Dissertation Subject

Cost Audit

Historical Background & Relevance of Cost Audit

History of Cost Audit
The Institute of Cost and Works Accountants of India set up in 1944 and its statutory recognition under the Cost and Works Accountants Act, 1959 marked beginning of the profession of cost accounting. Immediately after independent, large scale industrialization took place. Lot of concessions and facilities were given to entrepreneurs to establish industrial undertakings for production of common goods and essential services. Power was made available at confessional rates. Liberal finances were provided by the banks and financial institutions. Land was made available with all infrastructures. Transport facilities were provided. The Government had a right to ensure that ultimately the consumers are benefited in that they are able to obtain their requirements at a fair price and do not pay for the inefficiency of manufactures. In order to access the productivity of some important industries which had direct bearing on the supply management system for the growth of Indian economy and as a service to society, Cost Accounting Records under section 209 (1) (d) under Companies Act,1956 came in force. The information on input cost of products, machine utilization unit selling prices and profitability of individual products etc. as required could be maintained. The real beginning of Cost Audit, however, started in 1965 when the Companies Act, 1956 was amended to incorporate the provisions relating to the maintenance of Cost Accounting Records and Cost Audit. Such amendments were made on the basis of recommendations received from Vivian Bose Commission, Dutta Commission and Shastry Committee.

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Cost Audit
What is Cost Audit? The Cost Audit is quite different from
Financial Audit. It is to see whether the labour is efficient or not, whether the 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 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 is very essential, no doubt, and in factories and industries, everywhere, this cost audit should be emphasized.

The Institute of Cost and Works Accountants of India was incorporated by the Act of Parliament only in 1959. Sufficient number of Cost Accountants were not available at that time. Even the Government as under: According to Chartered Institute of Management Accountants, London (CIMA), cost audit is the verification of the correctness of cost accounts and of the adherence to the cost accounting plan. According to the Institute of Cost and Works Accountants of India, cost audit is 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 specified industries. It is an innovation introduced for the first time in the world & in India with a view to regulating vital industries on healthy and sound lines. Cost Audit is for cost-effective products ands services to be available to customers; proper revenue to the Governments Treasury and returns to other stake holders like vendors, workers, distributors etc. then Shri. T.T. Krishnamchari, the then Finance Minister indicated the future vision of

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Cost Audit
Thus the concept and scope of cost audit in India is much wider as the definition lays much emphasis on the evaluation of the efficiency of operations and the propriety of management actions and decisions, and executive programs and policies. In this sense, cost audit appears to by synonymous with efficiency audit. India is the first country in the world in introducing the provisions of compulsory maintenance of the Cost Accounting Records so that the industries become cost conscious, industrial efficiency is increased.

Necessity of cost accounting and cost audit :

Cost Accounting and Cost Audit are absolutely necessary for efficient resource utilization as well as monitoring and improving the efficiency of organizations leading to over all productivity and profitability improvement for the best interest of consumers, investors, workers and industry, and of the general public. Cost audit is based on the economic principle that resources should flow into the most remunerative channels. It ensures that every rupee invested in capital gives the optimum returns and that the planning of investment between different functions and aspects is designed to give the optimum results. Cost Audit measures the parameters indicating the efficiency in the

effective utilization of financial, physical, human resources etc. While Financial Audit, Internal Audit and Secretarial Compliance are all basically Attestation Functions, Cost Audit is a Dynamic Force which is mobile and effective covering areas of a wider spectrum like productivity, waste management, product mix, resource allocation, power utilization and several other areas in which Management has to be constantly vigil to sustain competition, in the Global Market. In a Nutshell Cost Audit covers Efficiency, Performance and properly.

