What is Cost Audit?
Cost audit is an important and continuous process that a company has to execute properly during its entire existence in the market. It accounts for the complete verification of the cost records of the company and also takes into consideration the other different types of accounts. Tracking the cash flow in a company and correcting the instances where wrong data exists is the main objective of the cost audit. To understand in-depth what cost audit is, you have to understand its functions, importance, and advantages.
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Objectives of Cost Audit
If someone has to read about why Cost audits are important, they have to understand what are the objectives and benefits of cost audits. Some of the objectives of cost audit are enlisted below:
To maintain the accuracy of the data related to cost.
To ensure coverage of all arithmetic data in any account book.
It helps in maintaining all cost-related principles and complete adherence to preparing cost accounts.
It helps in detecting errors, drawbacks, and frauds in accounts and correcting them immediately.
To observe if all features of cost audit are properly followed.
To check the overall working condition of the cost department also comes under the process of cost audit.
For ensuring proper management and usage of cost strategies at the right time.
To develop correctness among internal auditors of the company.
If one has to understand what a cost audit is, the best way is to study its objectives mentioned above.
Types of Cost Audits
There are several types of cost audit processes. Each one is done on behalf of some organization. Below are the examples.
Cost Audit on behalf of the government.
Auditing on behalf of Assist Management.
Cost Audit on behalf of tribunals.
Auditing for the trade association.
Cost Auditing under the Statute of the company.
However, apart from the above, there are other types of cost audits that depend on the necessity of the companies. One has to understand the meaning of cost audit properly to exclusively design the process for a specific company.
Applicability of Cost Records
According to Rule 3 of the Companies, Cost Records and Audit 2014, all cost records should be placed for the companies that produce commodities cited on Table A or Table B. The applicability of cost records will be considered mandatory in case of the above situation or has an aggregated turnover in the preceding year over INR 35 crore.
So, the applicability of the cost records is generally for large companies with a high turnover. In no case, the cost records will be applicable if both the above conditions are not satisfied.
Functions of the Cost Auditor
A cost auditor is the one who is responsible for the execution of cost auditing. The functions of a cost auditor are as follows.
Make clear cost audit reports with all the facts and data intact.
A cost auditor should make qualifiable reports.
Helping the central government with the cost auditing report in case of an investigation.
Cost auditor and financial audit have a vital connection as he has to omit the drawbacks and wrong implementations.
Advantages of Cost Audit
There are a number of advantages of cost audit and they are mentioned below briefly.
The features of cost audit help it to point out any wastage for the company.
The importance of cost audit is there as it points out the drawback in the production process of a company.
The stock value and worth of inventories can be integrated easily by cost auditing.
Proper cost auditing ensures effective staff management and tracking the functions of a staff auditor.
One of the other advantages of cost audit is to mark the inefficiency of staff or processes that can decrease the profit of the company.
Fun Facts
An efficient cost audit by a company can lead to a lesser number of incidents of fraud and laundering. Nowadays, large companies organize half-yearly cost audits to be clear about cost-related outcomes.
Solved Examples
Q1. What is the provision of a Cost Audit?
Answer: The Companies Act, Section 148 states that there are two tables on which the applicability of the audit depends on. These are tables A and B. the details of Table A and Table B goods are as follows.
Table A Goods: Total turnover greater than 50 crores and aggregate turnover over 25 crores in case of commodities and services.
Table B Goods: Total turnover of goods over 100 crores and aggregate turnover over 35 crores for commodities and services.
FAQs on Cost Audit: Meaning, Objectives, and Importance
1. What is a cost audit and what are its main objectives?
A cost audit is the systematic and independent examination of a company's cost records and accounts. Its primary goal is to verify the accuracy of these records and ensure adherence to the prescribed cost accounting principles. The main objectives include:
- Verifying the correctness of a company's cost accounts and statements.
- Detecting errors and preventing fraudulent activities related to costing.
- Ensuring the efficient use of resources by identifying and flagging wastage of material or labour.
- Providing reliable cost data to management for informed decision-making.
- Assisting in the determination and regulation of fair prices for goods and services.
