What’s the Difference Between Cost Audit and Financial Audit

Cost Audit and Financial Audit

It is now widely accepted that every form of accounting must be accompanied by an appropriate system of auditing. This is primarily done to ensure the credibility of accounts and their suitability to be used as a basis for making many business decisions.

Cost accounting is a critical tool for determining the selling prices and increasing the profitability of a company. However, the costing system must also be competent enough in order to avoid consumer exploitation. It is in this context that a system of cost audit is used to evaluate the accuracy and reliability of cost accounting records. This cost audit is carried out in addition to the audit of financial accounts by the statutory auditors appointed by the company. You may find the differences between cost audit and financial audit in the below paragraphs.

Financial audit

A financial audit is a legal requirement for the majority of businesses and public organizations/institutions. Tax audits conducted under the Income-tax Act are also included in this category. It is an exploratory critical review conducted by an authorized independent agency, as well as a monitoring mechanism, to examine the extent to which the organization’s accounts conform to expectations within a specific framework.

It results in an opinion about the accuracy of the presented data and financial information. It also ensures that generally accepted accounting principles are followed consistently. However, financial auditing has a serious weakness. It’s just a post-mortem examination. It follows a set of rules and applies a set of procedures. Because of its annual reporting, it cannot be used as a management tool. The information therein arrives too late, is too much in aggregate, and is insufficient for managerial decision-making.

Following are some of the features of a financial audit:

• A financial audit is compulsory for all companies. Every entity registered under the Companies Act, whether as a Private Limited or a Public Limited company, is required to have its books of accounts audited once a year.
• The primary goal of a financial audit is to form an opinion on an organization’s financial statements. The auditor must state whether or not the financial statements present a true and fair picture of the organization’s affairs.
• The Companies Act of 2013 specifies the qualifications of the statutory auditor who conducts a financial audit. In the case of a corporation, only a practicing Chartered Accountant or a firm of practicing chartered accountants can be appointed as a statutory auditor. However, a statutory audit has to be conducted only by external agencies. He cannot be an employee of the company of whose accounts he examines.
• A statutory auditor is appointed by owners or shareholders of a company at each AGM. The appointment is done for a period of 5 years after which re-appointment may be made for another 5 years subject to Rule 5 of Companies (Audit and Auditors) Rules, 2014 on the rotation of auditors. Moreover, the first statutory auditors of a company are appointed by its Board of Directors within 30 days from the date of the registration of the company. He holds office till the conclusion of the first AGM.
• A statutory auditor presents his report to the company’s shareholders at its annual general meeting.
• A company must hold the Annual General Meeting (AGM) within 6 months of the end of the fiscal year, and notice of the AGM must be given to all members at least 21 days before the AGM. Shareholders should be given a copy of the Directors’ Report and Audited Financial Statements, as well as the auditors’ report, along with the notice of the AGM.
• Statutory auditors should have access to the company’s books of accounts and vouchers at all times and they can seek any information from officers of the company as may be deemed necessary.
• The procedure for removing a statutory auditor before his tenure is very complicated. The statutory auditor can only be removed by the company in a general meeting. It must also obtain the permission of the central government.

Cost audit

A cost audit, on the other hand, is concerned with 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. 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.

Rule 4 of the Companies (Cost Records and Audit) Rules, 2014 prescribes the list of companies engaged in the production of some specified goods on which cost audit is applicable. For more details on its applicability, please follow this link.

Cost auditing is a legal reporting exercise, as it is related to annual reporting to the government about the efficiency of operations with specific reference to a specified product(s) in a prescribed format. It limits the auditor’s ability to report by confining it to specific areas only. The report is not distributed to investors, i.e., shareholders. It does not study and evaluate the role of top management in leading and making decisions. Nevertheless, cost audit deals with many strategic functions of an organization and can be developed into a management audit by collaborating with the Board of Directors and broadening its scope.

Some of the important points related to cost audit are as follows:

• Every company to which a cost audit is applicable needs to appoint a cost auditor within 180 days of the commencement of every financial year.
• The Board of Directors of a company appoints its cost auditor and his remuneration is ratified by shareholders subsequently.
• On the appointment of the cost auditor, the same has to be intimated by the company to the Central Government in e-Form CRA-2. This notice is to be made within 30 days of the board meeting in which the auditor is appointed or within 180 days of the commencement of the financial year, whichever is earlier.
• To be eligible to be appointed as a cost auditor, the concerned party must be a cost accountant or a firm of cost accountants in practice. Also, the cost audit must be conducted in compliance with the cost auditing standards issued by the Institute of Cost Accountants of India.
• Further, as per Section 148 (3), a statutory auditor of the company appointed under Section 139 cannot serve as a cost auditor.
• A cost auditor appointed under Section 148 continues in such capacity till the expiry of 180 days from the closure of the financial year or until he submits the cost audit report for the relevant financial year. However, the company has a right to remove him from office before the expiry of his term, through a board resolution, and after giving him a reasonable opportunity of being heard.
• On the completion of the cost audit, the cost auditor is required to submit his duly signed cost audit report to the company’s Board in e-Form CRA-3. Such a report has to be furnished within 180 days from the closure of the financial year to which the report relates. The report should provide the auditor’s reservations, observations, or suggestions if any.
• After examining the cost audit report and within 30 days of its receipt, the Board of Directors of the company needs to furnish such report to the Central Government in e-Form CRA-4 along with full information and explanation on every reservation or qualification contained therein.

Key Takeaways

Cost audit	Financial audit
Verification of cost records pertaining to certain specified goods	Verification of transactions recorded in the books of account
Checks whether cost accounting system followed in the company serves as a correct basis for ascertaining the cost of production	Ensures that a true and fair view of the company’s state of affairs is represented through its financial statements
Mandatory for certain specified classes of companies producing specified goods	A financial audit is a statutory audit. It is compulsory for every company registered under the Companies Act.
Scope of reporting is confined to cost accounting records only	Auditor’s report covers the review of all financial statements like P/L Account and B/S.
Views the current system of cost computation	Verification of past records of accounting relating to a previous year
Annual or may be for a particular year only (as per the directions of the Central Government)	Conducted regularly every year
Examines the reliability of systems that produce cost information	Aims at the detection and prevention of errors and frauds
Conducted by a qualified cost accountant	Conducted by a qualified chartered accountant
Appointed by the Board of Directors	Appointed by the shareholders of the company
Intimation of appointment of cost auditor to the Central Government	No such requirement
Only the adequacy of stock is judged	Includes the valuation of all assets and liabilities
Protects the interests of management and consumers	Protects the interests of shareholders
Looks into the utilization of labor, material, overheads, and other items of cost	Concentrates upon the books of accounts
Scope is narrow	It covers a wider financial field and not just a particular cost activity.

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