What is Cost Audit? Definition, Objectives, Advantages, Disadvantages

  • Post last modified:20 April 2021
  • Reading time:19 mins read
  • Post category:Finance
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What is Cost Audit?

Cost Audit means the checking and verification of the cost accountancy books, records, statements, reports and other data related to the cost of a product or service being provided by a business unit. Such verification is done by a cost accountant who is appointed by company management, with a prior approval from the Central Government, as the cost auditor.

Such verfication is done not only for the entries made in the cost accounting books but to see that the various resources are used by the company with maximum efficiency and the cost of production and cost of sales is kept to the minimum.

Cost audit is not a postmortem examination like financial audit. Cost auditor verifies the correctness of costs and if there is any inefficiency due to which additional costs have been incurred in the process of production, the cost auditor in his observations draws attention to such inefficiency and suggests measures to be used for eliminating such inefficiency.

While doing cost audit, the auditor also checks whether the cost accounting books and records have been prepared by following the accepted cost accounting principles and costing system adopted by the business unit. Cost audit, thus is the verification of correctness of cost accounts and of the adherence to the cost accounting plan.

Cost Audit Definition

The term ‘Cost Audit’ has been defined by various experts as well as by the Institutes such as CIMA and ICWAI. A few definitions are given below:

The detailed checking of the costing system, technique and accounts to verify their correctness and to ensure adherence to the objectives of cost accountancy.Smith and Day
Cost audit is the verification of the correctness of cost accounts and of the adherence to the cost accounting planChartered Institute of Management Accountants, London (CIMA)
A cost audit, briefly defined, is an examination of the records and methods employed in determining the cost of goods manufactured and sold, with two fold purpose of verifying the accuracy of the costs obtained and criticizing the methods whereby they are developedMontgomery
an audit of efficiency of minute details of expenditures while the work is in progress and not a post mortem examination. It is mainly a preventive measure, a guide for management policy and decisions, in addition to being a barometer of performanceInstitute of Cost and Works Accoutants of India (ICWAI)

Objectives of Cost Audit

The objectives of Cost Audit can be divided in two groups – General objectives and Social objectives.

General objectives of cost audit

  • To verify the arithmatical accuracy of the entries made in the Cost Accountancy Books.

  • To find out whether the cost accounts have been prepared and maintained according to the costing principles employed in the industry to which the business organisation belongs.

  • To detect the errors of principles, if any, committed in the records maintained by the business organisation.

  • To detect the frauds that are made in the cost records which might have been committed intentionally or otherwise.

  • To verify the total cost of each product, process, operation and job to see that such costs have been correctly ascertained.

  • To help the management by drawing its attention to any deficiency or inefficiency in the use of the resources, noted by the cost auditor.

  • To find out whether the cost accounting procedures prescribed by the company have been adhered to or not.

  • To verify whether the cost accoutancy books and other records prepared by the company are adequate to record the costs.

  • To verify whether each item of expenditure related to components of the goods manufactured has been properly incurred or not.

  • To find out whether the stock of materials, work in progress and finished goods have been accurately valued or not.

  • To advise the management for adoption of alternative course of action in place of the course of action currently followed by it.

  • To assist in improving the operation efficiency and profitability by reducing the cost of production or services by creating cost consciousness among the persons working at different levels.

  • To see whether the chargeable expenses as recorded by the cost accountant of the company are correct or not.

  • To verify that the cost statements are properly drawn up as per the records and they represent a true and fair view of the cost of production and cost of sales.

  • To see that the company is adequately managed.

  • To report to the appropriate authority as to the state of cost affairs of the company.

Social Objectives of Cost Audit

Cost audit provides a lot of valuable information which can be used by the Government and social institutions to see whether the work of providing goods and services is carried out by the business organisations at proper cost and in an efficient and effective way.

Such information can be used by the Government to fix prices of certain goods and services and to take decisions about amount of subsidy to be provided to the companies engaged in producing and selling some goods and services so that the entire burden of the cost incurred by them does not fall upon the consumers of these goods and services.

