UNDERSTANDING COST AUDIT

DR. AVIJIT ROYCHOUDHURY

INSPECTOR OF COLLEGES,
VIDYASAGAR UNIVERSITY
The terminology issued by the CIMA defines Cost Audit as
“the verification of the correctness of cost accounts and of the
adherence to the cost accounting plan”

ICWAI defines Statutory Cost Audit as a “system of audit

introduced by the Government of India for the review,
examination and appraisal of the cost accounting records
and added information required to be maintained by the
specified industries”
Cost Audit encompasses the following

 Verification of the cost accounting records e.g. the

correctness of the cost accounts, cost statements, cost
data, cost reports and costing technique

and

 Assessment of these records to make sure that they

stick to the cost accounting principles, plans,
procedures and objectives.
Objectives of Cost Audit

 Prospective Objective: To make Efficiency Audit feasible.

Efficiency Audit will verify and examine whether the
funds invested in the business are more profitably
employed to ensure the optimum results, by looking into
the planning of investment and the return for every rupee
of capital employed.

 Constructive Objective: Checking if the actual conforms

to the Cost Accounting Plan and emanating useful
information to the management regarding regulating
production, best method of operation, reducing cost of
operation and reformulating Cost accounting plans.
Applicability
The Companies Act, 1956 was amended by the Companies
Amendment Act, 1974 thereby introducing section 233B
empowering the Central Government to order audit of cost
accounts, for which maintenance of Cost Accounts was
prescribed in respect of companies engaged in production,
processing, manufacturing or mining activities under section
209(1)(d), such particulars relating to effective utilization of
material, labour or other items of cost as may be prescribed.
Cost Audit is to be conducted with regard to (i) provisions of
Companies Act, 1956, (ii) Cost Accounting Records Rules,
(iii) Cost Accounting (Report) Rules, and (iv) Cost and
Works Accountants Act, 1959.
Appointing Authorities of Cost Auditor

A cost auditor may be appointed by:

(i) By the management to conduct cost audit as an aid to

management.
(ii) By external authorities —
(a) Government to conduct audit on behalf of Government.
(b) Customer to carry out cost audit on behalf of customer.
(c) Trade associations or tribunals to facilitate cost audit on
behalf of trade association or tribunal.
Cost Audit Procedures

Cost audit comprises following three steps :

 Review

 Verification

 Reporting
 REVIEW
 Review the costing system in operation in relation to the
production process and method.
 Careful analysis of the production process and documents that
evolve in that course.
 A list of cost account books maintained by client should also be
obtained and analysed about their adequacy.
 Close examination and evaluation of the internal control
system and their effect on the cost account records.
 Preparation of detailed Audit Programme is of utmost
importance.
 Description of the audit should be clearly summarised in the
Audit Manual.
 VERIFICATION
CAPACITIES
 Examination of licensed capacity, installed and utilised
capacities of various products.
 Reasons for abnormal variance should be noted.
FINANCIAL RATIOS
The various Financial ratios to be used as a tool are to be
applied to derive useful results to identify lacunae if any.
 VERIFICATION
COST OF RAW MATERIALS CONSUMED
 The method of accounting followed and consumption of
major raw materials per unit of production compared with
the standard requirement should be verified.
 Variation in consumption of major raw materials per unit
of production in comparison to the preceding years are to
be verified.
 Verify the system or return of scrap and wastage.
 VERIFICATION
PROVISION FOR DEPRECIATION
 Method of depreciation adopted by the company.
 Depreciation provided should conform to section 205 (2)
of the Companies Act
 The basis of apportionment of depreciation to the cost of
products should be analysed.
EMPLOYEE COSTS
 Total man-days of direct labor available and actual
worked in the year should be verified.
 Verify the labour cost per unit of product or products
under reference.
 VERIFICATION
COST ON EMPLOYEE
 Variations as compared to the previous years should be
checked.
 Effect of incentive schemes towards increasing productivity
and its bearing on the cost.
COST OF STORES
 Verify the system of stores accounting.
 Cost per unit of production has to be verified.
ABNORMAL, NON-RECURRING AND SPECIAL COSTS
 Strikes, lockouts, major breakdowns in the plants,
substantial power cuts, serious accident etc., may affect
production. These factors should be checked for accuracy.
 VERIFICATION
OVER HEADS AND ALLOCATION
 Variations as compared to the previous two years.
 Distribution of overhead costs in a rational manner.
 Amount of expenditure should be compatible to the volume
of output.
COST OF POWER & FUEL
 Verify the adequacy of records maintained to ascertain the
cost of power, fuel, steam etc.
 Process of distribution of power cost to departments and
products has to be verified.
 VERIFICATION
COST STATEMENTS
 Determination of cost following the generally accepted cost
accounting principles.
 Application of costing system suitable to the product.
 Consistency in the application of costing system and cost
accounting principles.
 Verification of cost statements as to prescribed form and the
prescribed content.
 Elimination of substantial prior – period adjustments.
 VERIFICATION
RECONCILIATION WITH FINANCIAL BOOKS
 The cost records should be reconciled with the financial
books of account.
 The reconciliation should be done in such a manner the
profitability of the product can be correctly adjudge and
reconciled with over all profit of the company.
 Variations, if any, should be correctly specified and clarified.
REPORTING
 An audit report is to be prepared on conclusion of audit.
 The report should consist of notes, observations and
comments on the cost accounting system, financial position,
stores and spare parts, depreciation, sales, abnormal non-
recurring costs, etc.
 The report may also focus other points of interest like factors
responsible for the increase in cost of production.