Cost audit and its advantages:
We all know that audit involves verification and examination. Since books of account form the very basis for verification, it is often said that auditing begins where accounting ends. An audit is conducted to check whether the books of account present a true and fair view of the state of affairs or not.
When this concept of auditing is applied to cost records, it becomes a more specific and specialized form of audit activity. It is named cost audit. Cost audit refers to the verification of cost records/accounts and acts as a check on the adherence to cost accounting standards. It checks whether cost accounts, statements, and cost data are accurate and adhere to cost principles.
Thus, cost audit primarily comprises two things:
- The verification of cost accounting records, such as the accuracy of cost accounts, cost reports, cost statements, cost data, and costing methods.
- Examining such records to ensure that they correspond to the cost accounting plans, procedures, and objectives/principles.
In this blog, we have discussed the functions of cost audit, its types and advantages.
Section 148 of the Companies Act 2013 confers powers on the Central Government to direct certain classes of companies to get their cost records maintained and audited by a cost accountant. In other words, a cost audit is mandatory for certain specified classes of companies producing specified goods. Certain classes of companies involved in the manufacture of such goods or the provision of such services as may be prescribed and with a net worth or turnover of such amount as may be prescribed are directed to have their cost records audited. The cost audit report is furnished to the Central Government.
Functions of cost audit
There are mainly four functions of cost audit. These include:
- Verification of cost records as part of the process of audit.
- Examination of the correctness and accuracy of cost records and cost accounts.
- Analysis of whether the prescribed procedures and principles of cost accounting have been properly followed by the entity or not.
- Evaluation that the prescribed cost accounting procedures continue to be relevant for the entity under audit.
This includes an evaluation of (a) the appropriateness of cost accounting systems, records, and procedures, (b) their proper maintenance, (c) their proper compilation in the form of cost statements, and (d) conformity to the required cost accounting procedures.
Forms of cost audit
A cost audit is conducted in addition to a financial audit. It addresses two major aspects of a business enterprise, i.e., protective and constructive.
1. Propriety audit
From the protective aspect, a cost audit examines the following:
- Detection of fraud and errors
- Verification of cost records and ensuring that they are correctly maintained in accordance with the generally accepted cost accounting principles followed in the industry in which the entity operates
- Whether the prescribed system of cost accounting is properly carried out or not
2. Efficiency audit
From the constructive aspect, a cost audit examines the following:
- Whether the existing procedures are adequate and effective in respect of managerial decisions
- How can optimum results be obtained through projected expenditure?
- Is there a possibility of making a more profitable investment of money in another area?
- What’s the rate of return on capital employed?
Advantages of cost audit
As stated earlier, a cost audit is an independent evaluation of the cost statements, cost records, and other associated information of an enterprise in order to offer an opinion on them. It helps to determine whether cost records are accurate or not and whether they adhere to the cost accounting principles or not.
Cost audit is useful for cost control, cost reduction, and the efficient use of scarce resources. Additionally, a cost audit makes sure that accurate records are kept regarding the purchases and use of materials as well as costs associated with wages, overhead, etc. It also assures that the business unit was run in a cost-effective and efficient manner.
With an effective cost audit in place, the effectiveness of operations involved in the production of goods or services is increased. It has both internal and external advantages. In fact, the importance of cost audit and its advantages can be discussed from the viewpoints of:
- The management,
- The shareholders,
- Society, and
- The Government
Advantages of cost audit to the management
- Cost audit helps managers make decisions by using pertinent cost data. With the help of a cost audit, the management can get accurate and reliable cost data that it uses to make decisions and implement cost control measures.
- It helps in the regulation of the level of production.
- It detects and prevents fraud and errors.
- It keeps a check on wastage and minimizes cost.
- Cost audit helps to fix accountability for poor performance.
- It provides suggestions for improving procedures and their efficiency.
- It helps in comparison of actual cost with estimated cost and analyses the causes of variation.
- It assists the management in doing a comparative analysis of the profitability of different items/units.
- It exerts moral influence on the company’s staff and acts as a deterrent to the commission of frauds and errors.
- It ensures that proper principles of costing are applied.
- Cost audit allows the management to abandon less profitable units of production and focus on more profitable units of production.
- Cost audit assists the management in maintaining complete control over various elements of cost such as material, labor, and overhead expenses.
Advantages of cost audit to the shareholders
- Cost audit ensures that a proper system of accounting is there for expenses.
- It ensures that there is an efficient process of production.
- It assures an adequate return to investors and shareholders.
- A cost audit attempts to offer a genuine picture of the company’s state of affairs.
- It displays whether or not the resources, such as Plant and Equipment, are being utilized efficiently and effectively.
- Through cost audit reports, the stakeholders can get information on whether the company is making progress in the right direction and at a satisfactory pace.
Advantages of cost audit to the society
- Cost audit assists in the determination of the true cost of goods & services and fair selling price.
- It helps to determine the level of industrial efficiency and its contribution to economic development.
- It leads to the adoption of a proper standard of living as price levels are fixed fairly.
Advantages of cost audit to the Government
- Cost audit aids in making subsidy decisions in respect of industrial operations.
- It assists in controlling industrial sickness.
- It leads to regulated prices and profits.
- Cost audit helps in enforcing fair trade practices.
- It helps to ascertain future project costs.
- It leads to improved efficiency of industrial operations.
- It helps in the quicker settlement of industrial disputes.
- Cost audit gives pertinent information that may be useful to government agencies for levying taxes or duties on the cost of finished products.
- Cost audit assists the Tariff Board in determining whether or not to extend tariff protection to a specific industry. It helps in making tariff policy decisions on different industrial units.
Cost audit has its limitations as well. These are as follows:
- It is sometimes perceived that cost audit interferes with the internal operations of the management.
- Some people are of the view that cost records are a crucial tool for dealing with market competition, and the information contained within them must be regarded as trade secrets.
- It is a time-consuming activity. Verification extends across all spheres of activity and addresses several aspects of the manufacturing process, ranging from the initial purchase of raw materials to the final sale of finished products.
- Cost audits can take a long time to complete and their reports can be out of date. When they come up for consideration, they may be nothing more than history.
Despite the limitations of cost audit, it is recognized as an effective tool for exercising control and improving industrial efficiency. This has led to continuous growth in its importance and scope of applications.
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