Social objectives can be stated as under:

Consumer protection

Consumers are required to face the problem of inflation. The prices of the goods and services are constantly increasing and the consumers find it difficult to maintain their standard of living due to inflation. Companies engaged in producing the goods say that they are complelled to increase the prices of products because of increase in the cost of the resources used by them in production process.

However many times the increase in the cost of production is not matched by the increase made in the selling prices of the goods and services.

Increasing productivity

Cost audit provides valuable information about installed capacity of production and the actual capacity used by the industry and the companies. It thus brings to notice the idle and wasted production capacity in the company individually and in the industry collectively.

Such unused capacity can be put to use and increase in the volume of production can be achieved. This results in increasing productivity.

Decisions about Subsidy

It is the objective of cost audit to verify that cost of production is correctly ascertained on the basis of the costs recorded in the cost accountancy books, records, statements, etc. By using this information the Government can take proper decisions about the extent to which subsidy should be granted to those companies whose goods are to be sold at the prices fixed by the government.

Subsidy to be provided to the companies which export their product can be properly decided so that these companies can export their products at reduced prices and face the competition in the international markerts successfully.

Prevention of tax evasion

Government levies taxes like excise, sales tax, corporate tax, export and import duty, etc. for obtaining funds needed by it and uses such funds for various projects, schemes undertaken by it for development and welfare of the society.

Due to cost audit the Government obtains information about the quantity produced, quantity and value of sales effected by the company and payment of various taxes by the company. If any company tries to evade tax payment, it is brought to the notice of the Government and its tax department through the cost audit report.

Creation of new employment opportunities

Cost audit draws attention to unutilised and wasted resources by the company. It also guides the management of the company how these unutilised and wasted resources can be put to proper use.

Increase in volume of production also provides additional amount of profit to the company and funds created out of increased profits provide new investment opportunities to the company. Projects started by using these investment opportunities provide new jobs to the people and the severity of the unemployment problem can be reduced to some extent.

Use of alternative and better methods

Cost auditor studies the methods and techniques used by the company when he is doing the cost audit of the company. In the cost audit report he can suggest some alternative methods of doing the work.

These alternative methods and techniques can help the company to do the work at a lower cost, in a shorter time and produce better quality products. The company and the society can enjoy the benefits available from the use of the alternative and better methods suggested by the cost auditor.

Advantages of Cost Audit

Cost audit provides benefits to the management of the company, to the shareholders of the company, to the Government and also to the society. The important benefits available to each of these four groups are as under:

Advantages of Cost Audit to the Management

  • Cost audit provides accurate and reliable cost data to the management of the company by using which the management can take decisions about fixation of selling prices of its products, control measures to be adopted at appropriate stages and alternative methods to be used.

  • Cost audit provides correct information about cost of production and cost of sales to the management.

  • Cost audit ensures a proper system of management reporting. Unutilised capacity and resources, wastage of resources which lead to increase in the cost of production are brought to the notice of the management so that appropriate action can be taken by it.

  • Through the verification of data recorded in cost accounting books and other documents errors and frauds, if any, are reported to the management.

  • By doing efficiency audit the productivity of various departments and sections is measured and reported to the management. Suggestions are given to the management to control inefficiency and thereby increase the productivity.

  • On the basis of information provided by cost audit the management can decide about expansion or diversification of particular product line. (
  • Cost audit helps in correct valuation of work-in-progress and stock of the finished goods.

  • Through cost audit the management knows whether and to what extent the cost plan prepared by it for achieving the objectives has been implemented.

Advantages of Cost Audit to the Shareholders

  • Cost audit ensures the shareholders that the books of accounts and other cost records have been maintained by following correctly the principles of costing.

  • They can feel sure that the valuation of stock of work-in-progress and of finished goods is done properly and these figures are correctly shown in the financial statements prepared for the particular year.

  • The shareholders know how the funds invested by them in the company are utilised and whether they get a fair return on their investment or not.

