Features of Cost Audit

Features of Cost Audit:


The cost audit of the companies under the relevant provisions of the Companies Act, 1956 has the
following features:
(i) Assessing compliance of the relevant cost accounting records rules as applicable to the product
under review;
(ii) Study of the costing system to assess whether it is adequate for the cost ascertainment of the
product under review;
(iii) Evaluation of the operating and other effi ciencies of the organization under audit with special
reference to the product under review; to ensure the submission of necessary details required
under the Cost Audit Report Rules, 2001 as amended from time to time.
(iv) Submission of Cost Audit Report in the format prescribed.


Since cost audit is carried out under the various provisions of the Companies Act, 1956, a thorough
and comprehensive knowledge of the Indian Companies Act including various rules prescribed
thereunder and the circulars issued by the Ministry of Corporate Affairs is essential for conducting
an effective Cost Audit

Relevence of Cost Audit

Relevance of Cost Audit


In the initial years, Cost Audit was taken merely as a tool for ‘price control mechanism’ for
consumer and infrastructure industries in India. The main objective of Cost Audit when statutorily
introduced under the provisions of Companies Act, 1956 was to meet the Government requirements
for regulating the price mechanism in core industries like Cement, Sugar, Textiles and consumer
industries like Vanaspati, Formulations and Automobiles. The objective was to provide an authentic
data to the Government to regulate the demand and supply in the country through a price control
mechanism


The liberalization of the economy and consequential globalization has further enhanced the need
for authentic data. Therefore, the Cost Audit Report Rules have been amended from time to time to
ensure that the comprehensive authentic information is available in the format required. The basic
structure of the cost audit was laid down by the Cost Audit (Report) Rules, 1968 as prescribed under
the relevant provisions of Companies Act, 1956. They were superceded by the Cost Audit (Report)
Rules 1996, which were notifi ed vide GSR 511(E) dated 5.1.1996. These Cost Audit (Report) Rules
1996 were also subsequently superceded by the Cost Audit Report Rules 2001, which were notifi ed
vide GSR 294(E) dated 27.12.2001


The necessity for and utility of properly documented information is more keenly felt now than ever
before. In most parts of the world, free competition co-exists with appropriate rules and regulations
to ensure free trade and absence of unfair practices. Therefore, in the present competitive scenario of
globalization, the Cost Audit Reports have assumed greater importance and signifi cance being the
important source of reliable and authentic feedback to the government and its various departments
and agencies. It may be clarifi ed here that the Cost Audit Reports do not only contain merely the
cost details, but are full of information related to all aspects of business organization which, if
harnessed properly can provide a comprehensive analysis about the company, the industry and the
economy as a whole. The Cost Audit Report serves as an effective tool of information in the hands
of directors on the Board ensuring good corporate governance.


In an environment of increasing foreign trade under WTO regime, dumping of products at very
low prices have become a serious issue in the international trade. This dumping of products, often
well below the cost price, if not properly countered may harm the indigenous industry. The cost
records and the cost audit report play a very critical role in defense of local industry to substantiate
their fair approach against any allegation of dumping. Similarly, when dumping allegations are
levied against the exports by the Indian companies to any foreign company, the Cost Audit Reports
can provide the valuable feedback to protect the interest of Indian companies


The practice of selling below cost to ward off competition attracts the penal provisions of the
Competition Law. This necessitates the availability of authentic cost details of the products
marketed by industry and business houses to determine normative pricing or fair pricing. In fact,
Competition Law to be effective against any anti-competition activity presupposes the availability
of reliable and authentic cost data


The transfer pricing issue has gained considerable momentum in international scenario. Cost
Audit Report Rules 2001 include the provisions to take care of this aspect in right perspective. The
fundamentals of transfer pricing are based on “arm’s length” throughout the world. The cost details
form the very basis of determining arm’s length transfer pricing policy of any country. An audited
cost records and the resultant Cost Audit Report becomes a majorsource of information, which
can be effectively used by both Indirect and Direct Tax Authorities. The Central Excise Authorities
also use Cost Audit Reports for verifying claim of the companies relating to ex-factory prices of the
excisable goods especially in the case of inter-unit transfers


The Tariff Commission relies on authenticity of the cost audit reports and makes use of these
reports extensively in fi xation of tariffs for the products covered under Cost Accounting Records
Rules. The Cost Audit Reports are also made use of by the respective administrative Ministries of
Government of India for fi xation of administrative prices and working out subsidy, etc. Fertilizer
Industry Coordination Committee (FICC) under the Department of Fertilizers and the Directorate
of Sugar under Ministry of Food use Cost Audit Reports extensively in taking decision with
respect to the Industries under their purview. The Cost Audit Reports relating to Bulk Drugs and
Formulations are used by the National Pharmaceutical Pricing Authority for fi xation of prices of
various drugs and formulations covered under the Drug Price Control Order, 1995.


