misstated due to misstatement in one particular cost
element, class of transaction or disclosure that does not have pervasive effect on the cost
statements.
• when the cost auditor is unable to obtain audit evidence regarding particular cost element, its
allocation and apportionment, class of transaction or disclosure that does not have pervasive
effect on the cost statements.
 Cost and Management Audit

Adverse Audit Report

• An adverse audit report means that the cost statements are materially misstated and such mis-
statements have pervasive effect on the cost of production, cost of sales and margin of the
products.

Cost Audit Report In XBRL Format (As Per Taxonomy)

XBRL – Extensible Business Reporting Language
“Every company covered under these rules shall, within a period of thirty days from the date of receipt
of a copy of the cost audit report, furnish the Central Government with such report in Form CRA-4. All
the cost audit reports have to be filed online, with MCA, in XBRL format, attached to the prescribed
Form- CRA-4. XBRL is the open international standard for digital business reporting, managed by a
global not for profit consortium called “XBRL International”. XBRL is used around the world, in more
than 50 countries.
XBRL makes reporting more accurate and more efficient.

STEPS FOR FILING COST AUDIT REPORT IN XBRL FORMAT ON MCA PORTAL
1. Creation of XBRL instance document
The first step for creating the instance document is tagging of the XBRL taxonomy elements with
the information in the Cost audit report of the company by means of mapping of the taxonomy
elements with the Cost audit report. This converts the report into XBRL form.
2. Download XBRL validation tool
A separate tool has been provided on the MCA XBRL portal for validating the generated XBRL
instance document. You are required to download the tool from the portal and validate the
instance document before uploading the same. (www.mca.gov.in/XBRL)
3. Load the instance document
To load the instance document, you need to click the open button, select the instance document
and open it. You need not exit the tool to load another instance document just click on ‘open’
again in the menu bar to open the next document.
4. Validate the instance document
The next step is to validate the instance document. The following validations shall be performed
by the tool-
• Validating that the instance document is as per the latest and correct version of taxonomy
prescribed by MCA
• All mandatory elements have been entered
• Business Rules as specified by MCA

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STEPS FOR FILING COST AUDIT REPORT IN XBRL FORMAT ON MCA PORTAL
5. Pre-scrutiny of the instance document
Once the instance document is successfully validated from the tool, the next step is to pre-
scrutinize the validated instance document with the help of the same tool using a working internet
connection.
6. Convert to PDF and verify the contents of the instance document.
Once the instance document has been successfully pre-scrutinized, the next step is to generate
PDF by using ‘Export to PDF’ functionality in the tool to verify the final instance document.
7. Attach instance document to the Form CRA-4
Form CRA-4 is available on the MCA portal for filing in XBRL instance documents by the Company.
8. Submitting the Form CRA-4 on the MCA portal.
After the form is correctly filled, it is required to pre-scrutinize and then sign the form [with a valid
digital signature of the person authorized by the board resolution] and then upload the same as
per the normal e-Form filing process.

A. List of common errors [Annexure – II]

(1) Issue in net connec vity. Please check your connec on
(2) The PDF is not ge ng generated or PDF generated is of zero kilobytes in size.
(3) The format of the date entered is not as per the valid format.
(4) For Boolean data types ‘Yes’ or ‘No’ has been entered.
(5) Wrong Currency code like Rs entered.
(6) Mandatory fields have not been entered.
(7) In case of mandatory table, there is no element present.

B. Interpreta on of valida on errors [Annexure – I]

The following the instruc ons have to be followed to interpret those errors –
• All the Element Names will be shown within single quotes, like-’Quan ty of Material
Consumed’
• All the values will be shown within square brackets like- [In Employment]

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MANAGEMENT REPORTING
ISSUES UNDER COST AUDIT

09
Introduction
Performance measures help managers to create capable and matured processes. Effective performance
measures can let us:
• Monitor performance to judge how well the company is fairing,
• Know if company management is meeting its goals.
• If appropriate actions have been taken to affect performance or improve efficiency.
 Cost and Management Audit

PERFORMANCE ANALYSIS
(a) To improve profits and profitability.
(b) To op mize resource alloca on.
(c) To op mize the product and services por olio.
The following criteria may help the management auditor to select and include the various
performance measurement criteria in the Report on Performance Analysis:
(i) Effect on profitability
(ii) Effect on resource u lisa on
(iii) Effect on liquidity
(iv) Effect on risks
(v) Effect on quality
(vi) Effect on compe veness
(vii) Effect on responsiveness to the market etc.
An ideal Report on Performance Analysis should possess the following characteris cs:
1. Objec vity
2. Capability of being predic ve value
3. Comprehensiveness
4. No informa on overload
5. Coverage of strategic thrust
6. Trend measures and current status
7. Timeliness
8. Segmented and enterprise-wide coverage

MECHANISM FOR PERFORMANCE ANALYSIS

After analysing the activities within each process, we give below the mechanism for performance
analysis as follows:
(a) Monitor performance
(b) If company is meeting its own set goals
(c) Take action if the customers are satisfied.
(d) If improvements are necessary.

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STEPS SUGGESTED FOR REPORT ON PERFORMANCE ANALYSIS

Step 1 : Identify and understand the key strategies of the company.
Step 2 : Choose strategies that have more visible expressions in costs data.
Step 3 : Identify the activities that were impacted by the strategies. Step 4. Analyze the cost
implications of those activities.
Step 4 : Analyze the cost implications of those activities.
Step 5 : Present the evaluation, in a table.
Step 6 : Give explanatory notes for the terms used, calculations made, and assumption behind the
evaluations.
Step 7 : Finalize the finding after a discussion with the concerned operating executives and then with
the management of the company.

CONTENTS OF THE REPORT ON PERFORMANCE ANALYSIS

The Report on Performance Analysis may cover the following areas:
(i) Capacity Utilization Analysis
(ii) Productivity/Efficiency Analysis
(iii) Utilities/Energy Efficiency Analysis
(iv) Key-Costs & Contribution Analysis
(v) Product/Service Profitability Analysis
(vi) Market/Customer Profitability Analysis
(vii) Working Capital & Inventory Management Analysis
(viii) Manpower Analysis

CAPACITY UTILISATION ANALYSIS

The auditor’s checklist:
1. Technical documents pertaining to the equipment
2. Production planning reports
3. Interviews with managers responsible
4. Wastage reports
5. Benchmarking exercises done

PRODUCTIVITY AND EFFICIENCY ANALYSIS

The cost auditors checklist would include, inter alia, the following:
1. The Bill of Material (BOM) for each product
2. The standard cost card, if any
3. Internal reports on consumption, wastages per unit.
4. Production scheduling.

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 Cost and Management Audit

UTILITIES AND ENERGY EFFICIENCY ANALYSIS

The performance parameters could include the following:
(i) Energy generated per unit of fuel consumed.
(ii) Measurement of improvement in power factor.
(iii) The cost of generating energy per unit.
(iv) Trend analysis of energy costs

KEY COSTS AND CONTRIBUTION ANALYSIS

The checklist for the auditor could include:
1. Sales and production records.
2. Reconciliation with GST records.
3. Price lists and discount structure policy.

PRODUCT/SERVICE PROFITABILITY ANALYSIS

The checklist for the auditor could include:
1. Sales and production records
2. Reconciliation with GST records
3. Price lists and discount structure policy

MARKET / CUSTOMER PROFITABILITY

The checklist:-
1. Market and customer-wise sales and cost reports.
2. The marketing campaigns.
3. New customers added during the year.

WORKING CAPITAL AND INVENTORY MANAGEMENT ANALYSIS

The auditor’s checklist could include the reference to the following:
1. Records related to inventory of RM, WIP and FG, stock discrepancy reports.
2. Inventory aging reports.
3. Reports on receivables
4. Terms and conditions of working capital funds.

MANPOWER ANALYSIS
The auditor’s checklist for this content area may be:
1. Details of number of recruitments done, number of people left, the labour turnover ratios
2. The data on idle time.
3. Manpower productivity reports.
4. Use of temporary or casual labour.

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OTHER AREAS SUGGESTED TO BE COVERED IN THE REPORT ON PERFORMANCE ANALYSIS

(a) Risk Analysis: Risk analysis affect the future performance. The auditor should
(i) Identify the sources of various risks
(ii) Assess the potential downside or upside effect thereof.
(iii) Recommend risk mitigation tools.
(b) Environment and Sustainability: This can be assessed to provide insight into how effectively the
company is following policies on CSR, environment and sustainability.
(c) Quality Performance: This can be assessed by relating the quality costs incurred versus the
benefits achieved by reduction in customer complaints or increase in customer satisfaction index.
(d) R & D Performance: The future performance of companies would depend upon their success of
the R & D initiatives.
(e) Business Process Performance: The processes could be evaluated on the criteria like speed,
accuracy, empowerment, hurdles, facilitation etc.
(f) Human Resource Accounting: This is an extended analysis of total human resource costs.
(g) Value Added Analysis: The value added is measured as an absolute value created by the business
and the distribution thereof to the employees and other providers of capital.

MANAGEMENT ACCOUNTING TOOLS

The following table shows various management accounting tools that are used to serve different
objectives:

Purpose Management Accoun ng tool

Control Budgetary control, standard cos ng, variance analysis.
Cost computa on Full (absorp on) Cos ng, Job, batch, process or contract cos ng Ac vity
based cos ng, Time Driven ABC .
Cost reduc on Total Quality management, Quality cos ng, Kaizen cos ng, Lean
manufacturing, Value Analysis and Value Engineering, Six Sigma.
Pricing and decision Target cos ng, Life cycle cos ng, Throughput accoun ng, Variable or
making marginal cos ng
Total performance Balanced Scorecard, Performance Prism, Performance pyramid, Business
management Objects, Business Intelligence

Planning for the Report on Performance Analysis

Key Performance Indicators (KPIs) are:-
(a) Quantitative – these can be financial or non-financial
(b) Qualitative – these are often lead indicators i.e. they influence future performance
(c) Actionable – those which can be influenced by enterprise actions or controllable
(d) Trending – those which need to be assessed over a period of time to observe whether they
are improving or not.

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BASICS OF
MANAGEMENT AUDIT

10
INTRODUCTION
9 Management Audit is the total examination of transaction of an organization,
9 and includes checks on the effectiveness of managers, their compliances with company on
professional standard, the reliability of management functioning, the quality of performance of
duties and recommendations for improvement.
Management audit deals with –
(i) the objectives of an organisation;
(ii) the policies and procedures in terms of the objective of the organisation; and
(iii) adequate performance of an organisation in terms of objectives, policies, and procedures.
 Cost and Management Audit

Definition and Objects of Management Audit

Management audit is the unique process appraising the performance of directors, managers or in the
other words, appraising the performance of the management.
The main objectives of management audit can be summarized as follows:-
(i) to ensure optimum utilization on all the resource employed, including money, materials, machines,
men and methods;
(ii) to highlight efficiencies in objectives, policies, procedures and planning;
(iii) to suggest improvement in methods of operations;
(iv) to highlight weak links in organizational structure and in internal control systems, and suggest
necessary improvements;
(v) to help management by providing health indicators and help prevent sickness or help cure in case
of sickness; and
(vi) to anticipate problems and suggest remedies to solve them in time.

Benefits of Management Audit

(i) It helps management in framing basic policies for the organization and to define objectives.
(ii) management audit helps in preparing a viable and achievable plan for the organization.
(iii) It helps implement the plans.
(iv) It assists in smooth operation of the organization.
(v) It assists in analyzing SWOT (strengths, weaknesses, opportunities and threats) of the organization.
(vi) to ensure optimum utilization on all the resource employed, including money, materials, machines,
men and methods;
(vii) to highlight efficiencies in objectives, policies, procedures and planning;
(viii) to suggest improvement in methods of operations;
(ix) to highlight weak links in organizational structure and in internal control systems, and suggest
necessary improvements;
(x) to help management by providing health indicators and help prevent sickness or help cure in case
of sickness; and
(xi) to anticipate problems and suggest remedies to solve them in time.

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Scope and Usefulness of Management Audit

Accordingly, the scope of management audit may include –
(i) The suitability, practicability and present compliance or otherwise of the organization with its
desired objectives and aims.
(ii) The current image of the organization among customers, general public within its own particular
industrial or commercial field.
(iii) Efficient utilization of resources of the organization.
(iv) The rate of return of investors’ capital – whether poor, adequate or above average.
(v) Relationship of the business with its own shareholders and investing public in general.
(vi) Employee relation.
(vii) The aims and effectiveness of management.
(viii) Financial policies
Accountability is the main criteria of audit, particularly management audit. The process of
accountability includes following elements:
(i) Description of the organization and its participants.
(ii) Identification of objectives and the provision of relevant information to those objectives.
(iii) Ability of action on the part of the participants.

Uses of Management Audit

(i) It helps management in framing basic policies for the organization and to define objectives.
(ii) management audit helps in preparing a viable and achievable plan for the organization.
(iii) It helps implement the plans.
(iv) It assists in smooth operation of the organization.
(v) It assists in analyzing SWOT (strengths, weaknesses, opportunities and threats) of the organization.
(vi) to ensure optimum utilization on all the resource employed, including money, materials, machines,
men and methods;
(vii) to highlight efficiencies in objectives, policies, procedures and planning;
(viii) to suggest improvement in methods of operations;
(ix) to highlight weak links in organizational structure and in internal control systems, and suggest
necessary improvements;
(x) to help management by providing health indicators and help prevent sickness or help cure in case
of sickness; and
(xi) to anticipate problems and suggest remedies to solve them in time.

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 Cost and Management Audit

Concept of Management Audit

Conceptually management audit covers areas which are not normally covered by other audits.
Secondly, management audit does not go into the vouchers or other similar evidence but comprises
of the appraisal of management effectiveness in various areas of managerial operations.
Management function include –
(i) Planning.
(ii) Organising.
(iii) Staffing.
(iv) Coordinating.
(v) Communicating.
(vi) Directing.
(vii) Motivating.
(viii) Controlling.
(ix) Innovating.

Functions of Management Audit

(i) Marketing, including selling and distribution.
(ii) Manufacturing/servicing from selection to recruitment, training, motivating, retaining,
advancement, etc.
(iii) Personnel policies and industrial relations.
(iv) Finance including maintenance of accounts.
(v) Research & development.

Ingredients/ Basis Management Audit Internal Audit Financial, cost and other
audits
1. Expecta ons Appraising management Assis ng Management to Specific under statutory
iden fy problems. and other’s direc ons.
2. A tude Friend, Philosopher and Policeman/judge Watch dog/judge
guide.
3. Agency Outside team or Internal or External Specially designated
management persons
4. Force Force Statutory in some Statutory
cases.
5. Area Complete Management Mainly procedural. Specific objec ves
or specific problems.
6. Evalua on Effec veness/ quality of Quality of procedures Specific informa on
management/Policies Opera ons/data
7. Period covered Past, present and future. Past and present Mainly past
8. Procedures Flexible Structured Highly structured
9. Repor ng level Higher Opera onal Designated

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Ingredients/ Basis Management Audit Internal Audit Financial, cost and other
audits
10. Time span Futuris c Current and immediate. Current and immediate
past.
11 . Periodicity Regular Regular Annual

Steps of Management Audit

The steps of management audit are:-
1. Select an area of operation of management
2. Establish what should be the objective, standard or target of the operation.
3. Determine whether the actual results meet the standards, norms or targets. If not, why not?
(i) Is the target too difficult?
(ii) Is failure to achieve the target costing the organisation?
4. Establish what is done to ensure the achievement of the norms, target and standards.
What steps are taken for –
(i) planning
(ii) operations, execution
5. Carryout a detailed investigation.
6. Report the findings of the audit and make recommendations.

Management Auditing Procedure

1. Make a preliminary survey of the activity under audit.
2. Study the basic charter of the activity under audit (applicable laws and related legislative history.
3. Review the policies established to govern the activities.
4. Report on the findings of the audit work.

Techniques by which the auditor can identify problems areas

(i) Identification of possible control weakness by survey:- During the preliminary survey work
information is obtained on how the activity is supposed to function.
(ii) Review of management reports.
(iii) Review of internal audit or inspection reports.
(iv) Physical inspection:- Physical inspections of the organization’s activities.
(v) Discussions with the officials and employees.

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 Cost and Management Audit

Techniques of Management Audit

(i) Accounting or economic techniques
(a) Break-even analysis
(b) Budgetary control including flexible budget system
(c) Cost management techniques indicating how an organization’s assets should be allocated
over competing projects or
(d) Discounted cash flow and net present value methods.
(e) Cost benefit analysis.
(f) Standard costing and marginal costing
(g) Activity based costing to test.
(h) Quality analysis of company transactions.
(ii) Scientific techniques
(a) Computer Models: Decision on material mix, product, mix, make or buy etc.
(b) Network analysis
(c) Mathematical programming
(iii) Statistical techniques
(a) Activity sampling
(b) Monte Carlo Simulation
(c) Exponential smoothing
(d) Interfirm comparison
(iv) Personnel techniques
(a) Attitude survey
(b) Man-machine relationship (c)Training methods
(d) Profitability and productivity measurement
(v) General techniques
(a) Statistical theory of management
(b) Analysing the problem
(c) Establish management by objectives.
(d) Determine the key factors
(e) Brain storming
(f) Transfer pricing
(g) Management by objectives
(h) Management by exception

Management Audit Evidence

The auditor’s evidence comes from his discussions with the people concerned in the organization, the
survey and review of various reports of the organization.

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Management Audit Programme (MAP)

It is a plan of action drawn in advance of taking up the audit.
An efficient management audit programme shall comprise the following:
(i) Review of the organizational objectives and plans
(ii) Study of the policies and practices of the management
(iii) A critical review of the organizational structure
(iv) Study of the systems and procedures
(v) Evaluation of operations
(vi) Study of the efficiency of the use of physical resources available.
(vii) Check on adherence to the statutory obligation and
(viii) Above all, review the efficiency of manpower

Qualifications of Management and Administrative Auditors

The essential qualities of a management auditor are:
(i) Ability to grasp the business problems
(ii) General understanding of the nature, purposes and objects of the organization.
(iii) assist the progress of the organization.
(iv) Knowledge of the principles of delegation of authority.
(v) Understanding different internal control devices.
(vi) Sufficient knowledge statistical techniques, cost and management accounting.
(vii) General understanding of different laws.
(viii) Sufficient knowledge and experience in preparing various reports.
(ix) Tactfulness, perseverance, pleasing and dynamic personality.

Audit Checklist
A management auditor shall normally maintain an audit checklist. The organizational areas covered
fall under the broad categories of:-
• Planning
• Organising
• Staffing
• Coordinating
• Communicating
• Directing
• Motivating
• Controlling and
• Innovating

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 Cost and Management Audit

An auditor should look for any weakness which may affect efficiency of the organization
(i) Directorial weakness
(ii) Management weakness
(iii) Organisational weakness
(iv) Financial weakness
(v) Systems weakness
(vi) Procedural weakness
(vii) Functional weakness
(viii) Operational weakness
(ix) Marketing weakness
(x) Industrial relations weakness

Characteristics of A Good Management Audit Report

Characteristics of a good management audit report are:-
(i) Pertinence P
(ii) Comprehensiveness C
(iii) Brevity B
(iv) Timeliness T
(v) Motivating M
(vi) Formatting F

Special Reports for Banks, Shareholders, Employees & Small Business

Salient features for these special reports are briefly discussed below:-
(1) Reports for banks and creditors:-
Form and content of financial statements and schedules re important to the lender but explanatory
notes to the statements and schedules are perhaps more important to them.
(2) Report to shareholders :-
In India, auditor’s report in the prospectus at the time of public issue is very important.
(3) Reports to employees :-
Reports for employees are mainly prepared for better understanding of the business.
(4) Reports for small business :-
The management auditor should design his report in a very simple way as the report for a small
business if specifically directed to a person or a small group of persons only.

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MANAGEMENT AUDIT IN
DIFFERENT FUNCTIONS

11
Corporate Objectives And Culture
Corporate Objectives are the overall objectives of the organization that influence the direction of
corporate strategy.
In other words, what the organization seeks to achieve is corporate objective.
These are the specific, realistic and measurable aims which an organization plans to achieve.
These represent the charter that the organisation has laid down for itself.