Relevance of Cost Audit

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Cost Audit
In the initial years after the enactment, Cost Audit was taken to
be a tool for price mechanism for important industries in India. The main objective of Cost Audit when introduced was mainly to meet Government requirements for regulating the price mechanism in such industries which were core industries like Cement, Sugar and Textile and consumer industries like Vanaspati, Formulation and Automobiles. The objective was to provide to the Government an authentication data to regulate the demand and supply in the country by a price mechanism. Organizational effectiveness in a market driven economy

evolves from Cost Competitiveness, which in turn emanates from effective utilization of scarce resources. The Cost Audit is an operational and efficiency audit, which aims at optimum utilization and control over the scare resources of a company without which the cost competitiveness cannot come merely through market interactions. After India has opened up its economy and joined the global marketing concept, it has become important that the products and services are competitive by constantly improving efficiency by reducing vital input costs and reduction of wastage. This concept exercise has to be monitored by management and the Cost Audit. It is a powerful tool to high light areas of in-efficiency and improve performance. As such the need for Cost Audit is more in the present scenario than before.

In an environment of increasing foreign trade under WTO

regime, Anti-dumping measures have become a serious issue to check the unethical trade, from the importers on account of Anti-dumping. This threat, to be challenged in the international Forum, requires structured Cost Information, in line with International Practices, which is provided by the Cost Records maintained as per the existing provisions.

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Cost Audit
The cost records and the cost audit report will play a good
source documents for the Indian exporters to substantiate their fair approach against any allegation of dumping.

In todays free market economy lot of goods are imported from

different countries which hamper the growth of local industries due to dumping below costs. The provisions of levy of antidumping duty by Government require exercise of cost of the product for which a regular Cost Audit will help to streamline the procedure. Again, for imposing anti-dumping duties on the imports into India, the expertise of Cost Auditors and certification by them will be useful.

Under Competition Law, this has come into force as legislation

the provision of selling below cost to ward off competition is penalized. This requires authentication of the cost data of the products marketed by industry and business houses to determine normative 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 have been amended to take care of this aspect in right perspective. The fundamentals of transfer pricing are based on cost throughout the world. The cost details form the very basis of the Transfer Pricing Policy of any country. The involvement of Cost Auditor in reviewing the transfer pricing policy and judging its impact on business activities is going to pay a good dividend to the industries and the government squarely.

The formation of Audit Committee under section 292A of the

companies Act, 1956 and clause 49 of the listing Agreement of SEBI is a big leap in ensuring better corporate governance

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Cost Audit
among the Indian Companies. Cost Auditor is to be called for these meetings. The Cost Audit Report serves as an effective tool of information in the hands of external Directors on the Board ensuring good corporate governance.

An independently verified audited Cost Records and the

resultant Cost Audit Report becomes a major source 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 shareholders value has to be improved by highlighting

deficiencies in performance and management for a meaningful understanding under corporate governance.

The Cost Audit Reports are also made use of by the Income Tax
Authorities in the Assessment of Corporate Tax. The Cost Audit Report takes care of the Investors through its emphasis on the efficient and proper utilization of funds deployed by the public in Corporates. Other stockholders also such as banks and financial institutions find the reports very useful and purposeful to make continuous assessment of the financial health of an organization.

The Cost Audit Reports have been regularly used as evidence by

the Directorate General of Investigation and Registration (DGIR) in its pursuit of cases with the MRTP Commission relating to unwarranted increase in prices resorted to by companies by forming cartels.

The Tariff Commission relies on authenticity of the cost audit

reports and makes use of these reports extensively in its studies

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Cost Audit
related to fixation of tariffs of the products covered under Cost Accounting Records Rules. The Cost Audit Reports are also made of by the respective administrative administrative Ministries prices, for the out purpose subsidy, of fixation of working etc. Fertilizer