  • Cost audit ensures a true picture of company’s state of affairs and shareholders can decide whether or not the company is making progress in the proper direction and at a satisfactory rate.

Advantages of Cost Audit to the Government

  • Through cost audit the Government receives correct information about cost of production and cost of sales per unit for the product manufactured and sold and services provided by the company. This information enables the Government to take correct decision about fixation of the prices and to exercise control over prices of some products essential for society.

  • Due to reliable cost data received from the cost audit report the Government can take decisions about the subsidy to be provided and to what extent it should be provided to the companies producing certain products.

  • For increasing export of some type of goods the Government gives export subsidy to the companies which export their products. On the basis of cost information, the amount of subsidy to be given and for how much period it should be given can be correctly decided by the Central Government.

  • The Government becomes aware about the use of some critical resources by the companies belonging to specific industries. In case of underutilisation and wastage of such resources the Government can issue directives to the management of such companies to improve the use of the resources.

  • Cost audit shows the profiteering done by the companies to prevent exploitation of the consumers. The Central Government can exercise control on the managements of such companies and ask them to reduce the selling price of their products.

  • When the government gives contracts to the companies on ‘cost plus basis’, the information about the actual cost incurred by the companies provided through the cost audit enables the Government to pay proper amount for such contracts.

  • As cost audit provides information about correct amount of profit earned by the company the tax amount payable by the company is accurately decided and the tendency of the tax evasion on the part of companies can be curbed.

  • Errors and frauds committed intentionally or otherwise in the costing books and records are detected by the cost auditor and reported in his cost audit report. This enables the Central Government to take appropriate action against such companies.

  • The Government announces economic and industrial policies for achievement of certain objectives. How far these policies have been implemented by companies belonging to certain industries becomes clear to the Government through the cost audit reports.

    The Government can take decisions about modifications to be made in the policies or announce new policies to replace the existing policies. It may decide to give directives to the companies for corrective actions to be taken by them to ensure the achievement of the declared objectives.

Advantages of Cost Audit to the Society

  • Proper and full use of the resources belonging to the society is ensured through the cost audit.

  • Cost audit provides correct information about the cost of production of products manufactured and sold by the company. By comparing such cost with the market price of the products, the consumers and their association can find out whether or not the consumers are being exploited by the managements of the companies.

  • Cost audit helps in improving the efficiency and productivity of the companies which results in better utilisation of resources and increase in the standard of living of the people in the society.

  • Cost audit increases the cost consciousness of the management as well as other employees working in the company. This helps in checking the inflation in the economy and economic betterment of society becomes possible.

  • Cost audit suggests new methods of operations and alternative use of idle resources. This results in establishment of additional production units and provides additional jobs to the people in the society. Cost audit thus helps in reducing unemployment problem faced by society.

Disadvantages of Cost Audit

Though cost audit provides many benefits to the management, the shareholders, the Government and the society as explained above, it has some limitations which can be stated as under :

  • Maintenance of cost accounts books and other documents recording cost data requires incurring of a lot of expenditure. Appointment of a cost accountant for cost audit increases the expenditure further, such expenditure can be incurred only by a big or moderate size company.

    Small companies do not afford such expenditure and so even if they desire to have cost records and the cost audit they cannot make the arrangement for the same and are deprived from getting the benefits of the cost audit.

  • Cost information is of confidential nature and it is not provided by the costing department to even other departments of the company. Because of cost audit the secrecy and confidentiality of the costing data may not be preserved.

  • Maintenance of cost accounts books for cost audit is regarded as duplication of work by some people. They say that maintenance of the financial books and getting these books audited as required by the statutory audit is sufficient.

  • Cost audit which includes efficiency audit and propriety audit prohibits the higher management from taking initiative in decision making. They hesitate in taking quick decisions because they may be held responsible if some of these decisions are criticised by the cost auditor in his report.

  • Cost audit report is submitted by the cost auditor to the Central Government with a copy sent to the management of the company. The shareholders of the company do not get copy of the cost audit report and so they remain unaware about the remarks of the cost auditor

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