The corporate objectives of world famous ‘NIKE’ company are reproduced as under:
Protect & improve Nike’s position as the number one athletic brand in America;
Build a strong momentum in growing fitness market.
 Cost and Management Audit

The corporate objectives of ‘Apple Computers, USA are :

“To offer the best possible personal computing technology, and to put that technology in the hands
of as many people as possible.” Totally different and the business operations will differ dramatically
depending upon the exact choice of corporate objective.

Corporate Culture - Concept

Culture refers to a corporate’s values, beliefs and behaviours on the basis of which people interpret
experiences and behave. Generally firms with strong cultures achieve higher results. unsuccessful
companies generally have as the three R’s in their corporate culture i.e., “resistance”, “resentment”
and “revenge”.

Corporate culture should consists of the following:-

Commitment to honest productivity.
Planned performance and growth.
Informative, informing and informed, organization.
Consideration for others in partnership with the organization.

Corporate Services Audit

Corporate services audit means critical examination of the different aspects of services and their
extent that have been satisfactorily rendered by a corporate body.

The areas of corporate services audit criteria can be categorized as follows:

1. Consumers Quality goods at right prices, place and time.
2. Employees Pay, training, safety, welfare.
3. Shareholders Safety of investment, satisfactory return, capital appreciation.
4. Community social benefit, public relations
5. Fellow-businessmen Business ethics and fair trade dealings
6. State Compliance with the spirit of laws, payment of taxes.

Corporate Development Audit

A corporate development audit is an independent objective study of an organization’s capabilities. It
aims at identifying strengths and weaknesses.

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Corporate Development Audit assures that –

The various factors and forces constituting a corporate enterprise.
The pattern of departmentalization in an enterprise.
The personnel problems are handled appropriately.
A. Check list on corporate planning
(a) Whether SWOT analysis has been made?
(b) What are the corporate strengths and weaknesses in relation to price, product, quality,
market share, distribution net work, after sales services, technology.
(c) What are the opportunities and threats in relation to rivalry among existing firms.
(d) How are the threats overcome and opportunities availed of in the past?
(e) Whether the “corporate image” is going to improve in near future?
B. Checklist on corporate objectives
(a) Whether the corporate objectives are clear and explicit?
(b) Whether the different elements of the enterprise have separate objectives?
(c) How are these objectives defined?
(d) Are the objectives in writing?
(e) Is there sufficient flexibility.
C. Checklist on delegation of authority
(a) Whether there are clear lines of authority from top to bottom in the corporate enterprise?
(b) Whether accountability has been properly coupled with corresponding authority?
(c) Whether responsibility clearly defined in writing?
D. Checklist On Span Of Control And Management
(a) Whether span of control has been recognized in the organization?
(b) Whether everybody in department report only to one superior?

Evaluation Of Personnel Development

Evaluation of personnel development may include the following criteria -

(a) Pre-planning as an essential feature of human resource development.

(b) Ascertaining manpower needs for appropriate education, training and development.
(c) Adopting a suitable programme of recruitment, selection, training and development.
(d) Adequate manpower planning.

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 Cost and Management Audit

Scope of Personnel Function

“Personnel Management” is that part of the management function which is primarily concerned with
the human relationships within an organization.

(a) Organization • Continuous review and analysis of organization’s operation

review and may be necessary in order to determine and develop
analysis:- appropriate work structure.

(b) Manpower, • Forecasting and planning is essential

planning, for a sufficient number of qualified
recruitment personnel.
and selection:-

(c) Manpower, • Appropriate methods and

planning, techniques of training
recruitment and development may be
and selection:- adopted.

(d) Performance
appraisal:- • Rating and evaluation of performance of personnel.

(e) Employee • Wage and salary structure, incentive payments.

remuneration:-

(f) Employee • Health and welfare of all

services employees

Consumer Services Audit

The primary responsibility of a business enterprise towards consumers is to make available the
products of the right qualities at the right time, in right quantity, at the right place and right price.

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Checklist on ‘consumer services’ evaluation:

A. Products related policies and practices
(a) Do the products manufactured meet the needs of the customers of different classes ?
(b) Whether the prices are reasonable?
(c) Whether detailed information regarding the product, are adequately disseminated in order
to ensure that the communication made to the customers regarding price, quality, services,
etc. are truthful?
(d) Whether constant efforts are made for improvement of the product’s?
B. Customer Relationship
(a) Whether the customer complaints are handled promptly and efficiently?
(b) Whether the company responds quickly to the customers’ enquiries?
(c) Whether the labels of the products contain adequate information to help the consumers to
appreciate quality and other characteristics of the products?
C. General Considerations
(a) Whether safety norms relating to products are maintained ?
(b) Whether performance guarantees are explicitly stated?
(c) Whether all the “warranties” are explicitly stated?

Audit of Environmental Pollution Control

Pollution can be described in the following ranges :-
(i) Pollution as any alteration of the environment.
(ii) Pollution as a damage to man and to the environment.
(iii) Pollution as interference with other uses of the environment.

The different types, cause and effects of environmental pollution may be as follows -
(a) Air pollution :- Air pollution is the human introduction into the atmosphere of chemicals,
particulates or biological materials that cause harm or discomfort to humans or other living
organisms or damage the environment. Air pollution is caused by burning coal or crude oil from
automobiles.
(b) Water pollution :- Water pollution is the contamination of water bodies such as lakes, rivers and/
or oceans caused by effluents. Water pollution affects public health and safety, causes damage to
property and leads to many economic losses.
(c) Noise pollution :- Noise pollution is a type of energy pollution in which distracting, irritating or
damaging sounds are freely audible and is caused by noise due to running of heavy machines, big
aircrafts. Noise pollution may lead to loss of efficiency at work, loss of hearing.
(d) Smell pollution :- Discharge of industrial products, unclear garbage dumps, open sewers, etc. and
even causes psychological disorders.
(e) Thermal pollution :- Large inputs of heated water from a single plant or a number of plants using
the same lake or slow-moving stream can have harmful effects on aquatic life. Thermal pollution
is radiation of heat generated by plants in industries.

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 Cost and Management Audit

The different types, cause and effects of environmental pollution may be as follows -
(f) Visual pollution :- Effluents from chemical plants and washeries are discharged into the waterways
causing reduced visibility. Industrial fumes and dust causing loss of landscape attractiveness
(g) Climate pollution :- Radiation of heat in highly industrial centres leading to “micro climate zones”
causing deforestation, shortening plants growth.
(h) Radiation pollution :- Radioactive fallouts, leakage from nuclear reactors causes a significant
chronic affect by increasing the rate of genetic mutation.
(i) Soil/land pollution :- Indiscriminate use of fertilizers and pesticides. Due to pollution the quality
of soil deteriorates

Energy Audit
An Energy Audit has been defined as an inspection, survey and analysis of energy flows in a building,
process or system with the objective of instituting energy efficiency programs in an establishment.
In other words, an energy audit is conducted to seek opportunities to reduce the amount of energy
input into the system without negatively affecting the output(s).
Energy audit means monitoring the energy efficiency of different equipment and process.
An energy audit is a fundamental step of the energy conservation programme.
Energy audit and environment audit sometimes done together.

Productivity Audit/Efficiency Audit

The Productivity audit is basically an analysis of the productivity of the resources deployed by any
organization. The term ‘resources’ here would include not only “money” but also “men”, “machines”,
“materials” and “methods”. The objectives of productivity audit is – to attain optimum result, and to
improve on the benchmarks. This audit would generally comprise – comparison of expected returns
on utilization of the resources vis-a-vis the actual returns; and the steps taken to improve benchmarks
of returns and the utilization. Productivity audit is done by – (a) Ratio analysis – Return on capital
employed – Return on sales – Turnover ratios of fixed assets, current assets, inventories, category-
wise debtors etc.

The following ratios are generally used in measuring productive

efficiency of the resources deployed and utilized:
Resources Deployment:-
(a) Capital employed per capital
(b) Capital employed per unit of product
(c) Gross profit to capital employed
(d) Net profit to capital employed
(e) Debt equity ratio
(f) Net worth and long-term debts to gross fixed assets.
(g) Net worth and long-term debts to net fixed assets.
(h) Debts to fixed loans

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The following ratios are generally used in measuring productive

efficiency of the resources deployed and utilized:
(i) Debts to floating loans
(j) Current assets to current liabilities
(k) Net working capital
(l) Total inventory to capital employed.
Resource Utilisation:-
(a) Capacity utilisation – Installed capacity: Utilised capacity of machines (by units)
(b) Capacity utilisation – Installed capacity: Utilised capacity of machines (by machine hours)
(c) Machine time available: Machine time utilized.
(d) Machine time consumed : Per unit of product (individually).
(e) Machine time consumed : Per capita.
(f) Gross fixed assets : Turnover
(g) Net fixed assets : Turnover
(h) Inventories : Turnover
(i) Raw materials : Turnover
(j) Work in process : Turnover
(k) Finished goods : Turnover
(l) Labour time consumed : Division-wise
(m) Labour time consumed : Product-wise

Propriety audit
The expenditure should not, prima facie.
No authority should exercise its power.
Public money should not be utilized for the benefit.

Corporate Social Responsibility (CSR) under Companies Act, 2013

“Net profit” means
(i) Any profit arising from any overseas branch or branches of the company’ whether operated as a
separate company or otherwise; and
(ii) Any dividend received from other companies in India, which are covered under and complying
with the provisions of section 135 of the act.

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 Cost and Management Audit

Corporate Social Responsibility (CSR) Audit- Process

Human Rights: Fundamental Human Rights, Freedom of association and Collective bargaining, non-
discrimination.
Business behavior: Relations with clients, suppliers and sub-contractors, Prevention of corruption and
anticompetitive practices.
Human Resources: Labor relations, Working conditions, health and safety measures.
Corporate Governance: Board of Directors, Audit and internal controls.
Environment: Pollution control measures undertaken.
Community Involvement: Impacts on local communities.

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EVALUATION OF
CORPORATE IMAGE

12
Audit Checks of Different Managerial Functions
1. Directorial Checks
(a) What routine reports are considered as directors’ meetings?
(b) Do the directors receive projected information covering the various functions of the business?
(c) “Whether the Director review strategic and financial plans for achieving long-term success of
the company.
(d) What is the directors’ policy for ensuring that the right kind of senior managers including CEO
are engaged?
(e) What interest do directors take in R&D?
(f) Have the directors set out the objects of the organization in writing?
(g) Are all activities of the organization within the scope of its objectives?
(h) What control do directors exercise on the cash flow?
(i) What is the method of determining budgets?
(j) Do up-to-date organization structure exist?
(k) What control do directors exercise over senior management training?
 Cost and Management Audit

Audit Checks of Different Managerial Functions

2. Managerial Checks
(a) Are all level of managers competent in their functions?
(b) What evidence is there that managers are up-to-date in their particular function?
(c) Do all managers sufficiently and efficiently delegate their function?
(d) Are there any example of delegation to the point where control is lost?
(e) Are there adequately defined communication procedures?
(f) Is there adequate definition of stuff responsibilities?
(g) Is there a precise organizational structure?
(h) Is there a system of management by objectives?
(i) Are job specifications available?
(j) Are methods of work defined?
(k) What training facilities or arrangements are there for:
a. Managers?
b. Staff generally?
c. Newly joined staff?
d. Trainees?
(l) Who is responsible for training?
(m) Do managers use their time effectively?
3. Organisational Checks
(a) How effective is the coordination and integration of the various departments?
(b) What is the management information system and who is responsible for it?
(c) Is the information supplied well ?
(d) Is the information structured?
(e) What strengths and weaknesses of the organization are revealed by the scrutiny of the
special reports?
(f) How is inflation catered for in budgets?
(g) Has each manager defined the responsibilities of his staff?
(h) What checks are there on the accuracy of the information?
(i) Who has authority to amend such file information?
(j) What security controls are there on the various levels of management information?
(k) How is the business controlled in general?

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Audit Checks of Different Managerial Functions

4. Capital Checks
(a) who actually controls the cash flow on a day to day basis?
(b) How effective is the control of cash flow?
(c) Is the working capital adequate?
(d) Is the capital employed the optimum for the business?
(e) Are the fixed assets valued carefully
(f) What authorizations are required for the purchase of fixed assets?
(g) Is there an up-to-date asset register?
(h) How often is the asset register compared with the actual fixed assets position?
(i) Is the equity and loan capital adequate of the business?
(j) How do the ratio of such capital compare with other business audited?
(k) What is the capital structure in relation to ordinary and preference share?
5. Data Processing Systems Checks
(a) What are the main categories of data processing system?
(b) Are there adequate controls?
(c) Is use made of appropriate office techniques, such as photocopying, duplicating etc?
(d) Are computer systems used where appropriate?
(e) Is the computer installation appropriate in size and staffing?
(f) Who has access to the computer installations?
(g) How is systems testing organized?
(h) Are recovery procedures featured in systems testing?
6. Standard Procedures Checks
(a) Do standard procedures exist and are they in writing?
(b) Who is responsible for keeping them up-to-date?
(c) Do they adequately reflect changes in organization?
(d) To whom are they circulated?
(e) Are any checks carried out on behalf of general management to verify that the procedures
are being adhered to?
(f) If so, who is responsible for carrying out such checks?

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 Cost and Management Audit

Audit Checks of Different Managerial Functions

7. Planning Function Organisation Checks
(a) Who is responsible for overall planning within the organization?
(b) If detailed planning is a staff function, what arrangements are there for making sure the
planning does not get out of step with the planning policy makers?
(c) Is there a corporate planning unit?
(d) Is there a corporate stimulation model?
(e) How accurate are the models?
(f) How are the various models kept up-to-date?
(g) Are environmental surveys carried out?
8. Purchasing Function Checks
(a) Are there effective arrangements for minimizing the price of purchases?
(b) What arrangement are there for controlling stock investment, in particular for controlling
deliveries of raw materials, perhaps as a result of contracts placed for raw materials to be
called off as required?
(c) Is there evidence that the purchasing budget is developing on sound lines?
(d) Effective control on the purchasing function?
(e) Are ‘make-or-buy’ proposals made?
(f) What follow-up is there on scheduled deliveries?
(g) Is the receipt of goods adequately controlled?
(h) Is there an effective system of inspection of materials received?
9. Inventory Control Function Checks
(a) How are maximum and minimum stock controlled?
(b) What customer service level is required?
(c) How are these limits determined?
(d) Is stock control also a function of the economic batch quantities?
(e) How is the issue of stock controlled?
(f) What are the systems of stock security?
(g) Who has authority to scrap the stock?
(h) Are all stock movements accounted for by any paper work?
(i) Is there any security check that goods leaving the premises are covered by one or other of
the permitted authorizing documents?
(j) What system is in force for counting the stock?
(k) What is the procedure for investigating any discrepancies in stock?

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Audit Checks of Different Managerial Functions

10. Production Function Checks
(a) How are the production requirements for raw materials communicated to the purchasing
function?
(b) How is the production scheduled?
(c) Are these methods suitable for the type, size and complexity of the production processes?
(d) What is the system for amendments to the production schedule?
(e) How are labour requirement determined?
(f) What system is there for ensuring good utilisation for machinery?
(g) what is the system for ensuring good utilisation of labour?
(h) What is the inspection system during production?
(i) How are scrap items to be re-worked and controlled?
(j) What methods are used for forecasting the production levels?
11. Marketing Function Checks
(a) Have clear marketing objectives been set?
(b) What plans have been developed to attain those objectives?
(c) What is the extent and nature of market research?
(d) What principles apply to product planning?
(e) What arrangements are therefore the planning and control of packaging?
(f) How is the effectiveness of special sales promotions?
(g) How is the sales force divided geographically?
(h) How is the performance of salesman measured?
(i) What special incentives are there for salesmen?
(j) How are customers’ orders received?
(k) Has a standard order form been considered?
12. Distribution Function Checks
(a) Are there arrangements for deciding the most viable means of transport of finished goods?
(b) What are these arrangements?
(c) how were they developed?
(d) If the organization uses its own transport fleet, have the pros and cons been considered?
(e) Are decentralized warehouses part of the distribution system?

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 Cost and Management Audit

Audit Checks of Different Managerial Functions

13. Financial Function Checks
(a) Is there an internal audit department?
(b) Does the internal audit department make regular reports
(c) Are control checks made the financial records?
(d) Is there a budgetary control system?
(e) How effective is the budget system?
(f) Are the reasons for the discrepancies carefully ascertained and noted in the records?
(g) Are the financial records so organized that the performance of senior managers can be
measured?
(h) How is the personnel expenditure authorized?
(i) How is the material expenditure authorized?
(j) How is fixed asset expenditure authorized?
14. Personal Function Checks
(a) Is there a manpower specification?
(b) Who has the authority to amend the manpower specification?
(c) How do staff measure up to this manpower specification?
(d) Has job evaluation been carried out?
(e) Do job specifications exist for all jobs in the organization?
(f) Are adequate personnel records properly maintained at all times?
(g) Is there an active training programme?
(h) Who is responsible for training managers?
(i) What arrangements are there for the management development?
(j) Are adequate training records kept?
(k) How is basic training carried out?
(l) Is this carried out “in-house”, “externally” or a mixture of both?
(m) Are promotable employees readily identifiable?

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Audit Checks of Different Managerial Functions

15. Management Service Function and Data Processing Security Checks
(a) What services are covered by the department?
(b) Are the roles of the various specialists defined?
(c) To whom does the head of the management services report?
(d) To whom does the head of the computer department report?
(e) Are the duties of each section clearly defined?
(f) Are operation research techniques practiced?
(g) Are managers generally aware of the type of problem amenable to an operations research
approach?
(h) How are projects controlled?
(i) Are projects selected as a result of cost-benefit studies?
(j) Is a project team leader always appointed?
(k) Are the objectives of a project always specifically stated?
(l) What measurement of project progress are used?
16. Equipment Checks
(a) Who authorizes the purchase or rental capital equipment?
(b) What are the procedures for specifying equipment required?
(c) Is recently obtained equipment in accordance with the specification?
(d) How does capital equipment generally relate to the needs of the business?
(e) Is there the proper balance of office equipment and facilities?
(f) Where a large number of copies of computer output are required, have the merits of
producing an offset master and/or the use of micro film considered?
(g) What methods are used for the efficient scheduling of the use of machinery?
17. Methods and Systems Audit Checks
(a) What general control is there on methods and systems?
(b) How efficiently is this exercised?
(c) How are methods and systems knitted into the organizations?
(d) What detailed control is there on the implementation of a system?
(e) If the stages of implementation of a system?
(f) How are methods and systems maintained and documented?
(g) How are systems evaluated?
(h) What is the method of development of a system?
(i) Are flow charts used?
(j) How is the documentation used?

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 Cost and Management Audit

Audit Checks of Different Managerial Functions

18. Security Audit Checks
(a) What security precautions are taken against leakage of those aspects of the organization’s
policy and planning, which are desired to be kept secret?
(b) In particular, what security precautions are taken at boardroom level?
(c) Is assess to research and development areas controlled?
(d) Are the controls efficient?
(e) What are the documentary and drawings security controls?
(f) Who is responsible for the security of the company assets?
(g) What measures are taken for the security of cash?
(h) How is cash transferred to the bank?
(i) Is there a fixed asset register and who is responsible for maintaining it?
(j) How effective is the control of receipts and issues of stock-in- trade?
(k) How often are stock-in-trade and raw materials items physically counted?
(l) What action is taken when physically counted stock varies significantly from the book stock?

