Cost Audit and Efficiency Audit

Cost Audit and Efficiency Audit:


Efficiency Audit is systematic appraisal of management methods and is intended to assess the actual
performance levels relative to applicable peer benchmarks or internal standards (e.g., profi tability or
stated business plan objectives etc.). The process is also designed to identify opportunities to ensure
performance benefits. It aims at identifying efficiency and productivity improvement opportunities
so that the resources fl ow into the most remunerative channels to ensure the optimum returns.

The parameters of measuring effi ciency include overall rate of return, capacity utilization, utilization
of national, financial, physical and human resources, cash fl ow performance and the pay back
period of the entire organization. Thus efficiency audit seeks to evaluate the overall organizational
efficiency.


The cost audit report also mainly the comment on the efficiency of the company namely, utilization
aspect of the factors of production. To enable the cost auditor to make efficiency audit, Section 209
(1) (d) of the Companies Act provides for “records of utilization of material, labour and other items
of cost.” Since a proper appraisal of the extent of efficiency of utilization of factors of production is
possible in cost audit, it may appropriately be called efficiency audit.

The cost audit as efficiency audit can also be understood from the fact that cost audit reports enable
the determination of accurate costs of production of various products, services and activities with
a view to compare the same with the comparable figures of the earlier years and those of the peers
or benchmarks in the industry. It seeks to identify the areas of inefficiency or poor decision making
to ensure diversion of funds to most optimum channels. The information regarding exact unit
costs after proper allocation of overheads, capacity utilization, per unit consumption of major
raw materials (including power and fuel), man-hour productivity, idle hours or un-productive
manpower wastage etc. serve as basis for efficiency audit and helps in fixing appropriate prices of
goods and services produced by the company to ensure optimum returns. The detailed financial
analysis of the company in cost audit report like determination and comparison of different ratios
like ‘profi t as % of capital employed’, ‘profit as % of net sales’, ‘value addition’, ‘current asset as
% of current liabilities’, ‘profit as % of capital employed’ etc. help in assessing the operational
efficiency and comparing the financial health of the undertaking with the peers or others in the
industry aiming at bringing all round efficiency.

Scope of Cost Audit

Scope of Cost Audit:


Section 227(2) of the Companies Act, 1956, requires the auditor of a company to state whether the
accounts in his opinion give a true and fair view of the state of the company’s affairs in the case
of the balance sheet and of the profi t or loss for its fi nancial year in the case of the profi t and lossaccount. Therefore, statutory fi nancial audit of a company conducted by the Chartered Accountant
is an essential annual feature of all the companies registered under the provisions of Companies
Act, 1956. The Board of Directors of every company has a statutory obligation to place its audited
annual accounts viz. Profi t and Loss Account and Balance Sheet before the shareholders in the
Annual General Meeting, duly certifi ed by a Chartered Accountant appointed as an ‘Auditor’ under
the provisions of Section 224 of the Act. However, there is no corresponding statutory provision
for compulsory annual audit of cost accounts of a company covered under Section 209(1)(d) of the
Companies Act or under relevant Cost Accounting Records Rules.


One of the pre-requisites of cost audit is the maintenance of cost accounting records by the
company. Section 209(1)(d) makes it obligatory for a company pertaining to any class of companies
engaged in production, processing, manufacturing or mining to maintain such particulars relating
to utilization of material or labour or to other items of cost as may be prescribed, if such class
of companies is required by the Central Government to include such particulars in the books of
accounts. The rules provide that only those companies, which are covered under Section 209(1)(d)
of the Companies Act and a specifi c Cost Audit Order has been issued with reference to a specifi ed
product by the Cost Audit Branch of Ministry of Corporate Affairs are required to get their cost
accounts audited with respect to that specifi c product. Moreover, Cost Audit Report is not placed
before the shareholders during the Annual General Meeting.


The Central Government prescribes the separate cost accounting records for each class of companies
i.e. companies manufacturing a particular class of product or activity like Cement, Steel, Chemicals
and Electricity etc. and these are called the Cost Accounting Records Rules for that specifi c industry
or class of companies. When cost accounting records/formats are prescribed, they apply to those
companies engaged in the manufacture of a particular product or activity. In the case of companies
engaged in production or processing of other products or activities also in addition to production,
processing or manufacture of the specifi ed product, the records will have to be maintained only
for the manufacture of particular product for which rules are issued and not necessary for other
products. A company manufacturing bulk drugs, formulation and watches need not necessarily
maintain cost accounting records in respect of watch making activity if no statutory rules are
prescribed for watch making activity. The detailed provisions relating to the manner of prescription
of cost accounting records, selection of the product, the contents of the rules and the list of products/
industries covered by the statutory rules under Section 209(1)(d) of the Companies Act have also
been explained in Study Notes 2 and 3. Thus Cost Audit u/s 233B does not embrace a particular
activity of the company unless a separate cost accounting record rule is already notifi ed for that
particular activity under Section 209(1)(d) detailing the nature of cost accounting records to be
maintained.


The legal provisions relating to statutory cost audit are applicable only to companies registered
under the provisions of Companies Act, 1956. Therefore, cost audit is not applicable to other
enterprises like partnership, cooperative societies, etc. The Cost Audit is conducted by a Cost
Accountant in practice within the meaning of the Cost and Works Accountants Act, 1959. The cost
auditor is appointed by the Board of Directors of the company with the previous approval of the
Central Government. The report of cost auditor is to rendered to the Central Government with a
copy to the Company.

Objectives of Cost Audit

Objectives of Cost Audit:


Cost Audit has both general and social objectives. The general objectives can be described to include
the following :
• Verifi cation of cost accounts with a view to ascertaining that these have been properly
maintained and compiled according to the cost accounting system followed by the
enterprise.
• Ensuring that the prescribed procedures of cost accounting records rules are duly adhered
to.
• Detection of errors and fraud.
• Verifi cation of the cost of each “cost unit” and “cost center” to ensure that these have been
properly ascertained.
• Determination of inventory valuation.
• Facilitating the fi xation of prices of goods and services.
• Periodical reconciliation between cost accounts and fi nancial accounts.
• Ensuring optimum utilization of human, physical and fi nancial resources of the enterprise.
• Detection and correction of abnormal loss of material and time.
• Inculcation of cost consciousness.
• Advising management, on the basis of inter-fi rm comparison of cost records, as regards the
areas where performance calls for improvement.
• Promoting corporate governance through various operational disclosures to the directors.


Among the social objectives of cost audit, the following deserve special mention :
• Facilitation in fi xation of reasonable prices of goods and services produced by the
enterprise.
• Improvement in productivity of human, physical and fi nancial resources of the enterprise.
• Channelising of the enterprise resources to most optimum, productive and profi table areas.
• Availability of audited cost data as regards contracts containing escalation clauses.
• Facilitation in settlement of bills in the case of cost-plus contracts entered into by the
Government.
• Pinpointing areas of ineffi ciency and mismanagement, if any for the benefi t of shareholders,
consumers, etc., such that necessary corrective action could be taken in time.