industry Coordination Committee (FICC) under the Department of Fertilizers, and the Directorate of Sugar under Ministry of Food are the other users of The Cost Audit Reports in regulating the Industries under their purview. The Cost Audit Reports Relating to Bulk Drugs and Formulations are used by the National Pharmaceuticals Pricing Authority for fixation of prices of various drugs and formulations covered under the Drugs Price Control order, 1995. Conclusion The Indian economy is passing through the critical phase of reforms, wherein the administered pricing mechanisms are being dismantled in most of the places and the regulatory authority mechanism is taking its place. Liberalization dose not eliminate the need to regulate prices and profits to bring about economic balance. The regulatory authority mechanism is considered to be more transparent and efficient. In many countries, policy makers and financial administrators struggle to develop an appropriate regulatory framework with the objective to stimulate innovations and market penetration on the one side and ensure sound business practices or good corporate governance on the other side. Further regulatory mechanism should be applied in a manner, which would usher in investment and efficiency. Regulation itself is imperfect when the right regulatory mechanisms are not clearly defined. It is all the more imperfect when it is implemented without an adequate information base and sophistication. These regulatory authorities, therefore, need proper and professional information Management System, which are designed to dispense usable data in an efficient manner. This involves integration of heterogeneous

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Cost Audit
information. CARR 2001 is the just and Perfect solution

promulgated by the Regulatory Authorities.

Features of Cost Audit:

Cost Audit in these guidelines refers to the cost audit ordered under Section 233B of the companies Act, 1956. Such audit, in addition on the features mentioned above, has the following additional features: a) Assessing compliance by the company with the cost accounting records rules, as applicable to the product under review. b) Study of the costing system to assess whether it is adequate for the cost ascertainment of the product under review. c) Evaluation of the operating and the efficiencies of the organization under audit with special reference to the product under review. The basic structure of the cost audit was laid down by the Cost Audit (Report) Rules, 1968, prescribed under the Companies Act, 1956. They have been superseded by the Cost Audit (Report) Rules, 1996 which were published vide GSR 511(E) dated 5.11.1996. Further, Cost Audit (Report) Rules, 1996 have been superseded by the Cost Audit Report Rules, 2001 vide GSR 294(E) dated 27.12.2002. The Cost Audit (Report) Rules, 2001 referred to as Report Rules have come into force from 27.12.2001. However keeping in view the practical difficulties of the companies and cost auditors to comply with the rules, the application of the rules has been deferred. Any Cost Audit Report submitted on or after 1st October, 2002, irrespective of the financial year of the company to which it relates, has to be prepared as per the Report Rules, 2001 . Since audit is the part of the companies Act, 1956, a through and comprehensive knowledge of that Act, including various rules prescribed there under and the circulars issued by the Department of Company Affairs is essential for conducting an effective cost audit.

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Cost Accounting Records Rules:
It may be noted that Cost Audit U/Sec. 233-B of Co. Act is ordered only when Cost Accounting Records Rules are prescribe for that Industry. The nature of the records to be maintained by the companies U/Sec. 201 (1) (d) of the Cos. Act are prescribed by the Central Govt. in exercise of the powers conferred on them by the Sec.642 of the Cos. Act, which provides power to the Central Govt. to make rules which form the part of the sub ordinate legislation of the Govt. The records may include particulars relating to the utilization of material, labour and other items of the cost for the companies engages in production, processing manufacturing, & mining. It may be noted that financial records shows only money received & expended, sale & purchase by the company of goods, assets & liabilities of the companies. But the Cost accounts give the detailed break up of these items. The manner in which the money has been spent, raw materiel & utilities has been consumed, utilization if the plant & machinery etc. Section 209 (1) (d) also specifies that the rules are to be prescribed for any class of companies engaged in production, processing manufacturing, & mining. The class of companies may represent companies manufacturing a product for e.g. Sugar, textile, soaps &detergents, engineering products etc. Procedure for the Prescription of the Cost Accounting Records Rules: 1) Selection of the Product : The Central Government may select the product for which the Cost Accounting Records Rules are applicable on the basis of the following criteria: i) ii) iii) iv) Products/Services which are consumer oriented Products which are basic industrial raw materials Products which have a high profit margin Any other product for which representation is received from Consumer Association, Parliament, Chamber of Commerce etc. for prescription of the Cost Accounting Records Rules.