2. How does a cost audit differ from a financial audit?
While both are forms of audit, they serve distinct purposes. A financial audit focuses on verifying the truth and fairness of a company's overall financial statements, like the Profit & Loss Account and Balance Sheet, primarily for external stakeholders such as investors and banks. In contrast, a cost audit is an internal-facing examination focused on the efficiency of operations. It scrutinises the cost of production and processes to ensure resources are used optimally and provides detailed data for management's strategic decisions on cost control and reduction.
3. What are the main types of cost audits conducted in business?
Cost audits can be classified based on their purpose or the entity initiating them. The principal types are:
- Statutory Cost Audit: This is a mandatory audit required by law, such as under Section 148 of the Companies Act, 2013, for specific classes of companies meeting certain turnover criteria.
- Cost Audit on behalf of Management: This is conducted voluntarily by a company's management to aid in internal decision-making, performance evaluation, and cost control.
- Cost Audit on behalf of a Tribunal: This may be ordered by a court or tribunal to help settle commercial disputes related to costs or pricing.
- Cost Audit for a Trade Association: Performed to maintain pricing discipline, set benchmarks, and share best practices among member companies in an industry.
4. Which companies are required to undergo a mandatory cost audit in India?
According to the Companies (Cost Records and Audit) Rules, 2014, a mandatory cost audit is applicable based on a company's industry and turnover. The requirement is triggered if a company is engaged in producing goods or providing services specified in the rules and exceeds the prescribed annual turnover thresholds. These thresholds vary for regulated and non-regulated sectors, typically involving an overall turnover from all products/services (e.g., ₹50 crore or ₹100 crore) and turnover for specific products/services requiring cost records (e.g., ₹25 crore or ₹35 crore).
5. How does a cost audit help in improving a company's profitability?
A cost audit directly impacts profitability by improving operational efficiency. It contributes by:
- Identifying Wastage: It pinpoints losses from excess material consumption, idle time for labour, or underutilised machinery.
- Optimising Processes: It can suggest more efficient production methods or better resource allocation to reduce costs.
- Informing Pricing Strategy: By providing accurate product cost data, it helps management set competitive yet profitable prices.
- Improving Inventory Control: It ensures that capital is not unnecessarily blocked in excess or obsolete stock.
- Strengthening Budgetary Control: It verifies actual costs against budgeted figures, highlighting variances that require corrective action from management.
6. What key information is included in a Cost Audit Report?
A Cost Audit Report provides a comprehensive analysis of a company's cost structure and efficiency. Key components typically include:
- The auditor's opinion on the accuracy and fairness of the company's cost statements and records.
- Observations regarding the efficiency of resource utilisation, including materials, labour, and overheads.
- An analysis of the company's inventory valuation methods and their correctness.
- Comments on the effectiveness of the company's budgetary control system and variance analysis.
- Details on any transactions with related parties and their impact on costs.
- Any reservations or qualifications the auditor has concerning the company's cost accounting system.
7. What are the primary functions and responsibilities of a Cost Auditor?
The primary responsibility of a Cost Auditor is to conduct a thorough cost audit and submit a detailed report to the company's Board of Directors. Their key functions involve:
- Verifying that the company maintains proper cost records as per the requirements of the Companies Act.
- Checking for arithmetical accuracy throughout the cost accounts.
- Ensuring that the company's management has followed established cost accounting principles and plans.
- Detecting and reporting any significant errors, instances of fraud, or operational inefficiencies discovered during the audit.
- Helping the central government with required information for any investigation or policy-making.
8. Why is a cost audit important for a country's economy?
Beyond benefiting individual companies, a cost audit serves broader national economic interests. For government and regulatory bodies, it provides reliable data that is crucial for:
- Formulating Trade Policies: It helps in determining fair export incentives, anti-dumping duties, and import tariffs to protect domestic industries.
- Price Regulation: It assists in fixing fair prices for essential commodities or services in regulated sectors to safeguard consumer interests.
- Resource Allocation: It offers insights into the efficiency of key industries, which informs national industrial policy and planning.
- Enhancing Competitiveness: By promoting efficiency, it makes domestic products more competitive in global markets.