Audit Checks of Corporate Divisions/Departments

The audit checks of various corporate divisions/ departments include:
1. Evaluation of Purchase Management
2. Evaluation of Personnel Management
3. Evaluation of Production Management
4. Evaluation of Research and Development Activities
5. Marketing Audit
(i) Evaluation of Sales Management
(ii) Evaluation of Distribution Function

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INTERNAL CONTROL, INTERNAL
AUDIT UNDER THE COMPANIES
ACT, 2013 AND OPERATIONAL
AUDIT

13

INTERNAL CONTROL – CONCEPT

Control is a basic human requirement and it has existed throughout the ages in different facets of human
ac vity. Business as such is a complex process and has grown even more complex with the technological
advancement of the society. The formalisa on of the concept of internal control in the sphere of business
administra on is a compara vely recent phenomenon.
In the sphere of a business, control is an accepted device for op mum u lisa on of the resources and
opportuni es for maximisa on of profits. All opera ons of a business are carried on with the help of
human agents and equipment; both these factors need supervision so that the tasks assigned to them are
properly carried out and avoidable wastes and losses do not occur to eat up the fruit of the enterprise.
Internal Control means – Iden fying and Assessing the Risk of Material Misstatement Through
Understanding the En ty and its Environment.
The internal control may be defined as the process designed, implemented and maintained by those
charged with governance, management and other personnel to provide reasonable assurance about the
 Cost and Management Audit

achievement of an en ty’s objec ves with regard to reliability of financial repor ng, effec veness and
efficiency of opera ons, safeguarding of assets, and compliance with applicable laws and regula ons.
OBJECTIVES OF INTERNAL CONTROL
The main objec ves of internal control are to ensure that —
(a) transac ons are executed in accordance with managements general or specific authoriza on ;
(b) all transac ons are promptly recorded in the correct amount in the appropriate accounts and in the
accoun ng period in which executed so as to permit prepara on of financial informa on within a
framework of recognized accoun ng policies and prac ces and relevant statutory requirements, if
any, and to maintain accountability for assets;
(c) assets are safeguarded from unauthorised access, use or disposi on; and
(d) the recorded assets are compared with the exis ng assets at reasonable intervals and appropriate
ac on is taken with regard to any differences.
SCOPE OF INTERNAL CONTROL
It is clear from above that internal control is an essen al pre-requisite for efficient and effec ve
management of any organisa on and is therefore, a fundamental ingredient for the successful opera on
of the business in modern days. In fact, an effec ve internal control system is a cri cal success factor for
any organiza on in the long term. They are indispensable tools for the ever-increasing risks, exposures,
and threats to accoun ng systems, data, and assets. It embraces the whole system of controls –
financial, opera onal or otherwise, established by the management in the func oning of a business
including internal check, internal audit and other forms of control. In fact, internal control has now
been recognized as fundamental and indispensable to modern audi ng. Thus internal control has its
all-embracing nature and is concerned with the controls opera ve in every area of corporate ac vity as
well as with the way in which individual controls interrelate.
The scope of internal control, according to the aforesaid defini ons, extends well beyond accoun ng
control. Thus, the latest defini on of internal control encompasses opera onal controls like quality
control, work standards, budgetary control, periodic repor ng, policy appraisals, quan ta ve control,
etc., as all parts of the internal control system. In an independent financial audit or the statutory audit,
the auditor is concerned mainly with the financial and accoun ng controls. However, in an opera onal
audit (as part of internal controls), the auditor reviews all the controls including opera onal func ons.
The internal controls can be broadly classified into following four main categories: financial & accoun ng
controls, administra ve controls, opera onal controls and compliance controls.
(i) Administra ve control – Administra ve controls include all types of managerial controls related to
the decision - making process. An example of administra ve controls is the maintenance of records
giving details of customers contacted by the salesmen.
(ii) Opera onal control – This is exercised through “management accoun ng” techniques viz. budgetary
control, standard cos ng etc.
(iii) Financial and Accoun ng control – This control refers primarily the management plans, objec ves
and procedures that are concerned with the safeguarding of assets, preven on and detec on
of fraud and error, accuracy and completeness of accoun ng records, and mely prepara on of
reliable financial informa on.

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(iv) Compliance control - These controls aim at ensuring compliance with applicable laws and
regula ons. These Controls also help to ensure compliance with laws regarding the system and
intellectual property.
STRUCTURE OF INTERNAL CONTROL
There is no uniform or iden cal structure of internal control in all the organiza ons. It o en varies in
concept and applica ons, having regard to the following factors:
(a) Type of business ;
(b) Magnitude of the business ;
(c) Infrastructure available in the organiza on ;
(d) Poten ality of the human resources and their outlook.
LIMITATIONS OF INTERNAL CONTROL
Internal control can provide only reasonable, but not absolute, assurance that the objec ves” stated
above are achieved. This is because there are some inherent limita ons of internal control, such as:
(a) Cost: It is the management’s considera on that a control be cost-effec ve.
(b) No control for unusual transac on: It is the fact that most controls do not tend to be directed at
transac ons of unusual nature;
(c) Human Error: the poten al for human error; These include the reali es that human judgement in
decision- making can be faulty and that breakdowns in internal control can occur because of human
error. For example, there may be an error in the design of, or in the change to, a control.
(d) Collusion among employees: It is the possibility of circumven on of controls through collusion with
par es outside the en ty or with employees of en ty; For example, management may enter into
side agreements with customers that alter the terms and condi ons of the en ty’s standard sales
contracts, which may result in improper revenue recogni on.
(e) Abuse of authority: It is the possibility that a person responsible for exercising control could abuse
that authority, for example, a member of management overriding a control;
(f) Inadequate procedure: It is the possibility that procedures may become inadequate due to changes
in condi ons and compliance with procedures may deteriorate;
(g) Manipula ons by management: It is the manipula ons with respect to transac ons or es mates
and judgments required in the prepara on of financial statements.
EVALUATION OF INTERNAL CONTROL
The guiding factor for audit opera ons by the auditor depends to a great extent on the soundness or
otherwise of the internal controls in the business. Due to the limita on of me, an auditor can spend
limited me only on a company’s audit. Therefore, he has to decide the extent of in-depth audit of many
areas, par cularly the checking and verifica on of rou ne aspects of financial transac ons. Sub-para
(iv) of para 4 read with para 3 of the Companies (Auditor’s Report) Order, 2015 (CARO) requires that
the auditor’s report on the account of a company to which this Order applies shall inter-alia include a
statement as to whether there is an adequate internal control system commensurate with the size of the
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 Cost and Management Audit

goods and services. It will also include whether there is a con nuing failure to correct major weaknesses
in internal control system.
The Board of directors of every listed company and the following classes of companies, as prescribed
under Rule 6 of Companies (Mee ngs of Board and its powers) Rules, 2014 shall cons tute an Audit
Commi ee:
(i) all public companies with a paid up capital of `10 Crores or more;
(ii) all public companies having turnover of `100 Crores or more;
(iii) all public companies, having in aggregate, outstanding loans or borrowings or debentures or
deposits exceeding `50 Crores or more.
The paid up share capital or turnover or outstanding loans, or borrowings or debentures or deposits, as
the case may be, as exis ng on the date of last audited Financial Statements shall be taken into account
for the purposes of this rule.
Sub-sec on (5) of sec on 177 of the Companies Act, 2013 provides that the Audit Commi ee may
call for the comments of the auditors about internal control systems, the scope of audit, including the
observa ons of the auditors and review of financial statement before their submission to the Board and
may also discuss any related issues with the internal and statutory auditors and the management of the
company.
The Audit Commi ee shall have powers to inves gate any ac vity within its terms of reference, to
seek informa on from any employee, to obtain outside legal or other professional advice, to secure
a endance of outsiders with relevant exper se, if it considers necessary.
The roles of the Audit Commi ee are: (i) evalua on of internal financial controls and risk management
systems; (ii) reviewing, with the management, performance of statutory and internal auditors, adequacy
of the internal control systems; (iii) reviewing the adequacy of internal audit func on, if any, including the
structure of the internal audit department, staffing and seniority of the official heading the department,
repor ng structure coverage and frequency of internal audit; (iv) discussion with internal auditors of
any significant findings and follow up there on; (v) reviewing the findings of any internal inves ga ons
by the internal auditors into ma ers where there is suspected fraud or irregularity or a failure of
internal control systems of a material nature and repor ng the ma er to the board; (vi) discussion with
statutory auditors before the audit commences, about the nature and scope of audit as well as post-
audit discussion to ascertain any area of concern.
The Audit Commi ee shall mandatorily review the Internal audit reports rela ng to internal control
weaknesses; and the appointment, removal and terms of remunera on of the Chief internal auditor
shall be subject to review by the Audit Commi ee.
The evalua on of internal controls including internal accoun ng controls gives an opportunity to the
auditor to a clearer insight into the opera onal systems and an overall view of the organiza onal
workings to spot weaknesses in the systems and procedures both in respect of financial and opera onal
areas of the business. The audit process effec vely evaluates the auditee’s exis ng internal controls
through the use of ques onnaires and flow charts. The internal control ques onnaire is a list of
systema cally and logically prepared ques ons designed to find out and evaluate the effec veness of
internal control systems regarding various aspects and accoun ng transac ons of an organiza on. The
ques onnaires are to be comprehensive in nature to ensure that all aspects and accoun ng transac ons
are covered which are be replied by the officials of the department or division concerned. The criteria

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for replies against each ques on are “yes”, “no”, “not applicable”, “explanatory notes” and comments”.
Normally the affirma ve answers suggest sa sfactory internal controls while nega ve answers suggest
weaknesses of internal controls.
INTERNAL CONTROL AND THE AUDITOR
The auditor shall determine whether, on the basis of the audit work performed, the auditor has iden fied
one or more deficiencies in internal control. If the auditor has iden fied one or more deficiencies
in internal control, the auditor shall determine, on the basis of the audit work performed, whether,
individually or in combina on, they cons tute significant deficiencies. The auditor shall communicate
in wri ng significant deficiencies in internal control iden fied during the audit to those charged with
governance on a mely basis.
The auditor shall also communicate to management at an appropriate level of responsibility on a mely
basis:
(a) In wri ng, significant deficiencies in internal control that the auditor has communicated or intends to
communicate to those charged with governance, unless it would be inappropriate to communicate
directly to management in the circumstances; and
(b) Other deficiencies in internal control iden fied during the audit that have not been communicated
to management by other par es and that, in the auditor’s professional judgment, are of sufficient
importance to merit management’s a en on.
The auditor shall include in the wri en communica on of significant deficiencies in internal control:
(a) A descrip on of the deficiencies and an explana on of their poten al effects; and
(b) Sufficient informa on to enable those charged with governance and management to understand
the context of the communica on. In par cular, the auditor shall explain that:
(i) The purpose of the audit was for the auditor to express an opinion on the financial statements;
(ii) The audit included considera on of internal control relevant to the prepara on of the financial
statements in order to design audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effec veness of internal control; and
(iii) The ma ers being reported are limited to those deficiencies that the auditor has iden fied
during the audit and that the auditor has concluded are of sufficient importance to merit being
reported to those charged with governance.
INTERNAL AUDITING – EVOLUTION OF THE PROFESSION
Internal Audit is an independent, objec ve assurance and consul ng ac vity designed to add value and
improve an organiza on’s opera ons. It helps an organiza on accomplish its objec ves by bringing a
systema c, disciplined approach to evaluate and improve the effec veness of risk management, control
and governance processes.
The role of internal audit is to provide independent assurance that an organiza on’s risk management,
governance, and internal control processes are opera ng effec vely. Internal audit is conducted
objec vely and designed to improve and mature an organiza on’s business prac ces.
Internal audi ng provides insight into an organiza on’s culture, policies, procedures, and aids board
and management oversight by verifying internal controls such as opera ng effec veness, risk mi ga on

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 Cost and Management Audit

controls, and compliance with any relevant laws or regula ons.

Necessity of Internal Audit
The necessity of internal audit is as follows:
1. Internal Audit assists management to improve internal controls by iden fying weaknesses in systems
and provides an opportunity to correct those weaknesses. Internal auditors deal with issues that are
important to the con nued existence and prosperity of any organisa on.
2. It helps to detect errors and frauds and provides sugges ons to improve them which help the
management to take correc ve ac on.
3. It detects the misuse of resources in me which helps to reduce unnecessary expenses.
4. It increases the morale of honest staff because evalua on of performance of any staffs will be made
at any me.
5. Internal audit checks the books of accounts, detects errors and frauds and helps in its correc on
which makes the act of External/Statutory Auditor easier.
6. It helps capacity building for organiza onal effec veness.
Scope:
Although the objec ve of each internal audit engagement is the same the por olio of ac vi es included
in the engagement and scope of an internal audit varies from organiza on to organiza on. This is
because of the fact that,
• The defini on given by the HA is visionary in nature that is poised to embark the future of the internal
audi ng profession. It does not reflect a universal approach of the internal audi ng profession.
• Different countries across the globe, and also different organiza ons within the same country are
at different maturity levels of prac cing internal audi ng. Each individual organiza on lies on a
different scale on the con nuum of ‘Maturity Index’ of internal audi ng. The con nuum is depicted
below.

The Ini al The Intermediate The Contemporary

Posi on Posi on Posi on

Focus on Focus primarily Risk Based Internal

transac ons, on compliance, Audit, Focus
Internal checks final audit and on Informa on
and accoun ng opera ons audit Systems Audit and
controls Controls

Fig : Con num of ‘Maturity Index’ of Internal Audi ng

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Advancement towards a regime where internal auditor shall, in addi on to his role of assurance provider,
also be a trusted advisor to the management & THE Board on strategic issues.

The Contemporary
Position
The Intermediate
Position

The Initial Position

Fig : Growth of Internal Audit

With the audit principles and prac ces converging across the globe, regulators in different countries
are also trying to move towards a matured prac ce of internal audit. Research suggests that an internal
auditor of the 21st century is expected and should be prepared to audit virtually everything-opera ons
(including control systems), performance, informa on and informa on systems, legal compliance,
financial statements, fraud, environmental repor ng and performance, and quality.
PREPARATION FOR AN AUDIT
In any audit, the auditor examines the evidence available to him and gives his opinion on the basis
of such examina on. Further, he has to carry out the audit with the framework of standard audi ng
prac ces and that too with ethical conduct. Thus, the ques on involved is how the auditor should
proceed to collect the necessary purposeful evidence, i.e. how he should prepare himself for an audit.
The auditor has to move in a systema c manner so that he would be in a posi on to collect and review
the purposeful evidence and also sa sfy himself of the correctness of the financial opera ons of the
business. In general, the whole audit process involves the following:
(i) Defining the scope of the audit work, i.e. prepara on of the audit engagement le er.
(ii) Obtaining the knowledge of the client’s business and formula ng the audit programme.
(iii) Evalua on of the accoun ng and internal control system exis ng in the auditee enterprise.
(iv) Determining the nature, ming and extent of audit procedures keeping in mind the audit risk and
materiality involved.
(v) Adequate documenta on is also necessary, i.e. prepara on of audit note book and working papers.
(vi) Formula on of opinion about the financial statements.
(vii) Issuance of audit report.
The auditor uses the following techniques to collect the necessary evidence:
(i) Vouching
(ii) Confirma ons
(iii) Physical examina on and observa on

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 Cost and Management Audit

(iv) Analy cal procedures

(v) Test checking
(vi) Inquiry
(vii) Electronic data processing
(viii) Prepara on of reconcilia on statements
(ix) Flow char ng
(x) Scanning
Further, the auditor has to see that various provisions of the law governing the enterprise are complied
with. He has to examine the accoun ng principles followed and disclose the deficiencies and limita on
on the scope, if any, observed by him. It is be noted that the auditor is concerned not only with the true
and fair presenta on of the affairs of the enterprise but also with the system of maintenance of accounts
to bring real benefits of efficiency in working. At the same me, it is also a fact that the selec on of the
appropriate audit procedures is a ma er of experience and judgement.
Audit Programme
An audit programme is a detailed plan of the audi ng work to be performed, specifying the procedures
to be followed in verifica on of each item and the financial statements and the es mated me required.
To be more comprehensive, an audit programme is wri en plan containing exact details with regard
to the conduct of a par cular audit. It is a descrip on or memorandum of the work to be done during
an audit. Audit programme serves as a guide in arranging and distribu ng the audit work as well as
checking against the possibility of the omissions.
Advantages of audit programme
The main advantages of an audit programme are as follows:
(i) It serves as a ready check list of audit procedures to be performed.
(ii) The audit work can be properly allocated to the audit assistants or the ar cle clerks.
(iii) The auditor may easily know the extent of work done at any point of me. Thus, the progress of
work done can be under the supervision and control of the auditor.
(iv) Audit programme would not only be useful for the audit assistants in . carrying the audit work but
for the principal too as he would be in a posi on to account for the individual responsibili es.
(v) A uniformity of the work can be a ained as the same programme would be followed from me to
me.
(vi) It is a useful basis for planning the programme for the following year.
(vii) It may be used as evidence by the auditor in the event when any charge is brought against him. He
can prove that there has no negligence on his part and he exercised reasonable care and skill while
performing the task.
Disadvantages of audit programme
The main disadvantages of an audit programme are as follows:
(i) The auditor’s task becomes mechanical and the auditors may lose interest and ini a ve.

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(ii) Drawing up of an audit programme may be unnecessary for a small concern.

(iii) Though audit programme helps in fixing responsibili es but inefficient staff may defend themselves
by sta ng that the ma er was not contained in the audit programme.
(iv) Rigid programmes cannot be laid down for each type of business.
Though an audit programme may suffer from the above disadvantages but these can be removed by
taking some ini a ves such as consul ng the audit assistants, modifying the programme on the basis of
experience gained during audit, etc.
Specimen Audit Programme
The specimen of an audit programme is given below:
M/s. XYZ Private Limited Audit Programme for the Month/ Financial Year.
Type of Audit Statutory Audit/ Tax Audit/ Internal Audit etc.
Staff Involved Mr. A (Head)
Mr. B (Audit Assistant) ................
Par culars Remarks Time Signature of Audit Head
Taken
• Obtain Management Confirma on Le er
• Cash Book
• Bank Statements
• Bank Reconcilia on Statement
• Purchase Book
• Sales Book
• Bills Register
• Journal
• Fixed Assets Register
• Debtors/Creditors Confirma ons etc.
Con nuous and Final Audit
(a) Con nuous audit
Con nuous audit involves the detailed examina on of all the transac ons by the auditor con nuously
throughout the year or at regular intervals, say fortnightly or monthly. A con nuous audit is one
which is commenced and carried on before the close of the financial year to which it relates. It
involves the constant engagement of auditor’s staff at the client office throughout the period under
review. Con nuous audit is suitable in cases where the final accounts are desired to be presented
soon a er the close of the financial year or there is great volume of transac ons or the system of
internal check is weak.
(b) Final audit
A final audit is also called as Completed Audit or Periodical Audit. Final audit is done a er the close
of the financial year, i.e. a er the books of accounts have been closed and the final accounts are
drawn up. In this type of audit, the client gives the possession of books of accounts to the auditor
for audit and rou ne checking and other audit procedures begin only a er that.

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 Cost and Management Audit

Audit Working Papers

Audit working papers are the record of the planning and execu on of the audit engagement. Auditors
retain a set of working papers for each audit engagement for each year. The audit working papers for
the current year are referred to as the current working papers. Working papers that are relevant to
more than one audit engagement are o en kept separately in a file referred to as permanent working
papers. The audit working papers (current and permanent) for a client audit engagement are sufficiently
detailed to enable another appropriately experienced and competent auditor that is not familiar with
the client to obtain an overall understanding of the engagement.
Working papers (or documenta on) serve three purposes (i) aid in planning and performance of the
audit; (ii) aid in supervision and review of the audit work; and (iii) these papers serve as an evidence of
the audit work performed by the auditor to support his opinion.
These working papers also facilitate audit planning and supervision of the audit work. The form and
content of working papers vary from audits to audits, but they are affected by the following ma ers:
(a) nature if engagement;
(b) form of audit report;
(c) nature and complexity of client’s business;
(d) nature and condi on of client’s records
(e) degree of reliance of internal controls;
(f) Supervision of work performed by assistants.
Types of Working Paper Files
In case of recurring audits, some working papers files may be classified into permanent audit files and
current audit files. While the former is updated with the informa on of con nuing importance, the la er
contains informa on rela ng to audit of a single period. The contents of these files are given below:
Permanent Audit File Current Audit File
(a) Legal and organiza onal structure of the (a) Correspondence rela ng to acceptance of
en ty, e.g. MOA and AOA in case of a company. annual reappointment.
(b) Extracts or copies of legal documents, (b) Extracts of important ma ers in the minutes
agreements and minutes relevant to the audit. of Board Mee ngs and General Mee ngs
relevant to the audit.
(c) A record if study and evalua on of internal (c) Copies of management le ers.
controls.
(d) Analysis of significant ra os & trends. (d) Analysis of transac ons and balances.
(e) Copies of the audited financial statements of (e) Copies of communica on with other auditors,
previous year(s). experts and third par es
(f) Notes regarding significant accoun ng (f) Audit programme.
policies.
(g) Significa on audit observa ons of the earlier (g) Conclusions reached on significant aspects of
years. audit.