2) Preparation of the Rules: After selection of the product the cost accounting experts prepare the Cost Accounting

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Records Rules after studying the cost accounting system followed in the industry & prepare the draft Cost Accounting Records Rules, which are then sent to the Institute of Cost & Works Accountants of India and Institute of Chartered Accountants of India for their comments. After receiving the comments the rules are vetted and discussed in the meeting called by the Central Govt. in which representatives of the ICWAI, ICAI and other government bodies are invited. After the discussion the rules are finalized & cleared from the legal angle. Then they are notified in the official Gazette. Copies the rules are put before the both the houses of the parliament for the total period of 30 days. If both the houses are agreed on the modification of the rules the rules shall be notified in the modified form.

1. 2. 3. 1. 2. 3. 4.

The Records Rules generally have three parts Rules per se Schedule 1 Schedule 2 The Rules per se are in the nature of administrative law & normally deal with: Short Title & Commencement Application Maintenance of Records Penalty Applicability of the Cost Accounting Records (CAR) Rules: The CAR rules are applicable to the companies formed & registered under the Companies Act, 1956 (whether private or public) and not to the other form of the enterprise such as partnership, proprietorship etc. The wholly owned subsidiary of a company, to which CAR Rules are applicable, is also covered by the said rules provided that the product of the such subsidiary company forms a part/components of cost of production of the product or use of the utility/services for the holding company. Even if the company is potentially Sick Company or Sick Industrial Company under the

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Cost Audit
Sick Industrial Companies (Special Provisions) Act, 1985, no exemption is provided to maintain cost accounting records rules. The rules as said earlier will apply to every company engaged in manufacture of the product under reference. However these rules shall not apply to a company,the aggregate value of the plant & machinery installed wherein, as on the date of the last date of preceding financial year does not exceed the limits as specified for a Small Scale Undertaking under the provisions of the Industries (Development and Regulation) Act, 1951; and b) the aggregate value of the turnover made by the company from sale or supply of all its products during the preceding financial year does not exceed ten crore rupees.
a)

Penalty:
If the records are not maintained, the company and every officer of the company who is in default including the person responsible for the compliance of the records rules, shall be punishable with fine which may extend to Rs. 5000/-. Where the contravention is continuing one, a further fine of Rs. 500/- per day of contravention after the day of during which such contravention continues may be imposed. The inspector of the Central Govt. appointed U/Sec. 209A of the Cos. Act have a right to examine the cost accounting records and report as to whether there is a violation of the provisions of the Sec. 209 (1) (d).

Procedural part of the Cost Audit :

Issue of order: The beginning point for the cost audit is the receipt order by the company, specifying the year and product for which such cost audit is conducted. Since order specifies the product, the company need not have a cost audit for the product not specified in that order. For e.g. A company is producing Cement, cotton textile

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Cost Audit
& rayon, receives an order relating to cement, then it need not get the records for product rayon & textiles. Written Certificate of Cost Auditor:A company should obtain a written certificate from the proposed Cost Auditor to the effect that the appointment, if made, will be in accordance with provision laid down by the section 224 of the Companies Act, 1956. Section 224 (1-B) is a restrictive section. A person who is in full time employment cannot be appointed as an auditor. Similarly a person or a firm holding appointment as auditor exceeding the limit of specified number of companies also cannot be appointed as auditor. Board Resolution: As per section 233-B(2) the auditor shall be appointed by the Board of Director of the Company & with the previous approval of the Central Government. The company has to make an application to the Central Government for an appointment of Cost Auditor in form No. 23-C. Submission of Form 23-C should be accompanied by following: 1) Covering Letter 2) Certified Copy of the Board Resolution sanctioning the proposal for which govt. approval has been sought. 3) A certificate in writing obtain by the Board from the proposed Cost Auditor showing compliance of section 224(1-B). 4) Demand draft towards payment of application of applicant fee. The application fee is payable as under: Nominal Share Capital of a Fees Company Payable Less than Rs. 25 lacs Rs. 500/Rs. 25 lacs or more but less than Rs. Rs. 1,000/5Crore Rs. 5 crore or more Rs. 2,000/Approval of Cost Auditor by Central Government: -