The Cost Audit Reports have great potential in government procurements especially in case of
non-competitive procurements. There are no effective anti-trust laws in India. This always leaves
a scope for the traders/suppliers to charge exorbitant prices from the government supplies. For
example, ‘Clayton Act’ in USA clearly provides that any discrimination in price, services or facilities
shall be unlawful in USA. It also prohibits the discrimination in rebates, discounts or underselling
in particular localities. This ‘Act’ further provides that any differential in prices etc., shall have
to be justifi ed on the grounds of differences in the cost of manufacture, sale or delivery resulting
from the differing methods or quantities in which such commodities are sold or delivered and the
burden of rebutting the prima-facie case shall be upon the person charged with a violation of this
act. The ‘Clayton Act’ also provides that it shall be unlawful for any person to induce or receive a
discrimination in price, which is prohibited under the act. In other words, each seller of product or
service can charge a uniform price only in the USA. However, this is not the case in India, where
each purchaser may be charged a differential price by the supplier or the trader. A signifi cant
portion of the government budget is spent every year on procurements, where reasonability of
purchase price is always an issue. Therefore, Cost Audit Reports can always fi ll the vacuum in
government procurements ensuring reasonability of prices. Similarly in USA, an “Incurred Cost”
statement is made with respect to major projects funded out of Government budgets. This incurred
cost is nothing but Cost Audit Report.


In addition to above, Government has been giving various incentives for exports by the Indian
Industries. These incentives are mainly to refund the taxes paid in the country to provide level
playing fi eld to the Indian Industry. Similarly many of the exporters import duty - free material
for exports after further processing, where actual productivity is a major issue. Cost Audit Reports
provide not only the actual amount of various taxes paid by any unit but also provide the actual
productivity and wastage. Thus Cost Audit Reports can benefi t the Indian Industry to get at par
with global competitors.

Introduction to Cost Audit

Introduction to Cost Audit:

Methods and techniques of ‘cost accounting’ and audit of ‘cost accounts’ in India can be traced back
to the year 1925, when large number of fi rms were given contracts by the Government of India on
“cost plus” basis and the Government started verifying and investigating the cost structure of such
fi rms.


Need for large scale industrialization immediately after the independence required lot of
concessions and facilities to the entrepreneurs to establish industrial undertakings for production
of common man’s goods and essential services. Power, electricity and other inputs were provided
at concessional rates. Liberal fi nances were provided by the banks and other fi nancial institutions.
Land was made available with all infrastructures. Transport facilities were also provided. However,
there were only very few industrial groups and it was a suppliers market in almost all the areas.
There were many bureaucratic hurdles in opening of new industries along with need for licenses
and permits. Imports were mostly prohibitive due to scarce foreign exchange and very high rate
of custom duties on imports. Therefore, consumers had very few choices and there were often
complaints of excessive pricing, which encouraged smuggling and other malpractices like underinvoicing
of imports to save custom duties or over-invoicing of exports to get higher export benefi ts.
The high prices were often justifi ed on the basis of higher indigenous cost of production. Thus the
government felt the need for price controls.


Companies Act, 1956 was amended in the year 1965 to incorporate the provisions
relating to the maintenance of Cost Accounting Records and Cost Audit. These amendments were
made on the basis of recommendations from the Vivian Bose Commission, Dutta Commission and
the Shastry Committee.


Cost audit is the audit of cost records. According to Chartered Institute of Management Accountants,
London (CIMA), cost audit is “the verifi cation of the correctness of cost accounts and of the
adherence to the cost accounting plan”. In other words, cost audit is the verifi cation of the cost of
production of any product, service or activity on the basis of accounts maintained by an enterprise
in accordance with the accepted principles of cost accounting. This defi nition of Cost Audit is
relevant to the voluntary Cost Audit without any statutory backing


The Institute of Cost and Works Accountants of India on the other hand, defi nes 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 attendant information, required to be maintained by specifi ed
industries.” Thus the concept and scope of cost audit as defi ned in India is more specifi c and lays
emphasis on the evaluation of the effi ciency of operations and the propriety of management actions
as introduced by the Government of India for specifi ed industries. In this sense, cost audit in India
appears to be synonymous with effi ciency audit mainly as a guide for management policy and
decision making besides being a barometer of actual performance


The justifi cation for mandatory Cost Accounting and Cost Audit provisions has been very well
explained in the Parliamentary Debate that led to the adoption of Companies Amendment Bill,
1965 incorporating the provisions related to Sections 209 (1) (d) and 233B. Smt. Tara Ramchandra
Sathe (MP for Maharashtra) stated during the relevant Rajya Sabha Debate as under:
What is Cost Audit? The Cost Audit is quite different from the Financial Audit. It is to see whether the labour
is effi cient or not, whether the industry has provided effi cient labour or the labour which is required by that
industry is less than what is required, whether every material and every part of the machinery is used to the
optimum, whether any material is wasted, etc.

As we all know, we are short of material, there is so much material which is imported, when we are short of
foreign exchange. In these circumstances, it is very essential that there should be cost audit. In fact, it should
be introduced in almost all the industries, but the Government is trying this in certain cases only. So by this
we will know whether there is a proper utilization of the material or not. It is very essential, no doubt, and in
factories and industries, everywhere, this cost audit should be emphasized.” (Proceedings of Rajya Sabha, 14th September, 1965: Columns 3944 and 3945).


Thus Cost Audit in India refers to the statutory Cost Audit of the selected companies covered
under the relevant provisions of the Companies Act, 1956. These requirements are mandatory and
non-compliance may invite penal provisions also