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Working papers are the property of the auditor, the por ons or extracts of, which can be had at his
discre on. These working papers should kept in safe custody and in confiden al manner for such me
as is sufficient to meet the requirements of his prac ce or to sa sfy any related legal or professional
requirement of record reten on.
Audit Note Book
An audit book is usually a bound book in which a large variety of maters observed during the course of
audit are recorded. The audit note book is a permanent record of the auditor. For each individual audit,
the auditor usually maintains a separate audit note book. The audit note book should be maintained
clearly, completely and systema cally. An audit note book is a great eviden al tool available as a defence
with the auditors in the event of any charge is brought against them. In case of City Equitable Fire
Insurance Company, the auditors were relieved because they have maintained record of the audit work
performed at each stage.
Contents of Audit Note Book
(i) Name of the business enterprise.
(ii) Organisa on structure.
(iii) important provisions of Memorandum and Ar cles of Associa on.
(iv) Communica on with the previous auditor, if any.
(v) Management representa ons and instruc ons.
(vi) List of books of accounts maintained by the enterprise.
(vii) Accoun ng methods, internal control systems followed by the enterprise, applicable laws etc.
(viii) Key management personnel.
(ix) Errors and fraud discovered.
(x) Ma ers requiring explana ons or clarifica ons.
(xi) Special points that need a en on in the audit report and for subsequent’ audits.
Specimen of Audit Note Book
M/s. XYZ Private Limited Audit Notes for the Financial Year.

Voucher/ Account Amount Query/ Remarks How disposed of

Reference No. Involved
21 Machinery 2,000 Amount wrongly Rectified after
capitalized consulting with Mr.
A, Chief Accountant
64 P.F. 1,750 Late deposited Clarified with Mr. B
from HR
80 Advertisement 5,000 MD sanction required Sanction obtained
150 Colonel 40,000 No TDS TDS deducted and
Securities deposited with
interest
167 Rent 2,000 Receipt required Receipt obtained

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AUDIT ENGAGEMENT LETTER

Introduc on
Auditors agree with the client’s management, in wri ng, about the scope, terms and condi ons of the
audit engagement. This wri en communica on is referred to as an engagement le er. The le er is
usually addressed to chairman of the audit commi ee or, in the case of a corpora on, the chair of the
board of directors, with a copy being sent to the audit commi ee. The purpose of such a le er is to
minimize any possible misunderstanding concerning the scope and terms of the audit engagement.
The le er is sent to all new audit clients and where there has been a change in the terms of the
engagement or the auditor considers that management may not understand the exis ng terms of the
engagement, the le er is also sent to con nuing clients.
Terms of Audit Engagement
• Agreeing the terms of the engagement with the client; and
• the auditor’s response to a request by a client to change the terms of an engagement to one that
provides a lower level of assurance.
The auditor and the client should agree on the terms of the engagement. The agreement should
be in wri ng. Though the objec ve and scope of audit is determined by the relevant statue and the
pronouncement of the Ins tute, the audit engagement le ers will be informa ve to the clients.
The auditor should send an engagement le er, preferably before the commencement of the engagement,
to help avoid any misunderstanding with respect to the engagement. This will be in the interest of both
the client and the auditor.

Specimen Internal Audit Engagement Le er

[DATE]
[NAME, TITLE]
[DEPARTMENT]
[ADDRESS]
[CITY, STATE PIN]
Dear [HEAD OF DEPARTMENT]
The Internal Audit Team is planning its audit for [DEPARTMENT NAME], The objec ves of this audit will
be: [LIST ACTUAL OBJECTIVES HERE]
For example:
• Reliability and Integrity of Financial and Opera onal Informa on,
• Compliance with Laws, Regula ons, and Contracts,
• Safeguarding of Assets, and

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• Effec veness and Efficiency of Opera ons of the [AUDIT AREA], and
• To follow-up on recommenda ons included in prior audit reports. The proposed metable for this
year’s audit is as follows:
• Start date in the field: [DATE]
• Es mated weeks to complete: [NUMBER OF WEEKS] The audit team will include the following
members:

[NAME], Manager
[NAME], Staff Auditor
[NAME], Staff Auditor
At the beginning of our audit, we would like the opportunity to meet with you to discuss our audit
objec ves and solicit your input. Our goal is to perform an effec ve and efficient audit. We will need
your staff to provide us the following documents and schedules on:
1. [DOCUMENTS] and [DATE]
2. [DOCUMENTS] and [DATE]
At the conclusion of our audit, we will discuss audit results and poten al recommenda ons with
management of the audited area before scheduling an exit conference with you. Prior to the exit
conference, you will receive a dra audit report. A er the exit conference, a final audit report will be
delivered to you with a request for formal management’s responses to include in the audit report.
Our mission is to help you achieve [DEPARTMENTS] objec ves by providing you informa on about the
effec veness of internal control and by recommending courses of ac ons which improve performance.
If you have any ques ons about this year’s audit, please do not Hesitate to call
Yours truly,
[XYZ]
[Designa on]
ROLE OF CMAs IN INTERNAL AUDIT
Presently, the role of Internal Audit has become more cri cal. The backdrop and changing business
scenario and the role metamorphosed as technology have erased global barriers. Customer expecta ons
have increased and compliance demands are growing both in terms of quan ty and complexity. The
Enterprise Risk Management is emerging as the key element in Corporate Management.
The expecta ons of the Board from Internal Auditors are now to assist the Board in iden fica on,
monitoring and management of business risks and also to offer and provide insight, advice and
assurance on enterprise risks. The Internal Auditors should also inform directors about the tone of the
organiza on-culture, ethics, performance and con nuously evaluate the efficiency and effec veness of
opera ons. They should also check compliance with laws and regula ons and authen cate the reliability
of financial and management repor ng. Internal Auditors has the added role of safeguarding the assets
of the company. They should evaluate performance management and control systems and act as an
advisor to the Management. The role of effec ve Cost Management involves in waste reduc on and
enhancing produc vity and process improvement.
The Internal Audit must be synchronized to the expecta ons of the Board. It must develop an Internal

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 Cost and Management Audit

audit strategy that is linked with the organiza on’s strategic plan with a focus on op mizing risks, costs,
and value. It must develop dynamic internal audit plans. The communica on must be done frequently
with key stakeholders on their needs, expecta ons, sa sfac on with the internal audit. It should leverage
technology to op mize audit opera ons and assist management in developing and maintaining a
comprehensive performance management framework. It should support and facilitate business process
improvement and re-engineering and provide ac ve support in furthering good Corporate Governance.
CMAs have a colossal role to play as they have an unique blend of core competencies in accoun ng,
management and strategy. CMAs can apply their forward looking insights across the organiza on to
manage risks, reduce costs and create new opportuni es, preserve and enhance value.
CMAs possess the exper se to evaluate the opera onal efficiency, produc vity and profitability,
wastages, losses, inefficiency. They can apply their knowhow in judging efficiency of management of
resources, capacity u liza on, channeling resources into produc ve channels, standards of efficiency
of performance, produc on processes and performance of respec ve units. Efficiency of business
processes, Enterprise Performance Management, Business risks. Efficiency of Supply Chains, Efficiency
of U li es / Energy Consump on, Sustainability of Business are cri cal drivers to keep the business
focused on priority areas.
The perspec ve of CMAs have changed in the present era of mergers & acquisi ons, new product
development and also to climate change and sustainability. The financial perspec ve, customer
perspec ve, opera onal perspec ve and people perspec ve all can be aligned to meet the goal of the
business.
INTERNAL AUDIT UNDER COMPANIES ACT, 2013
Legisla ve background
The notes on clauses to the Companies Bill, 2011 read as follows:
“Clause 138. - This is a new clause and seeks to provide that prescribed Companies shall be required to
conduct internal audit of func ons and ac vi es of the company by internal auditor appointed by the
company. Manner of conduc ng internal audit shall be prescribed by the Central Government” Addi on
of this clause was suggested by the Standing Commi ee on Finance (2009-10). In 57th Report of the
Standing Commi ee on Finance (2011- 12) while dealing with the sugges on that in-house employees
shall be allowed as internal auditors, it was stated by the Ministry that “the provisions of clause 138
do not prohibit appointment of inhouse employee. Further, the provisions also empower the Board of
relevant company to appoint any professional (even other than a CA or CWA) as internal auditor if it so
decides. Hence both the sugges ons are already taken care of.”
The concept of internal audit was present in the Companies Act, 1956 in the form of Sec on 581ZF
which s pulated that ‘Every Producer Company shall have internal audit of its accounts carried out, at
such interval and in such manner as may be specified in ar cles, by a chartered accountant’.
‘Internal Audit’ was first made mandatory for some of the companies vide the Manufacturing and Other
Companies (Auditor Report) Order, 1975 (MAOCARO, 1975). MAOCARO, 1975 required the auditor to
cer fy whether the company has an internal audit system commensurate with its size and nature of its
business and also, whether there is an adequate internal control procedure commensurate with the
size of the company and the nature of its business, for the purchase of stores, raw materials including
components, plant and machinery, equipment and other assets, and for the sale of goods.
Therea er, MAOCARO, 1988 replaced the MAOCARO, 1975 and MAOCARO, 1988 was replaced by the

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Companies (Auditor’s Report) Order, 2003. Sec on 138 enshrines this concept with the power being
given to Central Government to prescribe the class of companies where the appointment of internal
auditor is mandatory.
The terms “func ons” and ac vi es” used in sub-sec on (1) of sec on 138 connote a much wider
scope than “Financial Audit” and “Opera ons Audit”. Therefore, it is clearly evident that the scope of
internal audit is very wide and it covers the compliance systems in companies covering all the func ons
of any company. Internal Audit requires an in depth understanding of the business culture, systems
and processes, understanding and improvement of internal controls for effec ve risk management,
understanding the governance structure of the organisa on and ability to provide value addi ons for
improvement in governance processes.
The internal audit may contribute in the following areas:
(a) Independent review and appraisal of control systems across the organiza on (both financial control
systems and opera onal areas where the organiza on may reap benefits)
(b) Ascertainment of the extent of compliance of policies, procedures, regula ons and legisla ons.
Checking compliance management systems of an organiza on.
(c) Facilitate good prac ces in management of risk. This requires systems for ascertaining, measuring,
managing and where possible mi ga on or dispersion of the risk.
(d) Achieve savings by iden fying waste, inefficiency and duplica on of effort across the organiza on
(e) Structuring programs and ac vi es such that company assets are safeguarded and there are
internal check systems which minimize the possibility for reducing fraud / early warning signals for
iden fying fraud.
Compulsory requirement for appointment of Internal auditor(s) in listed and specified companies
Sec on 138 read with rule 13 of the Companies (Accounts) Rules, 2014 provide that following class of
companies shall be required to appoint an internal auditor or a firm of internal auditor; namely:
(a) every listed company
(b) every unlisted public company having;
(i) paid up share capital of `50 crores or more during the preceding financial year; or
(ii) turnover of `200 crore or more during the preceding financial year; or
(iii) outstanding loans or borrowings from banks or public financial ins tu ons exceeding ` 100
crore or more at any point of me during the preceding financial year; or
(iv) which has accepted deposits of `25 crore or more at any point of me during the last financial
year; and.
(c) every private company having
(i) turnover of two hundred crore rupees or more during the preceding financial year; or
(ii) outstanding loans or borrowings from banks or public financial ins tu ons exceeding one
hundred crore rupees or more at any point of me during the preceding financial year:
Provided that an exis ng company covered under any of the above criteria shall comply with the
requirements of sec on 138 and this rule within six months of commencement of such sec on.

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Explana on — For the purposes of this rule—

(i) the internal auditor may or may not be an employee of the company;
(ii) the term “Chartered Accountant” shall mean a Chartered Accountant whether engaged in prac ce
or not.
The Audit Commi ee of the company or the Board shall, in consulta on with the Internal Auditor,
formulate the scope, func oning, periodicity and methodology for conduc ng the internal audit.
Eligibility for appointment as internal auditor
Such class or classes of companies as may be rprescribed shall be required to appoint an internal auditor,
who shall either be a chartered accountant or a cost accountant, or such other professional as may be
decided by the Board to conduct internal audit of the func ons and ac vi es of the company.
The Central Government may, by rules, prescribed the manner and the intervals in which the internal
audit shall be conducted and reported to the Board.
Requirement for filing of Form MGT-14 with the RoC on appointment of the Internal Auditor
The appointment of internal auditor can be done only by means of a resolu on passed at the mee ng
of the Board as specified under rule 8 of the Companies (Mee ng of Board and its Powers) Rules, 2014
and accordingly, the company is also required to file Form MGT-14 with the Registrar within 30 days from
the date of passing of resolu on by the Board. However, filing of resolu ons under clause (g) of sub-
sec on (3) of sec on 117 has been exempted for private companies vide Ministry of Corporate Affairs
no fica on No.G.S.R.464(E) dated 05.06.2015. However, the Private Company is s ll required to comply
the requirements of Sec on 179.
Authority to appoint the Internal Auditors
Rule 13(2) of the Companies (Accounts) Rules, 2014 set forth that the Audit Commi ee of the company
or the Board shall, in consulta on with the Internal Auditor, formulate the scope, func oning, periodicity
and methodology for conduc ng the internal audit.
Statutory Auditors cannot be appointed as Internal Auditors
MCA Circular No. 29 of 1976, dated 27-8-1976 states that the internal auditor is appointed by the
management and hence is in the posi on of an employee, whereas the statutory auditor is appointed
by the company in accordance with the provisions of sec on 224 [sec on 139 of the Companies Act,
2013] and the auditor is required to perform the du es enjoined on him under sec on 227 [sec on 143
of the Companies Act, 2013] and the Rules/ Orders issued there under. As such, in the opinion of the
Department (MCA), a statutory auditor of a company cannot also be its internal auditor.
Forma on of policy and procedure for appointment of the internal auditor
The Companies (Accounts) Rules, 2014 provides that the Audit Commi ee of the company or the
Board shall, in consulta on with the Internal Auditor, formulate the scope, func oning, periodicity and
methodology for conduc ng the internal audit.
Exis ng companies need to appoint the Internal Auditors within a period of six months, i.e. before
30th September, 2014
In case of an exis ng company, which needs to appoint internal auditors pursuant to the provisions of
sec on 138 of the Companies Act, 2013 read with Rule 13 of the Companies (Accounts) Rules, 2014,
shall appoint the internal auditor within a period of 6 months from the commencement of the sec on,

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i.e. needs to comply with the requirement before 30th September, 2014.
Scope of internal audit
Sub-sec on (2) of sec on 138 gives power to central government to make rules and prescribe the manner
and the intervals in which the internal audit shall be conducted and reported to the board. Rule 13 does
not provide the scope of internal audit. However, rule 13 prescribed that the audit commi ee of the
company or the Board shall, in consulta on with the Internal Auditor, formulate the scope, func oning,
periodicity and methodology for conduc ng the internal audit
Powers and du es of internal auditor
There are no powers and du es of internal auditor prescribed under the Act. The same may be governed
by the terms of reference of the appointment of internal auditor which may be decided mutually
between the company and the internal auditor.
Punishment and Compound ability
There are no specific penal provisions provided in this sec on 138. Therefore the penal provisions under
sec on 450 would apply in case of any non-compliance of this sec on. Accordingly, for contraven on,
the company and every officer of the company who is in default shall be punishable with a fine upto
`10,000, in case the contraven on is a con nuing one then the further fine shall be `1,000 every day. The
offences under this sec on are compoundable under sec on 441 of the Act.
INTERNAL AUDIT AND COMPANIES (AUDITOR’S REPORT) ORDER
The Central Government in exercise of the powers conferred under sub- I sec on (4A) of the sec on 227
of the Companies Act, 1956, has issued the I Companies (Auditor’s Report) Order, 2003 (“the Order” or
“the CARO”) vide I No fica on No. GSR 480(E), dated June 12, 2003. The Order contains certain I ma ers
on which the auditors of the Companies (excep ng those companies which are specifically exempted
under it) have to make a statement in their audit report.
Sec on 227(4A) of the Companies Act, 1956 ceased to be opera onal from 1 April 2014 a er no fica on
of sec on 143(11) under the Companies Act, 2013. Though sec on 143(11) of the 2013 Act provides
requirements similar to sec on 227(4A) of the 1956 Act, the MCA had not prescribed CARO related
requirements. Consequently, a er consul ng the Ins tute of Chartered Accountants of India (ICAI), the
MCA on 10 April 2015 issued the Companies (Auditor’s Report) Order, 2015 (CARO - 2015) prescribing
certain repor ng requirements for auditors of certain class of companies. CARO - 2015 will be effec ve
from the date of its publica on in the Official Gaze e. As compared to the CARO - 2003, the repor ng
requirements under the CARO - 2015 have been reduced considerably (i.e. from 21 repor ng clauses to
12 clauses).
Clause 4(iv) and Clause 4(vii) of CARO, 2003 and Clause 3(iv) of CARO, 2015 spells out the requirements
as to repor ng by the statutory auditors on the internal control system and internal audit system
respec vely. Each of these clauses is discussed as below.
Clause 4(iv) of CARO, 2003 and Clause 3(iv) of CARO, 2015
Is there an adequate internal control system commensurate with the size of the company and the nature
of its business, for the purchase of inventory and fixed assets and for the sale of goods and services.
Whether there is a con nuing failure to correct major weaknesses in internal control system [Clause
4(iv) of CARO, 2003]

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 Cost and Management Audit

Is there an adequate internal control procedure commensurate with the size of the company and the
nature of its business, for the purchase of inventory and fixed assets and for the sale of goods? Whether
there is a con nuing failure to correct major weaknesses in internal control. [Clause 3(iv) of CARO, 2015]
(i) Internal Control System
As per SA 200R, Internal Control System refers to all the policies and procedures adopted by the
management of the en ty to assist in achieving management’s objec ve ensuring the orderly and
efficient conduc ng the business, the accuracy and completeness of accoun ng records, the mely
prepara on of financial informa on, safeguarding of assets of enterprise and defec on of fraud and
error in a mely manner.
(ii) Extent of Repor ng
It may be noted that obtaining an understanding of internal control system is a normal audit
procedure. As per SA 315, the internal audit func on cons tutes a separate component of internal
control with the objec ve of determining whether other internal controls are well designed and
properly evaluated. While the requirement of the Order is confined only to the internal control
system as regards purchases of inventory, and fixed assets and the sale of goods and services, it
does not in any way reduces the responsibility of the auditor to examine other areas. It only signifies
that while a special a en on is required for the repor ng on specified items of this clause, but to
ensure a true and fair view of the financial statements, the examina on of internal controls has to
be extended to all the other areas.
(iii) Major Weakness
The Order does not define as to what cons tutes ‘major weakness.’ Thus, it may be interpreted that
major weakness depends upon the facts and circumstances of each case. For this, an auditor has
to exercise his professional judgment. One view may be taken that any weakness in internal control
which exposes the enterprise to a risk of significant loss is material weakness. Another view may be
that a weakness in internal control exposing an organisa on to the risk of material misstatement(s)
in the financial statements is major weakness. It may be noted that while evalua ng what is major
weakness, the concept of audit materiality should always be given due considera on. It should also
be noted that adequacy of internal controls and major weakness should be considered as dis nct
aspects of this clause, i.e. it does not mean that if there are no major weakness in internal control
system, then the internal control system is adequate
(iv) Adequacy of Internal Controls
As per SA 200R read with SA 315, the auditor should obtain an understanding of the accoun ng
system sufficient to iden fy and understand major classes of transac ons, manner of ini a on
of transac ons, significant accoun ng records, suppor ng documents and specific accounts in
the financial statements and the accoun ng and financial repor ng process. Accoun ng control
comprises the plan of an organisa on and the procedures and records that are concerned with the
safeguarding of assets and the reliability of financial controls. Internal control so far as financial and
accoun ng aspects are concerned, aims at the following:
(i) Providing the flow of work through various stages.
(ii) There should be proper segrega on of personnel du es so that no single person can be in a
posi on to handle whole of the work from its beginning to its end.