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Cost Audit
Central Government- Department of Company Affairs Cost Audit Branch is the authority for approving the appointment of Cost Auditor. After receiving the form 23-C with all particulars contained therein, and the other accompaniments as required, normally the approval letter is approved within a period of 30-60 days. However, there is no statutory limit within which the approval letter is to be issued by the Central Government. Form of the Cost Audit Report: The Cost Audit Report is to be submitted in two medias1. Hard Copy: It should be clearly readable, properly indexed. Pages should be properly numbered. 2. Soft Copy: A soft copy should be sent on a Compact Disk (CD) preferably a non-rewritable type CD. It is suggested that Cost Auditor/Company should authenticate the CD. The annexure to Cost Audit Report & Proformas must be also submitted along with the Cost Audit Report.

Who can be appointed as a Cost Auditor of the Company:

A person appointed as a Cost Auditor of the company should be the member of the Institute of the Cost & Works Accountants of India (ICWAI) and holds the Certificate of Practice(COP). In case of the Partnership Firm: a. All the partners are practicing cost accountants within the meaning of the Section 6 & 7 of the Cost & Work Accountants Act, 1959, and b. Then it self has been constituted with the previous approval of the Central government/Institute as required under Regulation 113 of the Cost & Work Accountants Act, 1959 as amended from time to time. In case of the partnership firm has been appointed as the Cost Auditor of the company, the authentication of the Cost Audit Report is to be made by the signature of

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the any one of the partner of the firm in his own hand for & on behalf of the firm.

Disposal of the Cost Audit Report by the Central Government: After considering the Report the Central Govt. is empowered to take such action on the report in accordance with the provisions of the Companies Act or any other law in force. Actions under various acts include action like: 1. If a company charges higher prices for drugs than that what is prescribed under Drug Price Control Order (DPCO), action can be taken under DPCO. 2. Any breach of provisions of the Essential Commodities Act can be taken cognizance of. 3. Violations of the Industries (Development and Regulations) Act, FEMA, if noticed can be proceeded against. 4. Incorrect or under payment of Excise Duty under the self removal system can be charged under the Central Excise Act. Under statement of the production for excise purpose, can be taken cognizance of. 5. Deliberate undervaluation of stocks, specifically finished goods and work in progress to evade payment of income tax if noticed can be inquired in to and proceeded against. Apart from the above, if the Central Govt. feels that the whole or part of the Cost Audit Report to be made known to the members of the company, it can direct the company to circulate the copy of the Report along with the notice of the annual general meeting held after the submission of the Cost Audit Report.

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Cost Audit

Name of the Industries to which Cost Audit Report Rules are applicable:

Cement Dry Cell Batteries Cycles Sulphuric Acid Caustic Soda Steel Tubes and Pipes Tyres & Tubes Engineering Air-Conditioners Electric Cables and Conductors Bearings Refrigerators Milk Food Batteries other than Dry Cell Batteries Chemical Electric Lamps Formulations Electric Fan Steel Plant Electric Motors Insecticides Motor Vehicles Fertilizers Aluminium Soaps & Detergents Vanaspati Cosmetics & Toiletries Bulk Drugs Footwear Sugar Shaving Systems Industrial Alcohol Industrial Gases Jute Goods Mining and Metallurgy Paper Electronic Products Rayon Electricity Dyes Plantation Product Soda Ash Petroleum Industry Polyester Telecommunication Nylon Textiles - 16 -

Cost Audit

Certificate to be given under Sec. 224 (1B) of the Companies Act, 1956

Date:________. The Company Secretary,

Dear Sir, Sub: Appointment of Cost Auditor for the product XXXXX for the year ending XXXX.

We are pleased to inform you that our appointment as Cost Auditor for the Product XXXXX, if made will be in accordance with the limits specified in Section 224(1B) and will be within the limits provided by the said section for the period ending March 31, XXXX. We hereby certify that none of the Partner of__________________ is in whole time employment in any company. We further certify that, our firm is constituted with the previous approval of the Central Government under Regulation 113 of The Cost and Works Accountants of Act, 1959. Kindly acknowledge receipt. Thanking You,

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Cost Audit

Yours Faithfully, For______________ Partner

Approval U/Sec. 233B(2) of the Companies Act, 1956 for Appointed of the Cost Auditor

Name of the Company Address of the Company

The Joint Director Government of India Ministry of Law, Justice & Co. Affairs (Department of Company Affairs) Cost Audit Branch Bikaner House, Hutment No. IV, Sahajahan Road, New Delhi - 110 011. Ref : Approval U/S 233B (2) of the Companies Act, 1956 for appointment of the Cost Auditor.

Dear Sir, We are submitting the herewith our application in Form No. 23-C for approval of the Central Government of the Cost Auditor in terms of order no.xx/xxx/CAB-xx dated xx/xx/xxxx for (Product under reference) for the financial year xx/xx/xxxx. Along with the application, we enclosed the following: a) Certified copy of the resolution passed by the Board of Directors at their meeting held on xx/xx/xxxx. b) Certificate from the proposed cost auditor U/Sec. 233(1B) of the Companies Act, 1956

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c) d) Demand draft no.xxxxxx dated xx/xx/xxxx for Rs. XXXX/- drawn on ____ Bank payable at New Delhi towards application fees along with Form no. 23-C A Xerox copy of the order no. no. xx/xxx/CAB-xx dated xx/xx/xxxx for your reference issued in the name of the ______ ( Name of Company).

We shall thank you to grant us necessary approval for the appointment of Cost Auditor at an early date. Thanking you, Yours faithfully For__________

Authorized Signatory Encl: As above

Form No. 23-C

Registration no. of the Company:______. Nominal Share Capital: Rs.___________. Form of application to the Central Government for the Appointment of Cost Auditor Pursuant to Section 233 B (2) 1. Name of the Company along with the address of the Regd. Office, date of Registration: 2. (a) Status of Company: Whether company is Indian or Foreign: 3. Detailed Capital Structure of the Company: 4. Principal line(s) of the Company: 5. Proposal for which the Governments approval is sought indicating the product for which cost audit is ordered: 6. No. & date of Company Law Boards order indicating cost audit: 7. (a) The name & Address of the Cost Auditor who is proposed to be appointed. (b) Whether the proposed cost auditor is the cost accountant with in the meaning of the Cost & Works Accountants Act, 1959 (23 of 1959) and whether he has certificate of practice. (c) The Associateship/Fellowship no. of the Cost Auditor. 8. Whether the cost auditor subject to any disqualification under section 233B (5) of the Companies Act, 1956: 8A. Whether certificate in writing has been obtained by the board from the cost auditor proposed to be appointed to the effete that appointment, if made, will be in accordance with the provisions of sub-Sec. 11(B) of Sec. 233 of the Companies Act, 1956. If so, a certified copy of the same is to be enclosed:

(b)

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9. Proposed remuneration of the Cost Auditor. 10. The financial year or years to be covered by the cost audit. 11. Date of the meeting of the Board of Directors proposing the name of the cost auditor: 12. A Certified copy of the resolution passed by the Board of Directors proposing the name of the cost auditor: 13. Name & Address pf the previous cost auditor, if any together with the financial of the company which was subject to the cost audit: 14. If the is any change in auditor, the reasons thereof may be stated: 15. Declaration: I/we solemnly declares that facts stated in the application are true to the best of my/our knowledge, information and belief. Signature____ Designation Dated this _____ day of ______20__.

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