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(iii) Adequate documenta on should be made at each stage of work.

(iv) The transac ons are recorded with appropriate amounts and in mely manner and that too as
per the applicable accoun ng policies and prac ces.
(v) The assets should be properly safeguarded. The access to the assets
(vi) should be restricted to only authorised persons.
(vii) Existence of organisa onal chart would help in fixing responsibili es.
(viii) Building up of a system to locate the devia ons and departures from the prescribed procedures
and to detect the frauds and errors automa cally without mush loss of me.
(ix) Standardized records and formats should be evolved. It would ensure availability of right
informa on at right me.
(x) There should be an efficient Management Informa on System.
(xi) Minimiza on of loss and wastages.
(xii) Employees should be encouraged to do good work and comply with the procedures. Special
a en on should be given to the disgruntled employees.
(xiii) Adequate cut off procedures should be formulated so that the transac ons of one period can
be separated from the transac ons of other period.
(v) Con nuing Failure
This expression has also not been defined by the Order. What cons tutes ‘con nuing failure’ again
depends upon the facts and circumstances of each case. For example, if the auditor has iden fied a
weakness in the previous year and reported the same to the management, but it con nues to exist
in the current year, then it would cons tute ‘con nuing failure.’ Further, where the auditor based on
the preliminary discussions with management, in mated the management of the major weakness
at the audit planning stage at the beginning of the year, but the same was not corrected even at the
me of issuing audit report, this would also cons tute a ‘con nuing failure.’
(vi) Checklist and Specimen Repor ng
1. On the basis of the understanding, documenta on and valida on thereof of the ac vi es in the
areas of Inventory cycle, property, plant and equipment cycle, revenue and receivables cycle,
review of internal audit reports whether sa sfied that there is an adequate internal control
system commensurate with the size of the company and the nature of its business for the
purchase of inventory and fixed assets and for the sale of goods and services;
2. If not, document the inadequacies and weaknesses thereof and consider implica ons for
repor ng;
3. Review the reports of internal audit, minutes of the Board, Audit commi ee, management
commi ee, if any and any other relevant internal reports to iden fy major weaknesses in
internal controls and whether there is any con nuing failure to correct such weaknesses;
4. In the case of con nuing failure to correct any major weakness iden fied, report the weakness
and steps taken by the management to correct such weakness, if addressed subsequent to the
balance sheet date or the fact of failure to correct such weakness;

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5. Consider the implica ons of such control weaknesses on the nature, extent and ming of audit
procedures in those areas and implica ons, if any, on the adequacy or reliability of the books of
account and the overall report.
Clause 4(vii) of CARO, 2003
In the case of listed companies and/or other companies having a paid-up capital and reserves exceeding
` 50 lakhs as at the commencement of the financial year concerned, or having an average annual turnover
exceeding five crore rupees for a period of three consecu ve financial years immediately preceding the
financial year concerned, whether the company has an internal audit system commensurate with its size
and nature of its business
(i) Extent
In respect of the companies, which do not fall within this clause, there is no requirement to make
any specific men on in the audit report. But the auditors should make inquiries regarding internal
audit since it forms an integral part of the internal control system. This will act as a supplement to
the auditor’s duty under clause 4(iv).
(ii) New Company and Turnover Criterion
A company cannot be covered under this clause during the first three years of opera on because
the average turnover of the three financial years immediately preceding the financial year under
audit is to be considered. It may also be noted that the financial year may comprise of a period
of more or less than 12 months. It may be further noted that turnover of the current year is not
relevant. Thus, even if the average turnover of the preceding three financial years exceeds `5 crores
but the turnover in the current year is nil, this clause will be applicable to the company.
The term, “turnover”, has not been defined by the Order. Part II of Schedule VI to the Act, however,
defines the term “turnover” as the aggregate amount for which sales are affected by the company.
It may be noted that the “sales effected” would include sale of goods as well as services rendered
by the company. In an agency rela onship, turnover is the amount of commission earned by the
agent and not the aggregate amount for which sales are affected or services are rendered. The
term “turnover” is a commercial term and it should be construed in accordance with the method of
accoun ng regularly employed by the company. For ascertaining the limit of rupees five crores:
(a) GST charged should not be taken into account separately to sales tax account or excise duty
account;
(b) trade discounts should be deducted from the figure of turnover;
(c) commission allowed to third par es should not be deducted from the figure of turnover; and
(d) sales returns should be deducted from the figure of turnover even if the returns are from the
sales made in the earlier years.
(iii) Lis ng requirements
CARO does not specify the date with reference to which the lis ng status of the company is required
to be determined. As per Statement on CARO issued by ICAI, if the company is listed on the recognised

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stock exchange as on the date of balance sheet, it should be considered as listed for the purpose
of this clause. Further, internal audit would apply to an unlisted company only if equity (paid up
capital and reserves) or turnover criterions are sa sfied. It may be noted that any security listed by
the company would give it a listed status. Thus, where the debentures of a company are listed on a
recognised stock exchange but its shares are not listed, this clause will s ll remain applicable to the
company.
(iv) Checklist and Specimen Repor ng
1. Is the company a listed company or having paid up capital and reserves exceeding `50 lakhs
as at the commencement of the financial concerned or having an average annual turnover
exceeding five crores rupees for a period of three consecu ve financial years immediately
preceding the financial year;
2. Consider the following factors to determine whether the internal audit system is commensurate
with the size of the and the nature of its business: Size of the internal audit department;
Qualifica ons of the internal audit staff; Repor ng levels of internal audit; Areas of coverage;
Adequacy of technical assistance available to die internal audit department; Reports submi ed
by the internal audit and follow up procedures thereof.
OPERATIONAL AUDIT
The internal audit func on in any organisa on can be broadly categorized into three major func ons
namely (a) financial audit (b) compliance audit and (c) opera onal audits. However, an opera onal audit
is some mes defined as an extension of a financial audit. Regulatory agencies or other organiza ons
concerned with compliance generally either send in their own auditors or hire an external audit firm.
Therefore, Internal Audit mainly plays a supplementary role only in financial and compliance audits, but
opera onal audi ng is the primary, albeit not the exclusive, domain of the internal auditor.
An opera onal audit (or value-for-money audit) has been defined as an organized search for ways
of improving efficiency and effec veness. The objec ve of this audit is to assist the organiza on in
performing func ons more effec vely and economically with focus on the efficiency and effec veness
of opera ons, it is also stated to be an early warning system for the detec on of poten ally destruc ve
problems.
An opera onal audit can lead to be er management of all aspects of business organisa on whether it
is produc on area or service area. Tradi onally, opera onal audits have been conducted by means of a
ques onnaire interview of departmental employees. Virtually all large companies conduct opera onal
audits in their major produc on and service departments. The financial audit tells where the en ty
was and where it is on the date of the balance-sheet. However, an opera onal audit tends to answer
the ques ons as to why the en ty is where it is and how it got there. It means the evalua on of
management’s performance and efficiency. Therefore, Opera ons Audit is a process to determine ways
to improve produc on. It falls into the category of a management service by evalua ng the four func ons
of management: (1) planning, (2) organizing, (3) direc ng, and (4) controlling. The opera onal audit can
also be broken down further as a func onal review; for example, Purchasing as a department versus the
overall Procurement opera on in coordina on with produc on scheduling and market forecas ng. The
following table highlights the salient features of the tradi onal form of internal audit and opera onal
audit :

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INTERNAL AUDIT OPERATIONAL AUDIT

1. Compliance objective Risk identification, process improvement objective
2. Financial accounts focus Business focus
3. Audit focus Efficiency & improvement focus
4. Transaction-based Process-based
5. Policies and procedures focus Risk management focus
6. Cost Centre wise budget monitoring Accountability for performance improvement results
7. Methodology : Focus on policies, transactions and Methodology : Focus on goals, strategies and risk
compliance management processes

The Commi ee of Sponsoring Organiza ons of the Treadway Commission (COSO) had recently issued
the “COSO report”, which was jointly sponsored by the Ins tute of Internal Auditors (IIA), the American
Ins tute of CPAs, the Financial Execu ves Ins tute, the American Accoun ng Associa on, and the
Ins tute of Management to provide a common, widely accepted defini on of internal control and provide
a framework of internal control which can be used as a benchmark for assessing its effec veness. The
COSO report defines internal control as follows:
…a process, effected by an en ty’s board of directors, management and other personnel, which is
designed to provide reasonable assurance regarding the achievement of objec ves in one or more
categories:
– effec veness and efficiency of opera ons
– reliability of financial informa on
– compliance with applicable laws and regula ons
Opera onal audits concerned with the objec ves of efficiency and effec veness. There are many reasons
for performing an opera onal audit: compliance with policies and procedures, excessive sales returns,
proposed product mix, equipment down me or personnel turnover etc. Therefore, an auditor must
establish the scope of an opera onal audit before formula ng the approach to ini ate an opera onal
audit. This step will determine the extent of the scope of audit. The second step shall be to understand
the auditee’s opera on, its purpose in the total environment of the en ty, its history, its image, its staff,
their skills and competence and its repor ng path. The repor ng path is of very cri cal importance
because this path is the communica on route along which, the audit results and conclusions will flow.
The prime records to be obtained in an opera onal audit are the organiza onal chart of the func on/
opera on, applicable policies, guidelines and procedures etc. These will outline each employee’s
responsibility and authority. The func on’s/opera on’s performance reports for the reasonable period
prior to the audit should be reviewed to do trend analyses or the cri cal analyses. These analyses
or reports could indicate poten al cri cal areas such as over- or under-staffing, noncompliance with
corporate policies and procedures, weaknesses in internal controls, or inadequate job rota ons etc.
These indica ons could help the management auditor in determining scope of inves ga on and areas
of poten al improvement. Reports must be based on facts, informa ve, submi ed in me and directed
to the proper levels of management.

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MEANING OF INTERNAL CONTROL

Internal control means Internal Control means the

procedures established,
identifying & assessing the risk
implemented & maintained by
material mis-statement
TCWG, MGT 4, other personnel in
understanding the entity & its organization which provides
environment. reasonable assurance regarding
achievement of organization’s
objectives with regard to

Internal Control means the procedures established, implemented & maintained by TCWG,
MGT 4, other personnel in organization which provides reasonable assurance regarding
achievement of organization’s objectives with regard to

Proper
Reliability of Compliance of
execution of Safeguarding
Financial applicable
day to day of assets and
Reporting. laws.
operations.

OBJECTIVES OF INTERNAL CONTROL

Transactions are Recorded assets are

Transactions promptly Assets are compared with
are executed as recorded in safeguarded physical assets at
per Correct Account, from reasonable intervals
Management’s Date & Correct unauthorized & in case of any
authorization. Accounting access. discrepancy, proper
Period. action is taken.

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SCOPE OF INTERNAL CONTROL

FINANCIAL AND
ADMINISTRATIVE OPERATIONAL COMPLIANCE
ACCOUNTING
CONTROL CONTROL CONTROL
CONTROL

It includes all types These controls are

of Managerial the managements
It is exercised
Controls related to plan relating to
through
decision making safeguarding of
management It relates to timely
process. An example assets, prevention &
accounting technique compliance of all
of It is maintaining a detection of frauds &
such as Budgetary applicable laws.
register showing the errors, accurate
Control & Standard
details of customers accounting records &
Costing.
contacted by timely preparation of
salesmen. financial Statements.

STRUCTURE OF INTERNAL CONTROL

Internal Control from organization to organization & it’s structure depends on
four factors.

Infrastructure Potentiality Of
Magnitude Of
Types Of Business available in the Human
Business
Organization. Resources.

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LIMITATION OF INTERNAL CONTROL

No matter how strong internal control is but it can only provide a reasonable
assurance with respect to achievement of organization’s objectives & never an
absdute assurance due to limitations of internal control.

MANUPULATION COLLUSION
UNUSUAL HUMAN ABUSE OF
COST BY AMONG
TRANSACTIONS ERROR AUTHORITY
MANAGEMENT EMPLOYEE

COST

Management may not want to make a strong internal control due to cost
evolving in it.

UNUSUAL TRANSACTIONS

No control can be made for unusual transactions.

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 Cost and Management Audit

HUMAN ERROR

There is always a chance of error being made by employees handling internal

control.

ABUSE OF AUTHORITY

Management may over ride the internal control for its own benefits.

MANIPULATION BY MANAGEMENT

Management may manipulate the accounting estimates & judgements.

COLLUSION AMONG EMPLOYEES

Employees may have ego clashes or other conflicts white managing internal
control.

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EVALUATION OF INTERNAL CONTROL

Evaluation of
Audit Committee is
It means checking internal control is
applicable on
the effectiveness of mainly done by
Companies under
internal control. Audit Committee
section 177
(AC).

FOLLOWING ARE THE COMPANIES REQUIRED TO CONSIDER

AUDIT COMMITTEE

Unlisted Public Co.

Unlisted Public Co.
Unlisted Public Co. having Outstanding
having Paid Up
Listed company having turnover Min Loan, Debenture,
Share Capital Min
100 Cr. Borrowings &
10 Cr.
Deposits > 50 Cr

These limits will be checked of last audited financial statements.

Also Audit Committee not applicable on following unlisted Public Co.

Wholly Owned
Joint Venture Dormant Company
Subsidiary

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ROLE/FUNCTIONS OF AUDIT COMMITTEE

Reviewing Discussion
Evaluation of Reviewing Asking the
the with
Internal the statutory Reviewing the
adequacy statutory
Financial performance auditor findings of
of internal auditor
Control & of both about its investigations
control & before the
Risk statutory & comments by internal
internal audit about
management internal on internal auditors.
audit his scope of
system. auditors. control.
functions. audit.

INTERNAL CONTROL & THE AUDITORS

Auditors shall
The auditors report to
shall identify the Auditors will also Management
All significant
deficiencies in find out (i) All Significant
deficiencies shall
Internal Control significant deficiencies
be reported by
on the basis of deficiencies if any
auditors in writing
audit work in Internal (ii) Other deficiencies
to TCWG.
performed by it. Control. which auditor feels
that Management
should be made
aware.

While Reporting deficiencies in Internal Control to TCWG & Management

Auditors will also communicate to them.

That auditor’s Deficiencies

That preparation
objective is only reported are
of Internal
to form an audit limited to only
Control is not
opinion on those which have
Auditors
financial been identified
responsibility.
statements. by auditor.

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INTERNAL AUDITS NECESSITY

It assists the
Management
to improve It helps to It helps to It Helps in
Internal detect detect increases checking Improves
Control by frauds & wastage of morale of of Books Organization’s
identifying errors. resources. honest of effectiveness
the staffs. Accounts.
weakness.

SCOPE OF INTERNAL AUDIT & IT’S EVOLUTION

(Maturity Index)
INTERMEDIARY CONTEMPORARY
INITIAL POSITION
POSITION POSITION

Risk based audit

Initially scope of i.e. to identify
Compliance
internal audit was Risk of Material
checking &
only limited to mis-statement
operational Audit
checking of information
also became its
transactions & its system audit is
scope.
accounting. also added in
scope.

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 Cost and Management Audit

INTERNAL AUDITING UNDER THE COMPANIES ACT 2013

Applicability

Unlisted Public Private Company

Company satisfying satisfying any
Listed Company any one of the four one of two
conditions. conditions.

Unlisted Public Company satisfying any one of the four

conditions.

Loan, Borrowing,
Public Deposits Turnover Min 200
Paid Up Share Outstanding from
outstanding Min. Cr.
Capital Min 50 Cr. Banks/PFI min
25 Cr.
100 Cr.

Private Company satisfying any one of two

conditions.

Loan, Borrowing,
Outstanding from Banks/PFI Turnover min 200 Cr.
more than 100 Cr.

NOTE :- These limits are to be taken of immediately preceding Financial Year.

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INTERNAL AUDITOR
Appointment Form No. Duties & Scope
Eligibility Penal Provision
Authority

CA or CMA or
any other BOD shall MGT 14 has to
professional (CS). Not mentioned
appoint in be submitted to
Internal Auditor in Act so it will
consultation inform ROC No specific
may or may not be as per Terms
be an employee. with Audit within 30 days provision exists.
of
Statutory Auditor Committee If of
Engagement.
cannot be any. appointment.
Internal Auditor.

PREPARATION FOR AN AUDIT

Determine
Define the scope Evaluate nature, timing &
Obtain the Accounting
of audit & send knowledge of extent of audit
an engagement system & procedures to be
clients business. Internal Control.
letter. performed.

PREPARATION FOR AN AUDIT

Adequate Issue an Audit

Documentation is Form an Opinion. Report.
necessary.

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AUDIT TECHNIQUES THROUGH WHICH AUDITORS OBTAINS

EVIDENCES

Analytical Electronic
Verification Confirmation Data
Procedures
Processing

Test Checking
Vouching Inquiry Inspection i.e., sampling.

AUDIT PROGRAMME

It is a detailed layout of audit plan which contains exact audit procedures to be

applied on exact dates on exacts items of financial statements by exact
auditing staffs.

ADVANTAGES OF AUDIT PROGRAMME

Work can be
It’s a ready allocated to Audit Plan It makes
checklist of audit is Audit audit more
audit assistants Audit is achieved. evidences effective.
procedures easily. timely are
that have completed. collected.
been
applied.

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DISADVANTAGES OF AUDIT PROGRAMME

Unusual or It kills the

Audit Audit
new areas initiative of
becomes becomes
may be efficient
mechanical. rigid.
neglected. staffs.

CONTINOUS AUDIT FINAL AUDIT

1. It’s a type of Internal audit which starts It’s a type of audit which is done after
before the end of financial year. financial year ends.

2. Its done throughout the financial year or Its not done throughout the year.
may be monthly.

3. Its suitable for organizations having large Its suitable for organizations having less
volume of transactions or where Internal volume of transactions or where Internal
Control is weak. Control is strong.

AUDIT WORKING PAPERS/DOCUMENTATION

DEFINITION

Audit working papers means audit file containing audit

procedures applied, audit evidences collected & auditor’s
observations.

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 Cost and Management Audit

AUDIT WORKING PAPERS/DOCUMENTATION

ADVANTAGES

1. It helps in audit planning.

2. Helps in future references of articles & assistances.
3. Acts as a legal evidence that audit was properly conducted.

2 TYPES OF AUDIT FILES

Permanent Audit File Current Audit File

PERMANENT AUDIT FILE

It records those non-recurring audit matters which generally does not

change year after year.
Contents are :-
1. Clients MOA
2. Clients AOA
3. Significant accounting policies.
4. Significant audit observations.
5. Significant ratios & trends.

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CURRENT AUDIT FILE

It records those recurring audit matters which generally changes year after
year.
Contents are :-
1. Results of vouching.
2. Results of verification.
3. Communication of Management.
4. Communication with Expert.
5. Communication with Other Auditors.

AUDIT NOTE BOOK

Meaning Contents

It is a bound book which contains large variety of audit manner.

CONTENTS

1. Audit queries which are not resolved immediately.

2. Client’s important clauses of MOA & AOA.
3. Internal Control Details.
4. Auditor’s observations.
5. Communication with previous year auditor.
6. Communication with Management.

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 Cost and Management Audit

Form & extent of Audit working papers depend on following factors.

1. Size of 2. Nature of 3. Complexity

Organizations organizations Involved

4. Reliance placed on 5. Type of audit 6. Risk Of Material

Internal Control. procedures applied. mis-statement.

ENGAGEMENT LETTER

Meaning Contents

It’s a letter sent by auditor to the client before accepting his audit.

CONTENTS

1. Auditor’s scope of audit.

2. Auditor’s responsibility.
3. Managements responsibility.
4. Auditor’s unrestricted access to books of Accounts.

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ROLE OF CMAs IN AUDIT

Exactly same as Internal Audit necessity & Internal Audit

Evolution.

OPERATIONAL AUDIT

Operational audit is a type of internal audit in which day to day operations

are checked.

Internal Audit is of 3 types.

A ) Financial
B ) Compliance
C ) Operational

INTERNAL AUDIT OPERATIONAL AUDIT

1. Compliance objective. Risk identification & process improvement
objective.
2. Transaction based. Process based.
3. Financial Accounts focus. Business Focus.
4. Typical & procedures focus. Efficiency & improvement focus.
5. Policies & procedures focus. Risk management focus.

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 Cost and Management Audit

NOTE

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 AUDIT OF SERVICE
ORGANISATIONS/INTERNAL
AUDIT IN DIFFERENT SECTORS

14
Introduc on
Having discussed about Internal Audit and its concepts in the previous study note, we now discuss in this
study note how internal audit is to be conducted in various service organisa ons.
AUDIT OF HOSPITALS
The following points are to be considered necessary for conduc ng an audit of Hospital.
(i) Check the le er of appointment to ascertain the scope of responsibili es.
(ii) Study the Charter or Trust Deed under which the hospital has been set up and take a special note
of the provisions affec ng the accounts.
(iii) Examine, evaluate and verify the system of internal check, internal control and determine the
nature, ming and the extent of the audit procedures.
(iv) Vouch the entries in the Pa ent’s Bill Register with a copies of bill issued. Test check the selected
bills to see that these have been correctly prepared taking into considera on the period of stay of
each pa ent as recorded in the A endance Schedule.
 Cost and Management Audit

(v) Vouch the collec on from pa ents with copies of bills and entries in Bills Register. Arrears of dues
should be properly carried forward and where these are deemed to be irrecoverable, they should
be wri en off under due authoriza ons.
(vi) Interest and/ or dividend income should be vouched with reference to the Investment Register and
Interest and Dividend warrants.
(vii) In case of legacies and dona ons which are received for specific purposes, it should be ensured that
any income therefrom is not u lized for any other purposes.
(viii) Where receipts of subscrip on show a significant devia ons from budgeted figures, it should be
thoroughly inquired into and the ma er be brought to the no ce of the trustees or the Managing
Commi ee.
(ix) Government grants or grants from local bodies should be verified with the reference to the
correspondence with the concerned authori es.
(x) Clear dis nc on should be made between the items of capital and revenue nature.
(xi) The capital expenditure should be incurred under proper authoriza on by a valid resolu on of the
trustees or the Managing Commi ee.
(xii) Verify the system of internal check as regards purchases and issue of stores, medicines etc.
(xiii) Examine that the appointment of the staff, payment of salaries etc. are duly authorized.
(xiv) Physically verify the investments, fixed assets and inventories.
(xv) Check that adequate deprecia on has been provided on all the depreciable assets.
AUDIT OF HOTELS
The business of running a hotel is very much dissimilar to running an industrial unit for manufacturing
of products. It is a service-oriented industry. The business is characterized by handling of large amounts
of liquid cash, stock of foods providing a variety of services, and keeping watch on customers to ensure
that they do not leave hotel without se ling the dues. In view of these, the following ma ers require
special a en on by the auditor.
(i) Internal Control: Pilferage is one of the greatest problems in any hotel and it is extremely important
to have a proper internal control to minimize the leakage. The following points should be checked:
(a) Effec veness of arrangement regarding receipts and disbursements of cash.
(b) Procedure for purchase and stocking of various commodi es and provisions.
(c) Procedure regarding billing of the customers in respect of room service, telephone, laundry,
etc.
(d) System regarding recording and physical custody of edibles, wines, cigare es, crockery and
cutlery, linen, furniture, carpets, etc.
(e) Ensure that are trading accounts are prepared preferably weekly, for each sales point. A
scru ny of the percentage of profit should be made, and any devia on from the norms is to be
inves gated.
(ii) Room Sales and Cash Collec ons

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(a) There are various sales points sca ered in a hotel and sales are both for cash and credit. The
control over cash is very important. The charge for room sales is made from the guest register,
and tests are to be carried out to ensure that the correct number of guests are charged for the
exact period of stay. Any difference between the rate charged to the guests and standard room
rent is to be inves gated to see that it is properly authorized.
(b) The total sales reported with the total bills issued at each sales point have to be reconciled.
(c) Special care must be taken in respect of bills issued to customers who are staying in the hotel,
because they may not be required to pay the bills immediately in cash but at a future date or
by credit cards. Billing is to be done room-wise. It must be ensured that all customers pay their
bills on leaving the hotel or within specified dates.
(iii) Stock
The stocks in a hotel are all saleable item like food and beverages. Therefore, following may be
noted in this regard:
(a) All movement and transfer of stocks must be properly documented.
(b) Areas where stocks are kept must be kept locked and the key retained by the departmental
manager.
(c) The key should be released only to trusted personnel and unauthorized persons should not be
permi ed in the stores area.
(d) Many hotels use specialized professional valuers to count and value the stocks on a con nuous
basis throughout the year.
(e) The auditor should ensure that all stocks are valued at the year end and that he should himself
be present at the yearend physical verifica on, to the extent prac cable, having regard to
materiality considera on and nature and loca on of inventories
(iv) Fixed Assets: The fixed assets should be properly depreciated, and the Fixed Assets Register should
be updated.
(v) Casual Labour: In case the hotel employs a casual labour, the auditor should consider, whether
adequate records have been maintained in this respect and there is no manipula on taking place.
The wages payment of the casual labour must also be checked thoroughly.
(vi) The compliance with all statutory provisions, and compliance with the Foreign Exchange Regula ons
must also be verified by the auditor, especially because hotels offer facility of conversion of foreign
exchange to rupees.
(vii) Other special aspects are to be verified as under:
(a) Consump on shown in various physical stock accounts must be traced to the customers’ bills
to ensure that all issues to the customers have been billed.
(b) All payments to the foreign collaborator, it any, are to be checked.
(c) Expenses and receipts are to be compared with figures of the previous year, having regard to
the average occupancy of visitors and changes in rates.
(d) Special receipts on account of le ng out of auditorium, banquet hall, spaces for shops,
bou ques, and special shows should be verified with the arrangements made.

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 Cost and Management Audit

(e) In depth check should be carried out on the customers’ ledgers to verify that all charges have
been properly made and recovered.
(f) The occupancy rate should be worked out, and compared with other similar hotels, and with
previous year. Material devia ons should be inves gated.
(g) Expenses for pain ng, decora on, renova on of building, etc. are to be properly checked.
(h) It is common that hotels get their bookings done through travel agents. The auditor should
ensure that the money is recovered from the travel agents as per credit terms allowed.
Commission paid to travel agents should be checked by reference to the agreement on that
behalf.
(i) Apart from control over stock of edibles, control over issue and physical stock of linen crockery,
cutlery, glassware, silver, toilet items, etc. should be verified.
(j) The auditor should verify the restaurant bills with reference to KOT (Kitchen order Ticket).
(k) The auditor should ensure that all taxes have been included in the client’s bills.
(I) Computa on and payment of salaries and wages vis-a-vis number of employees must be
checked.
AUDIT OF EDUCATIONAL INSTITUTIONS
The special steps involved in the audit of an educa onal ins tu on are the following:
(i) Examine the Trust Deed, or Regula ons in the case of school or college and note all the provisions
affec ng accounts. In the case of a university, refer to the Act of Legislature and the Regula ons
framed thereunder.
(ii) Read through the minutes of the mee ngs of the Managing Commi ee or Governing Body, no ng
resolu ons affec ng accounts to see that these have been duly complied with, specially the
decisions as regards the opera on of bank accounts and sanc oning of expenditure.
(iii) Check names entered in the Students’ Fee Register for each month or term, with the respec ve
class registers, showing names of students on rolls and test check amount of fees charged; and
verify that there operates a system of internal check which ensures that demands against the
students are properly raised.
(iv) Check fees received by comparing counterfoils of receipts granted with entries in the cash book
and tracing the collec ons in the Fee Register to confirm that the revenue from this source has
been duly accounted for.
(v) Total up the various columns of the Fees Register for each month or term to ascertain that fees
paid in advance have been carried forward and the arrears that are irrecoverable have been
wri en off under the sanc on of an appropriate authority.
(vi) Check admission fees with admission slips signed by the head of the ins tu on and confirm that
the amount had been credited to a Capital Fund, unless the Managing Commi ee has taken a
decision to the contrary.
(vii) See that free studentship and concessions have been granted by a person authorised to do so,
having regard to the prescribed Rules.

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(viii) Confirm that fines for late payment or absence, etc., have either been collected or remi ed under
proper authority.
(ix) Confirm that hostel dues were recovered before students’ accounts were closed and their deposits
of cau on money refunded.
(x) Verify rental income from landed property with the rent rolls, etc.
(xi) Vouch income from endowments and legacies, as well as interest and dividends from investment;
also inspect the securi es in respect of investments held.
(xii) Verify any Government or local authority grant with the relevant papers of grant. If any expense
has been disallowed for purposes of grant, ascertain the reasons and compliance thereof.
(xiii) Report any old heavy arrears on account of fees, dormitory rents, etc, to the Managing Commi ee.
(xiv) Confirm that cau on money and other deposits paid by students on admission have been shown
as liability in the balance sheet and not transferred to revenue.
(xv) See that the investments represen ng endowment funds for prizes are kept separate and any
income in excess of the prizes has been accumulated and invested along with the corpus.
(xvi) Verify that the Provident Fund money of the staff has been invested in appropriate securi es.
(xvii) Vouch dona ons, if any, with the list published with the annual report. If some dona ons were
meant for any specific purpose, see that the money was u lised for the purpose.
(xviii) Vouch all capital expenditure in the usual way and verify the same with the sanc on for the
Commi ee as contained in the minute book.
(xix) Vouch in the usual manner all establishment expenses and enquire into any unduly heavy
expenditure under any head.
(xx) See that increase in the salaries of the staff have been sanc oned and minuted by the Commi ee.
(xxi) Ascertain that the system ordering inspec on on receipt and issue of provisions, foodstuffs,
clothing and other equipment is efficient and all bills are duly authorised and passed before
payment.
(xxii) Verify the inventories of furniture, sta onery, clothing, provision and all equipment, etc. These
should be checked by reference to Stock Register and values applied to various items should be
test checked.
(xxiii) Confirm that the refund of taxes deducted from the income from investment (interest on
securi es, etc.) has been claimed and recovered since the ins tu ons are generally exempted
from the payment of income- tax.
(xxiv) Verify the annual statements of accounts and while doing so see that separate statements of
account have been prepared as regards Poor Boys Fund, Games Fund, Hostel and Provident Fund
of Staff, etc.
AUDIT OF CO-OPERATIVE SOCIETIES
Sec on 17 (2) of the Co-opera ve Socie es Act, 1912 specifically requires the auditor to conduct an
examina on of the overdue debts, if any, and a valua on of the assets and liabili es of the society.The

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auditor of a co-opera ve society is also required to point out various irregulari es, improprie es, and
departures from the provisions of the Act, rules framed thereunder, and the bye-laws of the society.
The special features of co-opera ve socie es audit, to be borne in mind while conduc ng the audit are
as follows:
1. Examina on of overdue debts: Overdue debts for a period from six months to five years and more
than five years will have to be classified and shall have to be reported by an auditor. It affects
its working capital posi on. They will have to be classified as good or bad. The auditor will have
to ascertain whether proper provisions for doub ul debts is made and whether the same is
sa sfactory. The percentage of overdue debts to the working capital and loans advanced will have
to be compared with last year, so as to see whether the trend is increasing or decreasing whether
due and proper ac ons for recovery are taken, the posi on regarding cases in co-opera ve courts,
District Courts etc. and the results thereof.
2. Overdue Interest: Overdue interest should be excluded from interest outstanding and accrued due
while calcula ng profit. Overdue interest is interest accrued or accruing in accounts, the amount of
which the principal is overdue.
3. Cer fica on of Bad Debts:. Bad debts and irrecoverable losses before being wri en off against
Bad Debts Funds, Reserve Fund etc. should be cer fied as bad debts or irrecoverable losses by the
auditor where the law so requires. Where no such requirement exists, the managing commi ee of
the society must authorise the write-off.
4. Valua on of Assets and Liabili es: Regarding valua on of assets there are no specific provisions or
instruc ons under the Act and Rules and as such due regard shall be had to the general principles
of accoun ng and audi ng conven ons and standards adopted. The auditor will have to ascertain
existence, ownership and valua on of assets. Fixed assets should be valued at cost less adequate
provision for deprecia on. The incidental expenses incurred in the acquisi on and the installa on
expenses of assets should be properly capitalised. If the difference in the original cost of acquisi on
and the present market price is of far reaching significance, a note regarding the present market
value may be appended; so as to have a proper disclosure in the light of present infla onary
condi ons. The current assets be valued at cost or market price, whichever is lower. Regarding the
liabili es, the auditor should see that all the known liabili es are brought into the account, and the
con ngent liabili es are stated by way of a note.
5. Adherence to Co-opera ve Principles: The auditor will have to ascertain in general, how far the
objects, for which the co-opera ve organisa on is set up, have been achieved in the course of its
working. While audi ng the expenses, the auditor should see that they are economically incurred
and there is no wastage of funds. Middlemen commissions are, as far as possible, avoided and the
purchases are made by the commi ee members directly from the wholesalers. The principles of
propriety audit should be followed for the purpose.
6. Observa ons of the Provisions of the Act and Rules: An auditor of a co-opera ve society is required
to point out the infringement with the provisions of Co-opera ve Socie es Act and Rules and bye-
laws. The financial implica ons of such infringements should be properly assessed by the auditor
and they should be reported. Some of the State Acts contain restric ons on payment of dividends,
which should be noted by the auditor.
7. Verifica on of Members’ Register and examina on of their pass books: Examina on of entries

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in members, pass books regarding the loan given and its repayments, and confirma on of loan
balances in person is very much important in a co-opera ve organisa on to assure that the entries
in the books of accounts are free from manipula on.
8. Special report to the Registrar: During the course of audit, if the auditor no ces that there are
some serious irregulari es in the working of the society, he may report these special ma ers to the
Registrar, drawing his specific a en on such irregulari es. The Registrar on receipt of such a special
report may take necessary ac on against the society. In the following cases, for instance a special
report may become necessary:
(i) Personal profiteering by members of managing commi ee in transac ons of the society, which
are ul mately detrimental to the interest of the society.
(ii) Detec on of fraud rela ng to expenses, purchases, property and stores of the society.
(iii) Specific examples of mis-management including decisions of management against co-opera ve
principles.
(iv) In the case of urban co-opera ve banks, dispropor onate advances to vested interest groups,
such as rela ves of management, and deliberate negligence about the recovery thereof. Cases
of reckless advancing, where the management is negligent about taking adequate security and
proper safeguards for judging the credit worthiness of the party.
9. Audit classifica on of society: A er a judgment of an overall performance of the society, the
auditor has to award a class to the society. This judgment is to be based on the criteria specified by
the Registrar. It may be noted here that if the management of the society is not sa sfied about the
award of audit class, it can make an appeal to the Registrar, and the Registrar may direct to review
the audit classifica on. The auditor should be very careful, while making a decision about the class
of society.
AUDIT OF SELF-HELP GROUPS
Self Help Group (SHG) Movement in India has been recognized as an effec ve strategy for mobiliza on
and empowerment of rural people, par cularly poor women and other marginalized groups.In India, Self
Help Groups or SHGs represent a unique approach to financial intermedia on. The approach combines
access to low-cost financial services involving a process of self-management, with an objec ve of social
and economic development for the women SHG members. Forma ons of SHGs are facilitated by the
Government or by NGOs. SHGs are linked not only to banks but also to wider development programmes,
SHGs are seen to confer many benefits, both economic and social.
As expert accoun ng professionals are hardly available at Gram Panchayat level, the need of the hour
is “Community Audit” and it is necessary to develop sufficient number of “Community Auditors” for the
sake of financial transparency.
The Ins tute & WBSRLM have entered into a MOU to enable undertaking of various collabora ve
ac vi es for establishing “Community Audit” system for Self Help Groups in West Bengal by developing
sufficient number of quality “Community Auditors” for mee ng the audit needs of SHGs in the state.
Applying the Field Balance Sheet Approach to Audit:
1. Background Review: During a background review, a preliminary examina on of the group level
records,including the cash book, is conducted. The auditor also does a general review of the group

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 Cost and Management Audit

level records and member passbooks to verify/ cross-check data entries for their accuracy and
correct pos ng.
2. Prepare Field Balance Sheet:
The auditor prepares the Field Balance Sheet for the group, as on the date of the audit, based
on the SHG’s internal records and then cross checks the correctness of balance sheet items. The
primary objec ve is to ascertain the retained earnings of the SHG.
Sl. No. Assets Amount Sl. No. Liabili es Amount
1 Cash in Hand 1 Voluntary Saving
2 Cash at Bank 2 External loan Outstanding
3 Loan Outstanding with 3 Equity:
members
4 Fixed Deposit a Compulsory saving
5 Fixed Asset b Retained Earning
Total
h p://www.microsave.net/files/pdf/IFN_54_SHG_Audit_A_Field_Balancing_Approach.pdf
3. Private Mee ngs with Members: The auditor conducts private interviews with 25% of total
members to triangulate informa on collected from the background review, as well as from the
Field Balance Sheet and to ascertain the decision-making pa ern in the group.
4. Mee ng with the SHG Group: If serious issues were raised during the course of the audit, the
auditor will meet with the en re group for further discussion.
5. Repor ng: Once the audi ng is complete, the auditor summarises any weak prac ces that put
savings at risk or make records unreliable, and recommends any be er methods. S/he submits the
Field Balance Sheet, along with a summary report to the MFI/bank, to all group members and adds
relevant comments to enable decision making regarding provision of credit.
AUDIT OF NON-GOVERNMENT ORGANISATIONS (NGOs)
Audit Procedure for Conduc ng the Audit of Non-Government Organisa on NGO’s can be defined as
non-profit making organisa ons which raise funds from members, donors or contributors apart from
receiving dona on of me, energy and skills for achieving their social objec ves.
Non-Government Organisa ons are generally incorporated as socie es under the Socie es Registra on,
Act, 1860 or as a trust under the India Trust Act, 1882, or under any other law corresponding to these
Acts enforced in any part of India. NGO’s can also be incorporated as a company under sec on 8 of the
Companies Act, 2013.
While planning the audit of a Non-Government Organisa on (NGO), the auditor may concentrate on
the following;
(i) Knowledge of the NGO’s work, its mission and vision, areas of opera ons and environment in which
it operates.
(ii) Reviewing the legal form of the organisa on and its Memorandum of Associa on, Ar cles of
Associa on, rules and Regula ons.

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(iii) Reviewing the NGO’s Organisa on chart, Financial and Administra ve Manuals, Project and
Programme Guidelines, Funding Agencies Requirements and Formats, budgetary policies, if any.
(iv) Examina on of minutes of the Board/Managing Commi ee/Governing Body/Management and
Commi ees thereof to ascertain the impact of any decisions on the financial records.
(v) Study the accoun ng system, procedures, internal controls and internal checks exis ng for the NGO
and verify their applicability.
The audit programme should include in a sequen al order all assets, liabili es, income and expenditure
ensuring that no material is omi ed:
(i) Corpus fund :The contribu ons/grants received towards corpus be vouched with reference to the
le ers from the donor(s). The interest income be checked with investment Register and physical
investments in hand.
(ii) Reserves : Vouch transfers from projects/programmes with donors le ers and board resolu ons of
NGO. Also
check transfers and adjustments made during the year.
(iii) Ear-marked Funds : Check requirements of donors’ ins tu ons, board resolu on of NGO, rules and
regula ons of the schemes of the ear-marked funds.
(iv) Project/Agency Balances: Vouch disbursements and expenditures as per agreements with donors
for each of the balances.
(v) Loans : Vouch loans with loan agreements receipt counter –foil issued.
(vi) Fixed Assets : Vouch all acquisi ons/sale or disposal of assets including deprecia on and the
authorisa ons for the same. Also check donor’s le ers/agreements for the grants. For immovable
property, check tle, etc.
(vii) Investments : Check Investment Register and the investments physically ensuring that investments
are in the name of the NGO. Verify further investments and dis-investments for approval by the
appropriate authority and reference in the bank accounts for the principal amount and interest.
(viii) Cash in Hand : Physically verify the cash in hand and imprest balance, at the close of the year
and whether it tallies with the books of accounts.
(ix) Bank Balance : Check the bank reconcilia on statements and ascertain details for old outstanding
and unadjusted amounts.
(x) Stock in Hand : Verify stock in hand and obtain cer ficate from the management for the quan es
and valua on of the same.
(xi) Programme and Project Expenses : Verify agreement with donor/contributor (s) suppor ng the
par cular programme or project to ascertain the condi ons with respect to undertaking the
programme/project and accordingly, in the case of programmes/projects involving contracts,
ensure that income tax is deducted, deposited and returns filed and verify the terms of the contract.
(xii) Establishment Expenses : Verify that provident fund, life insurance and their administra ve charges
are deducted, contributed and deposited within the prescribed me. Also check other office and
administra ve expenses such as postage, sta onery, travelling, etc.

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The receipt of income of NGO may be checked on the following lines:

(i) Contribu on and Grants for projects and programmes: Check agreements with donors and grants
le ers to ensure that funds received have been accounted for. Check that all foreign contribu on
receipts are deposited in the foreign contribu on bank account as no fied under the Foreign
Contribu on (Regula on) Act, 1976.
(ii) Receipts from Fund arising programmes: Verify in detail the internal control system and ascertain
who are the persons responsible for collec on of funds and mode of receipt. Ensure that collec ons
are counted and deposited in the bank daily.
(iii) Membership Fees: Check fees received with membership register, ensure proper classifica on is
made between entrance and annual fees and life membership fees. Reconcile fees received with
fees to be received during the year.
(iv) Subscrip on : Check with subscrip on register and receipts issued. Reconcile subscrip on received
with prin ng and despatch of corresponding magazine/circulars/periodicals. Check the receipts
with subscrip on rate schedule.
(v) Interest and Dividends : Check the interest and dividends received and receivable with investments
held during the year.
AUDIT OF LOCAL BODIES
Local bodies are ins tu ons of the local self governance, which look a er the administra on of an area
or small community such as villages, towns, or ci es. The Local bodies in India are broadly classified into
two categories. The local bodies cons tuted for local planning, development and administra on in the
rural areas are referred as Rural Local Bodies (Panchayats) and the local bodies, which are cons tuted
for local planning, development and administra on in the urban areas are referred as Urban Local
Bodies (Municipali es).
Ar cle 243J of the Cons tu on states that the Legislature of a State may, by law, make provisions with
respect to the maintenance of accounts by the Panchayats and the audi ng of such accounts.
Ar cle 243Z of the Cons tu on states about the audit of accounts of Municipali es. The Legislature of
a State may, by law, make provisions with respect to the maintenance of accounts by the Municipali es
and the audi ng of such accounts .
Financial Administra on of Local Bodies.
Salient Features of Financial Administra on of Local Bodies
(i) Budgetary Procedure: The objec ve of local bodies budgetary procedure are financial accountability,
control of expenditure, and to ensure that funds are raised and moneys are spent by the execu ve
departments in accordance with the rules and regula ons and within the limits of sanc on and
authorisa on by the legislature or Council. Different aspects covered in budge ng are determining
the level of taxa on, fees, rates, and laying down the ceiling on expenditure, under revenue and
capital heads.
(ii) Expenditure Control: At the State and Central level, there is a clear demarca on between the
legislature and execu ve. In the local body, legisla ve powers are vested in the Council whereas
execu ve powers are delegated to the officers, e.g., Commissioners. All ma ers of regular revenue
and expenditures are generally delegated to the execu ve wing. For special situa ons like, reduc on

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in property taxes, refund of security deposits, etc., sanc on from the legisla ve wing is necessary.
(iii) Accoun ng System: Municipal Accoun ng System has been conven onally prepared under the
cash system. In the recent past however, it is being changed to the accrual system of accoun ng.
The accoun ng system is characterised by
(a) subsidiary and sta s cal registers for taxes, assets, cheques etc.,
(b) separate vouchers for each type of transac on,
(c) compulsory monthly bank reconcilia on,
(d) submission of summary reports on periodical basis to different authori es at regional and state
level.
The objec ve of audit are:
• To report the content and presenta on of financial statements are true and fair
• Detec on and preven on of error fraud, misuse of funds
• To ascertain that full value received for money spent
• Legal and administra ve requirements fulfilled
The audit programme for local bodies include the following:
• All sanc ons are accorded by competent authority
• Expenditure incurred are according to provisions and as per regula ons framed by competent
authority
• Different schemes, programmes, and projects are running economically and the purpose such
programme is achieved.
AUDIT OF GOVERNMENT EXPENDITURE
(a) Government Expenditure Audit
Audit of government expenditure is one of the major components of government audit conducted
by the office of C & AG. The basic standards set for audit of expenditure are to ensure that there is
provision of funds authorised by competent authority fixing the limits within which expenditure can
be incurred. Briefly, these standards are explained below:
(i) Audit against Rules & Orders: The auditor has to see that the expenditure incurred conforms to
the relevant provisions of the statutory enactment and is in accordance with the financial rules
and regula ons framed by the competent authority.
(ii) Audit of Sanc ons: The auditor has to ensure that each item of expenditure is covered by
a sanc on, either general or special, accorded by the competent authority, authorising such
expenditure.
(iii) Audit against Provision of Funds: It contemplates that there is a provision of funds out of
which expenditure can be incurred and the amount of such expenditure does not exceed the
appropria ons made.
(iv) Propriety Audit: It is required to be seen that the expenditure is incurred with due regard
to broad and general principles of financial propriety. The auditors aims to bring out cases

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 Cost and Management Audit

of improper, avoidable, or infructuous expenditure even though the expenditure has been
incurred in conformity with the exis ng rules and regula ons. Audit aims to secure a reasonably
high standard of public financial morality by looking into the wisdom, faithfulness and economy
of transac ons.
(v) Performance Audit: This involves that the various programmes, schemes and projects where
large financial expenditure has been incurred are being run economically and are yielding
results expected of them. Efficiency-cum-performance audit, wherever used, is an objec ve
examina on of the financial and opera onal performance of an organisa on, programme,
authority or func on and is oriented towards iden fying opportuni es for greater economy,
and effec veness.
(b) Role of C&AG in the Audit of a Government company:
The auditor of a government company is appointed by the C&AG.
The C&AG have powers under sec on 143 of the Companies Act, 2013 as follows:
(i) to direct the manner in which the company’s accounts shall be audited by the auditor and
to give such auditor instruc ons in regard to any ma er rela ng to the performance of his
func ons as such;
(ii) to conduct a supplementary or test audit of the company’s accounts by such person or persons
as he may authorise in this behalf; and for the purposes of such audit, to require informa on
or addi onal informa on to be furnished to person or persons so authorised, on such ma ers,
by such person or persons, and in such form, as the Comptroller and Auditor-General may, by
general or special order; direct.
In addi on, the C&AG has a right to comment upon or supplement the audit report in such manner
as he thinks fit.
PROPRIETY AUDIT IN THE CONTEXT OF GOVERNMENT AUDIT
Propriety Audit: Under ‘propriety audit’, the auditors try to bring out cases of improper, avoidable, or
infructuous expenditure even though the expenditure has been incurred in conformity with the exis ng
rules and regula ons. However, some general principles have been laid down in the Audit Code, which
have for long been recognized as standards of financial propriety. Audit against propriety seeks to
ensure that expenditure conforms to these principles which have been stated as follows:
1. The expenditure should not be prima facie more than the occasion demands. Every public officer is
expected to exercise the same vigilance in respect of expenditure incurred from public moneys as
a person of ordinary prudence would exercise in respect of expenditure of his own money.
2. No authority should exercise its powers of sanc oning expenditure to pass an order which will be
directly or indirectly to its own advantage.
3. Public moneys should not be u lised for the benefit of a par cular person or sec on of the
community unless:
(i) the amount of expenditure involved is insignificant; or
(ii) a claim for the amount could be enforced in a Court of law; or
(iii) the expenditure is in pursuance of a recognised policy or custom; and

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(iv) the amount of allowances, such as travelling allowances, granted to meet expenditure of a
par cular type should be so regulated that the allowances are not, on the whole, sources of
profit to the recipients.
AUDIT OF COMMERCIAL ACCOUNTS
The government also engages in commercial ac vi es and for the purpose it may incorporate following
types of en es:
(i) Departmental enterprises engaged in commercial and trading opera ons, which are governed by
the same regula ons as other Government departments such as defense factories, mints, etc.
(ii) Statutory corpora ons created by specific statues such as LIC, Air India, etc.
(iii) Government companies, set up under the Companies Act, 2013. All aforesaid en es are required
to maintain accounts on commercial basis. The audit of departmental en es is done in the same
manner as any Government department, where commercial accounts are kept. Audit of statutory
corpora ons depends on the nature of the statute governing the corpora on. In respect of
government companies, the relevant provisions of Companies Act, 2013 are applicable.

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 Cost and Management Audit

AUDIT OF EDUCATIONAL INSTITUTIONS

Audit shall apply the following audit procedures to conduct the audit of
educational institutes

1. If school, colleges have been 2. In case of university 3. Also read the 4. Auditor will vouch fees
registered under a trust then read the Act passed by the minutes of meetings received from cash book,
auditor should read trust deed legislature to understand of managing student attendance
to identify various provisions the provisions relating to committee or register & counterfoil of
relating to accounts and audit. accounts &audit governing body fees receipt.

Audit shall apply the following audit procedures to conduct the audit of
educational institutes

8. Check arrears of
5. Check that fines if 6. Check that 7. Check that
fees received or not
any have been collected scholarship if any hostel dues have
& what steps of
by appropriate granted by appropriate been received or
recovery have been
authority. authority. not .
taken.

Audit shall apply the following audit procedures to conduct the audit of
educational institutes

12. Check that cautions

many i.e. security
11. If government
10. Check legacy deposit has been
9. Check Donations grants received,
income & also see the refunded or adjusted
Income & its source. As 12 followed or
will document . with dues or not &if not
not.
it should be shown as
liability.

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Audit shall apply the following audit procedures to conduct the audit of
educational institutes

15. Check refund 16. Games fund,

13. Check payments of taxes if scholarship fund
14. Check income from
made to staffs & applicable have have ben used for
investments.
teachers. been property proper purpose or
applied or not . not .

AUDIT OF CO-OPERATIVE SOCIETY

Co-operative society’s Central Act is Co-operative Society Act 1912 &

auditor shall apply following procedures to audit Co-operative society:-

1. Examination of Overdue 2. Examination of overdue

3. Bad debts Certification.
debt. interest.

p Examination
y of Overdue
y debtf

More than 6 months upto 5

More than 5 years due
years due

Auditor should also report whether its affecting working capital positions or not & whether these overdue
amounts are good or bad.

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 Cost and Management Audit

Examination of overdue interest

Interest on overdue debt booked on accrual basis but not yet received
should be excluded from interest while computing profits.

Bad debt Certifications

Before writing off bad loans against provision for bad debt or reserve
fund auditor should certify it as bad debt.

AUDIT OF CO-OPERATIVE SOCIETY

Co-operative society’s central Act is Co-operative society Act 1912 & auditor shall apply
following procedures to audit Co-operative society:-

4. Verification of Assets and 5. Adherence to Co-operative 6. Members register and

Liabilities Principles passbook.

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Valuation of Assets and Liabilities

Auditor shall check whether assets & liabilities have been valued as
per Generally Accepted Accounting principles. He shall also check
their existence, ownership/obligation & valuation. Fixed assets
should be valued at cost less provision for depreciation. Current
assets at cost or realizable value which ever is lower.

Adherence to Co-operative Principles

Auditor shall check that mutual assistance principle followed by

members or not .

Member’s register & pass book

If loan given to a person check that his name was there in register of
member or not & also see his passbook whether he actually received
the money or not .

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 Cost and Management Audit

AUDIT OF CO-OPERATIVE SOCIETY

Co-operative society’s central Act is Co-operative society Act 1912 & auditor shall apply
following procedures to audit Co-operative society:-

7. Observation of Act & Rules 8. Special report to registration 9. Awarding class to society

Observation of Act & Rules

Auditor shall check whether Co-operative society has followed

applicable Act & Rules or not.

Special report to registration

Auditor shall report to Registrar :-

Profiteering Dis proportionate

of member of Any fraud detected Mis management advances made to
managing committee member

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Awarding class to society

After completing audit auditor shall award class to society & if

maangement is not satisfied it can appeal to Registrar who may ask
auditor to reconsider his decision.

AUDIT OF GOVERNMENT EXPENDITURE

C & AG shall apply 5 principle while auditing the government expenditure :

Audit against rules Audit against Audit against Propriety Performance

& Order sanctions provision of Audit Audit
funds

Audit against rules Audit against Audit against Propriety Performance

& Order sanctions provision of Audit Audit
funds

C & AG Shall Whether Whether It means It means checking

check whether Government Government checking that that objective
Government was expenditure Government of government
expenditure is sanctioned was incurred expenditure expenditure fulfilled
consistent with by from proper should not be or not & the project
constitution appropriate fund which was infructions i.e. in which such
of india, Rules autority or created for that wasteful expenditure was
framed by not. purpose incurred is operating
parliament & C economically,
& AG effectively &
effectively or not.

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 Cost and Management Audit

3 Principle of propriety audit

1. The expenditure should not be

more than what the occasion
2. No part of Government
demands. Government officers 3. No public money should be
expenditure should be incurred for
should exercise strict vigilance expended for any particular
any direct/indirect benefits of any
while expending public money as person or community unless
Government officer.
if they are expending their own
money.

3. No public money should be expended for any

particular person or community unless

The amount is Its ordered by the

Its as per the custom.
insignificant or court or

Role of C & AG in audit of Government

company.

2. CAG has the power u/s 143 to

1.CAG has the right to appoint of give directions to the auditors as 3. CAG also has the power to
auditors of government to how to conduct the audit & also comment upon the audit
company u/s 139 of the conduct supplementary audit on report of Government
Companies Act 2013. any item of its financial company.
statement.

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Audit of Commercial Accounts

Government also engages in commercial activities by opening any one of the following
entities:-

Departmental Organisation Statutory Corporation Government company

Government transfers its power It is formed by passing special Act of Means a company whose atleast
It is formed by passing special Act of
department. parliament. 51% PUSC is held by CG/SG or
parliament eg. LIC, Air India .
Eg. Defence factory Eg. LIC, Air India . both.

Note :- All the above three entities audit is conducted by complying same 5
principle of government expenditure audit.

Audit of Self Help Groups:-

Self help groups are created in India to mobilize empowerment of

rural people specially woman & marginalized (neglected) section of
society. SHG are facilitated by government or NGOs.

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 Cost and Management Audit

Audit Procedure/Field Balance Sheet Approach in SHG

Meeting with
Background Prepare Field Private Meeting
SHG Reporting
Review Balance sheet with members
(30 minutes)
In case of any
Auditor should irregular
do meeting with activity,(eg. Fraud Auditor will
Auditor will check
the object of SHG
& its cash Book.
* atleast 25%
members of SHG
to understand
detected) auditor
should conduct
meeting with
report his
audit
summaries.
their issues. entire self help
group.

* Format of field balance sheet

SL.NO Asset Amount SL.NO Liabilities Amount

1 Cash in hand 1 Voluntary saving of

2 Cash at bank members
3 Loan to members 2 External borrowing
4 Fixed deposit 3 Profit /equity
5 Fixed assets a. Compulsory
b. Retained earnings

Audit of NGO

While planning audit of NGO , auditor should identify the following:

Understand the Identify its legal Read the minutes of

Understand the Understand its
vision mission & form i.e society meetings of
organizational accounting
its area of or trust or sec 8 managing committee
chart. system.
operations. company. or its board.

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Audit programme should consider the following items of NGO:

Corpus Ear marked Project Cash &

Reserves Loans Fixed asset Investments
fund fund balance bank

Check
amount
Its Check Check from
Check collected Check
includes reserves fixed asset Check from Check
transfer & all the
all created register & investment cash
to/from expended loans
donations for specific physical register. book
reserves. for a taken.
& grants purposes. verification
particular
project.

Audit of income of NGO

Contributions & Receipts from fund Subscription Interest &

grants Membership fees
raising programme income dividend

Auditor will
check details of
Auditors will
Auditor will check fund Auditor will tally subscribers who Auditor will
check source of
raising programme from members have taken check it from
such
details. register subscription of investment
contributions &
newsletter & register.
grants.
magazines
issued by NGO.

Audit of local Bodies

BBuuddggeettaary prroocceedduurere EExxppeennddittuurreeccoonnttrrooll Accounting system

a. Separate register of taxes,

assets & cash maintained or
Auditor will check the budget of Auditor will find variances between not .
receipts & payments of local budgeted & actual expenditure & b. Separate voucher for each
bodies. the reasons behind it. type of transaction
c. Monthly BRS should be made.
d. Submission repot to state
government.

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 Cost and Management Audit

Audit of Hospital
Auditor shall apply following steps to conduct audit of hospital:

2. Auditor should read

1.Auditor should check the trust deed or
4. Vouch patients fees
the letter of Charter (constitutional 3. Check the patient’s from cash book,
appointment & also documents) to register. counterfoil of patients
understand his scope of understand the
receipts.
responsibilities. provision related to
accounts

Auditor shall apply following steps to conduct audit of hospital:

4. Evaluate internal 6. Vouch dividend 7. Vouch income of

control system to income , interest medicine shop & 8. Vouch canteen
identify nature, timing, income on investments ambulance if these are income if any.
extent of audit with reference to owned by hospital.
procedures. investment register.

Auditor shall apply following steps to conduct audit of hospital:

11. If there was

significant deviation
9. Vouch donation & 10. If Government between budgeted & 12. Check that proper
legacy income & verify received check whether actual expense whether distinction has been
their source AS 12 followed. approval of managing made between reserve
committee taken or & capital expenditure .
not.

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Auditor shall apply following steps to conduct audit of hospital:

13. Check that

15. Check that all
appointment of staffs & 14. Physically verify depreciable assets have
payment of salaries investment & Fixed been appropriately
have been properly assets. depreciated.
authorized.

Audit of Hotels
1. Internal control : The biggest problem in any hotel is pilferage & so there must exist a strong IC
minimise the pilferage & leakages . Strong IC incorporate following points :

d. Procedure
a. Effectiveness of b. Procedure for c. Procedure regarding e. Ensure that
cash collections & purchase of stocks regarding billing recording & weekly trading
payments. & assets. of customers. physical custody A/C are prepared.
of assets.

2. Room sales & cash collection

a.Identify various sales point

which generates revenues for
the hotel. b. Check that total sales reported
Example: room sales, matches with sales at various
restaurant incomes, sports sales points.
Centre income , spa income
banquet income etc.

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 Cost and Management Audit

NOTE

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 ANALYSIS ON MANAGERIAL
PERFORMANCE / CASE STUDIES ON
PERFORMNACE ANALYSIS

15

PERFORMANCE APPRAISAL – WHAT IT MEANS?

The performance of a company may have different meaning in the eyes of the management of the
company and different in the perspec ve of government or regulators. Similarly, the performance of
a company in the outlook of investors would be different than what customers of the products of the
company look for.
The purpose of performance analysis is to determine if a company is performing well and if it is not,
to iden fy areas that require improvement. By evalua ng a company’s performance, it is possible to
keep the company on track. If there are problems with performance, it is possible to make adjustments
accordingly. This brings us to the issue of evalua ng strategies formulated by the management of the
company. While it is true that the implica ons of formula ng strategies include many parameters, the
cost impact is a significant one. Hence the cost auditors’ appraisal of the performance of the auditee
company will be an important input for the top management of the company.
 Cost and Management Audit

PERFORMANCE APPRAISAL REPORT

The Companies (Cost Audit Report) Rules, 2011 required a cost auditor to submit a Performance
Appraisal Report to the Audit Commi ee/Board of Directors. However, Companies (Cost Records and
Audit) Rules, 2014, 2018 and 2019 are silent about submission of Performance Appraisal Report. Though
there is no statutory requirement of submission of such a report, it would be a good prac ce for a cost
auditor to appraise the Board of Directors in the form of an appraisal report. This report would help
the Board especially the independent directors to have an idea about the opera onal ac vi es of the
company.
Since the performance analysis is closely related to the strategies formulated by the management of the
company, the following steps/approaches may be taken by the cost auditor:
(i) Preliminary discussion with the Management of the company to apprise them of the objec ve of
the cost auditor and the report.
(ii) Iden fying and understanding the key strategies of the company, both prescrip ve and emergent
strategies included.
(iii) Choosing strategies that have more visible expressions in costs data maintained by the company.
(iv) Iden fying the ac vi es that were impacted by the strategies selected and also implemented
during the year of audit.
(v) Analysing the cost implica ons of those ac vi es and linking it with the expected results of the
strategies.
(vi) Presen ng the evalua on, in a table or any other easily comprehensible format like histogram,
chart, graph etc.
(vii) Giving explanatory notes for the terms used, calcula ons made, and assump on behind the
evalua ons.
(viii) Finalising the finding a er a discussion with the concerned opera ng execu ves and then with the
management of the company.
AREAS OF PERFORMANCE APPRAISAL
There are various areas where management performance should be efficient and effec ve which
ul mately contribute to the profitability and growth of the company. Besides, there are various ways to
compute and assess the managerial efficiencies in the crucial areas of company’s ac vi es.
APPLICATION OF RATIOS FOR ASSESSMENT OF PERFORMANCE
Accoun ng ra os are rela onships expressed in mathema cal terms between figures which are
connected with each other in some manner. Obviously, no purpose will be served by comparing two
sets of figures which are not at all connected with each other. Over the past few years, financial ra os
have been subjected to empirical analysis to find their other uses.

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CLASSIFICATION OF RATIOS
Ra os can be classified as:
Classifica on in view of
Financial Analysis

Profitability Ac vity Solvency

Ra os Ra os Ra os

Profitability Ra os:
(A) In Rela on to Sales
1. Gross profit Ra o
2. Opera ng Ra o
3. Opera ng Profit Ra o
4. Net Profit Ra o
5. Expense Ra o
(B) In Rela on to Investment
1. Return on Investment
2. Return on Equity Shareholders Fund
3. Return on Total Resources
Ac vity Ra os:
1. Inventory Turnover Ra o
2. Debtors Turnover Ra o
3. Creditors Turnover Ra o
4. Fixed Assets Turnover Ra o
5. Working Capital Turnover Ra o
6. Capital Turnover Ra o
Solvency Ra os:
A. Long Term Solvency Ra os
1. Debt Equity Ra o
2. Proprietary Ra o
3. Fixed Assets Ra o
4. Capital Gearing Ra o

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 Cost and Management Audit

B. Short Term Solvency Ra os

1. Current Ra o
2. Liquidity Ra o
3. Interest Coverage Ra o
4. Absolute Liquid Ra o
WASTE MULTIPLIER
In many con nuous process industries cost data are arrived at with complexi es in the calcula on.
A Spinning unit of Co on Tex le Industry has a set of processing departments like Mixing and Blow
Room, Carding, Drawing, Combing, Fly Frames and Ring Frames. Actually spinning unit comes under
con nuous process industry. Mixing and Blow Room are the star ng point when the raw material co on
enters and comes out as yarn in the Ring Frame sec on. Obviously like every processing industry in
spinning mills certain amount of wastage is emerging out of produc on in each and every department.
It is segregated as usable waste and saleable waste apart from invisible loss. While the usable waste
and saleable waste can measured physically the invisible loss is found out from the input and output of
raw materials a er considering due weightage of usable and saleable waste. The actual waste which is
extracted from the machine process depends upon the impuri es in the co on. The produc on process
involving wastage has a rou ne or cycle.
For example the output of Blow Room goes to Carding and usable waste of Carding goes back to the
co on mix in Mixing and Blow Room and so on. The ‘back’ and ‘forth’ waste movement are given due
considera on while calcula ng the raw material cost. The realiza on of saleable waste is given due
credit in the cost of raw material consumed.
Waste mul plier is that quan ty of output from any process , which will be needed to get one unit of
final output.
UTILITIES CONSUMPTION
The term ‘U li es’ refer to significant inputs such as power, steam, water, compressed air and the like
which are used for manufacturing process but do not form part of the final product.Broadband internet
services (both fixed- line and mobile) are increasingly being included within the defini on.
COST ACCOUNTING STANDARD – 8 (CAS-8) is issued by the Council of The Ins tute of Cost Accountants
of India on “COST OF UTILITIES”
This standard deals with the principles and methods of classifica on, measurement and assignment of
cost of u li es, for determina on of the cost of product or service, and the presenta on and disclosure
in cost statements.
The objec ve of this standard is to bring uniformity and consistency in the principles and methods of
determining the cost of u li es with reasonable accuracy.
CAPACITY DETERMINATION AND UTILISATION
Capacity is the maximum level of output that a company can sustain to make a product or provide a
service. Planning for capacity requires management to accept limita ons on the produc on process.
Cost Accoun ng Standard - 2 (Revised 2015) on “Capacity Determina on” issued by the Council of the
Ins tute of Cost Accountants of India.

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This standard deals with the principles and methods of classifica on and determina on of capacity of
an en ty for ascertainment of the cost of product or service, and the presenta on and disclosure in cost
statements.
The objec ve of this standard is to bring uniformity and consistency in the principles and methods of
determina on of capacity with reasonable accuracy.
Installed capacity: Installed capacity is the maximum capacity of producing goods or providing services,
determined either based on technical specifica on of the facility or through a technical evalua on.
Normal capacity is the volume of produc on or services achieved or achievable on an average over a
period under normal circumstances taking into account the reduc on in capacity resul ng from planned
maintenance.
Actual capacity u liza on: Actual capacity u liza on is measured in terms of volume of produc on
achieved or service provided in a specified period.
Capacity shall be determined in terms of units of produc on or services or equivalent machine or man
hours.
VALUE ADDITION
The term“ Value Addi on” has been defined under the Companies (Cost Records and Audit) Rules, 2014
as the difference between net output value(net sales adjusted for WIP and finished stock) and cost of
bought out materials and services for the product under reference.
Annexure to the Cost Audit Report - Part D prescribes the method of calcula on of Value Addi on. Value
Added has to be established with reference to ac vity carried out during the year under reference.
INVENTORY VALUATION
An inventry valua on allows a company to provide a monetary value for items that make up their
inventory. Inventories are usually the largest current asset of a business, and proper measurement
of them is necessary to assure accurate financial statements. If inventory is not properly measured,
expenses and revenues cannot be properly matched and a company could make poor business decisions.
Inventory management is the process of efficiently overseeing the constant flow of units into and out
of an exis ng inventory.
The inventory valua on involves two major aspects:
• The cost of the purchased or manufactured inventory has to be determined and
• Such cost is retained in the inventory accounts of the company un l the product is sold.
Costs of Inventories Cost of inventory can be classified as
(a) Costs of purchase
(b) Costs of conversion
(c) “Other costs” incurred in bringing the inventories to their present loca on and condi on
Costs that are excluded from inventory valua on Certain costs are excluded in valuing inventory are:-
(a) Abnormal amounts of wasted materials, labor, or other produc on costs
(b) Storage costs unless they are essen al to the produc on process

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 Cost and Management Audit

(c) Administra ve overheads that do not contribute to bringing inventories to their present loca on
and condi on
(d) Selling costs.
TECHNIQUES OF MEASUREMENT OF COSTS
Several acceptable methods of handling those are
(i) Specific iden fica on.
(ii) Average cost.
(iii) First-in, first-out (FIFO).
(iv) Last-in, first-out (LIFO).
ABNORMAL EVENTS SUCH AS STRIKE, LOCK-OUT AND OTHER FACTORS
As per (CAS-6) COST ACCOUNTING STANDARD ON MATERIAL COST, any abnormal cost shall be excluded
from material cost. So cost of Abnormal Events such as Strike, Lock Out and other factors are not
included in Cost.
PROFITABILITY ANALYSIS
Profitability analysis is a component of resource planning that allows administrators to forecast the
profitability of a proposal or op mize the profitability of an exis ng project. Profitability analysis can
an cipate sales and profit poten al specific to aspects of the market such as customer age groups,
geographic regions, or product types.
Profitability analysis helps an enterprise to:
• Iden fy the most and least profitable products or services.
• Discover which sources of informa on offer the most reliable facts.
• Op mize responses to changing customer needs.
• Evolve the product mix to maximize profits in the medium and long term.
• Isolate and remedy the causes of decreasing profit margins.
Profitability Ra o Analysis forms part of Part D of the Annexure to Cost Audit Report.
RECONCILIATION OF FINANCIAL AND COST RECORDS
When the Cost and Financial accounts are kept separately,it is impera ve that these should be reconciled,
otherwise the Cost Accounts would not be reliable.
1. Items appearing only in financial accounts
The following items of income and expenditure are normally included in financial accounts and not
in cost accounts. Their inclusion in cost accounts might lead to unwise managerial decisions. These
items are:
(i) Income:
(a) Profit on sale of assets
(b) Interest received
(c) Dividend received

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(d) Rent receivable

(e) Share Transfer fees
(ii) Expenditure
(a) Loss on sale of assets
(b) Uninsured destruc on of assets
(c) Loss due to scrapping of plant and machinery
(d) Preliminary expenses wri en off
(e) Goodwill wri en off
(f) Underwri ng commission and debenture discount wri en off
(g) Interest on mortgage and loans
(h) Fines and penal es
(iii) Appropria on
(a) Dividends
(b) Reserves
(c) Dividend equaliza on fund, Sinking, fund etc.
2. Items appearing only in cost accounts
There are some items which are included in cost accounts but not in financial account.
These are:
(a) No onal interest on capital;
(b) No onal rent on premises owned.
3. Under or over-absorp on of overhead
In cost accounts overheads are charged to produc on at pre-determined rates where in financial
accounts actual amount of overhead is charged, the difference gives rise under-or over-absorp on;
causing a difference in profits.
4. Different bases of stock valua on
In financial books, stocks are valued at cost or market price, whichever is lower. In cost books,
however, stock of materials may be valued on FIFO or LIFO basis and work-in-progress may be
valued at prime cost or works cost. Differences in store valua on may thus cause a difference
between the two profits.
5. Deprecia on
The amount of deprecia on charge may be different in the two sets of books either because of
the different methods of calcula ng deprecia on or the rates adopted. In company accounts, for
instance, the straight line method may be adopted whereas in financial accounts It may be the
diminishing balance method.
Profit Reconcilia on as per Cost and Financial Records forms part of Part D-2 of the Annexure to Cost
Audit Report.

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 Cost and Management Audit

Case Studies on Performance Analysis

Ratio Analysis

Ratio is a relation between two figures and its analysis helps us to know whether company’s financial
position and financial performance is strong or weak. (Ratio can be in percentage or decimal)

Classification of Ratios

On the basis of origin On the basis of

function/financial analysis

Balance Sheet Ratio Both numerator and

denominator are from balance. Profitability Ratio
Example: Current Ratio

Profit and Loss Ratio

Both from P/L. Turnover/Activity Ratio
Example: Net Profit Ratio

Combined Ratio
One from P/L and other from balance sheet. Solvency Ratio
Example: Return on Capital Employed

Profitability Ratio

GP Ratio Operating Profit Ratio

(A) In
relation to
sales
NP Ratio Expense Ratio

Operating Ratio

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GP Ratio

Gross Profit x 100

Net Sales
Where,
GP = Net Sales – COGS
COGS = Opening Stock + Purchase and direct expense – Closing Stock
Net Sales = Cash Sales + Credit Sales – Sales Return

Net Profit Ratio

Net Profit Ratio = Net Profit x 100

Net Sales

Operating Ratio

Operating Ratio = Operating Ratio x 100

Net Sales

Where,
Operating Cost = Material Consumed + Labour Cost + Factory Overhead
+ Administrative Overhead + Selling and distribution Overhead

Operating Profit Ratio

Operating Ratio x 100

Net Sales
Where,
Operating Profit = Net Sales – Operating Cost

Expense Ratio

Expense Ratio = Total Expense x 100

Net Sales

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(A) In relation to Investment

Return on Investment Return on Total Resources

Or Or
Return on Capital Employed Return on Total Assets

Return on equity shareholders fund

Or Return on Net Wort

Return on Investment Or Return on Capital Employed

Total Earnings x 100

Return on Capital Employed =
Average Capital Employed
Where,
Capital Employed:
Net Fixed Asset (Asset Backing Approach) + Working Capital (Current Asset – Current Liabilities)
This means investments are miscellaneous expense not taken.

Return on Equity Shareholders Fund Or Return on Net Worth

PAT x 100
Return on Net Worth =
SH’s Fund

SH’s Fund (ESC + PSC + R&S) {Liability Backing Approach}

=Long term Loan – Investments – Miscellaneous Expense

Return on Equity Shareholders Fund Or Return on Net Worth

Opening + Closing x 100

Average =
2
Total Earnings = PAT + Interest Or i.e., EBIT – Provision for Tax

Return on Total Resources Or Return on Total Assets

Total Earnings x 100

Return on Total Assets =
Total Assets

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Solution for Illustration 1

Total Earnings x 100

(A) Return on Capital Employed =
Average Capital Employed

Where,
Total Earnings = Earnings before Interest & Tax – Tax
= Rs (900 – 360)
= Rs 540

Computation of Average Capital Employed (Asset Blocking Approach)

Particulars 31.3.18 (Lakhs) 31.3.17 (Lakhs)
(A) Net Fixed Assets 1560 1200

Add
(B) Working Capital
Current Assets
Stock 720 600
Debtors 420 300
Cash and Bank 120 120
Other Current 150 150
Assets
(-) Current (774) 636 (150) 1020
Liabilities
2196 2220

Therefore,
= 2208 lakhs
Therefore,
= 24.46 %

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 Cost and Management Audit

In the above Q, CE could have been found by liability backing approach also :-
Particulars 31.3.18 31.3.17
Shareholders Fund 2196 2100
(1500 + 696) (1500 + 600)
(+) Long Term Loans 600 720
(-) Miscellaneous Expense (360) (420)
(-) Investments (240) (180)
2196 2220

Therefore,
= 2208 lakhs

(C( (etu(n on (et (o(t(

As per sec 2(57) of the Companies Act 2013, net worth means aggregate of closing PUSC
+ Reserves and surplus including securities premium but excluding revaluation reserve –
miscellaneous expenditure – P/L Debit balance.

Where, PAT =
Lakhs
Earning before interest and tax 900
(-) Interest (144)
(-) Tax (360)
396
Net Worth =
Share Capital 1500
Reserve and Surplus 696
(-) Miscellaneous Expense (360)
1836
Therefore,
= 21.57 %

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Turnover/Activity Ratio

Stock Turnover Ratio:-

COGS (Sales – GP or Opening Stock + Purchase and direct expense – Closing stock)
Average Inventory
If COGS’s date not available then taken sales instead of COGS.

2. Stock velocity/Average Holding Period:-

3. Debtors Turnover Ratio:-

4. Debtors velocity/Average collection period:-

5. Creditors Turnover Ratio:-

6. Creditors Velocity/ Average Payment Period:-

7. FA Turnover Ratio:-

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 Cost and Management Audit

8. Total Asset Turnover Ratio:-

9. Working Capital Turnover Ratio:-

Solvency Ratio

(A) Short term Solvency Ratios:

CA & CL have maturity period upto 1 year. (Adequate Ratio 2:1).

2.

Adequate Ratio is 1:1.

3.

4.

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(B) Long Term Solvency Ratio:-

3.

Self Note:- Ratios which are important to judge the

stability.
Liquid Asset to
Current Ratio operating expense
per day ratio.

Return on
Debt Equity Ratio Proprietary Ratio Investments Ratio

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 Cost and Management Audit

Answer of illustration 1 part (ii)

Since, COGS data not given to us.

Therefore, we shall take sales.

= 660 lakhs
Therefore,

(iv)
Where Current Assets as on 31.3.18
Lakhs
Stock 720
Debtors 420
Cash and Bank 120
Other CA 150
1410

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Current Liabilities = 774

Therefore,

Where Shareholder's Fund

Lakhs
Share Capital 1500
(+) Reserve and Surplus 696
(-) Accumulated Loss/ Miscellaneous (360)
Expense
Total Assets
Net Fixed Assets 1560
Current Assets 1410
2970

Therefore,
= 0.6182 times
= 0.62 times

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 Cost and Management Audit

Answer of Illustration 4:-

Key Ltd.'s Stability Ratio
Particular 2017 2018
1.
(A) Current Assets
Stock 1124 1219
Debtors 728 824
Bank 93 33
Total (A) 1945 2076

(B) Current Liabilities

Creditors 947 926
PFT 56 68
Short Term Borrowings 424 800
Total (B) 1427 1794

Therefore,

1.36 times 1.16 times

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2.

(A) Total Outside Liability

Current Liabilities 1427 1794

Long Term Borrowings 254 210

1681 2004
(B) Shareholder’s Fund
Share Capital and Reserves 1265 1182
(-) Accumulated Loss/ Miscellaneous (165) (169)
Expense
1100 1013

Therefore,
= 1.528 times = 1.978 times

3. 1100 1013

(FA + CA) (836 + 1945) (941 + 2076)

4.

= 9.06 % = 5.57 %

5.

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 Cost and Management Audit

Where, Liquid Assets

Current Asset 1945 2076
(-) Stock (1124) (1219)

(A) 821 857

Operating Expense per day (B) 13.983 11.934

Therefore, 58.71 days 71.81 days

(aste Multiplie(

(ts t(at (uantit( w(ic( is (e(ui(ed to p(oduce one unit o( (inal output.
(aste Multiplie( is (ound out in case o( continuous p(ocess indust((.
((ample(A spinning unit o( cotton te(tile indust(( (as a set o( (a(ious p(ocesses and depa(tments
li(e mi(ing and (low (oom( ca(ding( d(awing( com(ining( (l( ((ames and (ing ((ames.

(ust li(e an( ot(e( indust(( in(ol(ing se(e(al p(ocesses(spinning unit also in(ol(es lots o( wastages
in di((e(ent p(ocesses and so its impo(tant to compute waste multiplie(.

Example Process I Process II Process III

Percentage of loss 10 % 5% 6%
Compute waste multiplier factor for each process.

Process Percentage of Net Output Waste Multiplier

Wastage Factor
Total 100 1.244
I 10 % 90 1.1196
II 5% 85.5 1.064
III 6% 80.37 1

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80.37 units of output, we require 100 units of input.

1 unit of output use we shall require input =
= 1.244 waste multiplier factor

Solution Illustration 1
Process Percentage of Net Output Waste Multiplier
Wastage Factor
Total 100 1.316
Blow room 9.18 % 90.82 1.1953
Carding 7.17 % 84.31 % 1.1096
Drawing 1.10 % 83.38 % 1.0974
Racing 0.30 % 83.13 % 1.0941
Ring Frame 7.21 % 77.13 % 1.0152
Reeling 1.50 % 75.98 % 1

75.98 100 units of input

Output
1 output

A((((r (o I(((((r(((o( 2

I( or((r (o (o((((( ((((( (((((((((r

((((or(( r((((r(((r(((((((o(((((((( (( (o(((((( (((o((

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 Cost and Management Audit

Process (A) Input (B) Output (C) Wastage Percentage of

(D = B- C) wastage

1. Blow room 4672563 kg 4258274 kg 414289 8.87 %

2. Carding 4274362 kg 3976420 kg 297942 6.97 %
3. Draw Frame 3948241 kg 3901810 kg 46431 1.18 %
4. Roving 3874125 kg 3831510 kg 42615 1.10 %
5. Ring Frame 3911645 kg 3641741 kg 269904 6.9 %
6. Reeling 3635420 kg 3580889 kg 54531 1.50 %

Process Percentage of Wastage Net Output Waste Multiplier

Total 100 1.3.16
1. 8.87 % 91.13 1.199
2. 6.97 % 84.78 1.115
3. 1.18 % 83.78 1.102
4. 1.10 % 82.86 1.090
5. 6.9 % 77.14 1.015
6. 1.5 % 75.98 1

75.98 100 units of input

Output
1 output

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