12

Cost Audit

Question 1 Define Cost Audit, How it is useful: (1) (2) (3) To the Management To the Society To the Shareholders, and (4) To the Government? 2003, Nov, 2008 4 marks) Answer

(May, 1999, 2000,

According to the Institute of Cost and Management Accountants of England, Cost Audit is defined as the verification of Cost Accounts and a check on the adherence to the Cost Accounting plan. The cost audit, therefore comprises: (a) the verification of the cost accounting records such as the accuracy of the cost accounts, cost reports, cost statements, cost data, costing techniques and examining these records to ensure that they adhere to the cost accounting principle, plans, procedures and objectives.

(b)

Usefulness of Cost Audit Cost audit will prove to be useful to the management, society, shareholders and the government as shown below. (1) Usefulness to the Management : (i) The management will get reliable data for its day to day operations like price fixing, control, decision making, etc. (ii) A close and continuous check on all wastages will be kept through a proper system of reporting to the management. (iii) Inefficiencies in the working of the company will be brought to the notice of the management to take corrective action.

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Cost Accounting

(iv)

Management by exception becomes possible through allocation of responsibilities to individual managers. (v) The system of budgetary control and standard costing will be greatly facilitated. (vi) A reliable check in the valuation of closing stock and workin-progress can be established. (vii) It helps in the detection of errors and fraud. (2) Usefulness to the Society : (i) Cost audit is often introduced for the purpose of fixation of price. The prices so fixed are based on the correct costing data and so the consumers are saved from exploitation. Price increase by the industry is not allowed without proper justification as to increase in cost of production, consumers are saved from unreasonable price hike. Cost Audit is also useful for the purpose of Cost Control; Cost reduction and proper utilisation of scarce resources. Usefulness to Shareholders : Cost audit ensures that proper records are kept as to purchases and utilisation of material and expenses incurred on wages, overheads, etc. It also ensures that the unit has been run economically and efficiently. It also makes sure that the valuation of closing stocks and work-in-progress is on a fair basis. Thus, the shareholders are assured of a fair return on their investment. Where the government enters into a cost plus contract, cost audit helps the government to fix the price of the contract. Cost audit helps the fixation of selling prices of essential commodities and thus undue profiteering is checked. Cost audit enables the government to focus its attention on inefficient units. Cost audit enables the government to decide in favour of giving protection to certain industries. Cost audit facilitates settlement of trade disputes brought to the government.

(ii)

(iii) (3) (i)

(4) Usefulness to the Government : (i)

(ii)

(iii) (iv) (v)

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(vi)

Since cost audit ensures efficient running of the business and correct and accurate use of cost data, a healthy competition is generated among the various units in an industry. This imposes an automatic check on inflation.

Question 2 What are the important aspects of cost audit? How is it useful to the shareholders of a company? (Nov., 1997, 6 marks) Answer Important aspects of Cost Audit: Cost audit offers valuable assistance to the management in its decision-making process by examining the reliability of cost accounting data and information. Due to the assistance provided by cost audit, management is in a position to know what price is to be fixed for a product, whether the wastages are avoidable, whether to re-organise sales or inventory system, to make the work more efficient and so on. Also cost audit is of great help in maintaining internal control and internal check and can be of advantage even to the statutory financial auditor. Cost audit, apart from having all the normal ingredient of audit. I.e., vouching, verification etc., has within its domain elements of efficiency audit propriety audit as well. Efficiency audit is directed towards the measurement of whether corporate plans have been effectively executed. It is concerned with the utilisation of the resources in economic and most remunerative manner to achieve the objectives of the concern. It comprises of studying the plans of organisation, comparing actual performance with plans and investigating the reasons for variances to take remedial action. For example, the effective utilisation of capital in an organisation can be guaged by determining the return on capital employed. Propriety audit is concerned with the executive actions and plans bearing on the finances and expenditure of the company. The cost auditor has to judge: (a) (b) (c) Whether the planned expenditure is designed to give optimum results. Whether the size and channels of expenditure were designed to produce the best results. Whether the return from expenditure on capital as well as current operations could be bettered by some other alternative plan of action.

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Cost Accounting

Usefulness of Cost audit to shareholders: Cost audit ensures that proper records are kept as to purchases and utilisation of materials and expenses incurred on wages, overheads etc. It also ensures that the unit has been run economically and efficiently. It also makes sure that the valuation of closing stocks and work-in-progress is on a fair basis. Thus, the shareholders are assured of a fair return on their investment. Question 3 Define Cost Audit and state its purposes. November,2002, 3 marks) Answer Definition of Cost Audit: It is defined as the verification of cost accounts and a check on the adherence of Cost Accounting plan. It in fact comprises of: (i) The verification of cost accounting records such as accuracy of the cost accounts, cost reports, cost statements, cost data, costing techniques. Examining cost accounting records to ensure that they adhere to the cost accounting principles, plan, procedures and objectives. (May, 2001 &

(ii)

In other words, the Cost Auditor ensures that the cost accounting plan is in accordance with the objectives established by the management and in conformity with the appropriate system of cost accounting. Broadly, the purposes of cost audit can be classified as (I) Protective, and (ii) Constructive. Protective purpose : In examines that there is no undue wastage or losses and the costing system brings out the correct and realistic cost of production or processing. Constructive purpose: It provides management with information useful in regulating production, choosing economical methods of operation, reducing operations costs and reformulating plans etc. Question 4 Distinguish between: Efficiency audit and Proprietary audit? (May, 2003, 2007, 2 marks) Answer Efficiency audit & Propriety audit: Efficiency audit is directed towards the measurement of whether corporate plans have been

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effectively executed. It is concerned with the utilisation of resources in economic and most remunerative manner to achieve the objectives of the concern. It comprises of studying the plans of organisation, comparing actual performance with plans and investigating the reasons for variances to take remedial action. For example, the effective utilization of capital in an organization can be gauged by determining return on capital employed. Propriety audit is concerned with executive actions and plans bearing on the finances & expenditure of the company. The cost auditor has to judge: (a) (b) (c) Whether the planned expenditure is designed to give optimum results. Whether the size and channels of expenditure were designed to produce the best results, and Whether the return from expenditure on capital as well as current operations could be bettered by some other alternative plan of action.

Question 5 What as a Cost Auditor, will you verify in the area of work-inprogress? (Nov., 1996,May, 2002, 4 marks) Answer The Cost Auditor should verify the following area of work-inprogress: 1. That the work-in-progress has been physically verified and it agrees with the quantity shown in job-cards of uncompleted work. That the valuation of the work-in-progress is correct with reference to the stage of completion of each job or process and the value job cost cards or process cost sheet. That there is no over-valuation or under valuation of opening work-in-progress or closing work-in-progress, thereby artificially, pushing up and down net profits or net assets as the case may be. That the volume and value of work-in-progress is not disproportionate as compared with finished production.

2.

3.

4.

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Cost Accounting

Question 6 Distinguish between cost audit & statutory audit? (Nov., 2004, 2 marks) Answer Cost audit and statutory audit Cost audit offers valuable assistance to the management in its decision-making process by examining the reliability of cost accounting data and information. Due to the assistance provided by cost audit, management is in a position to know what price is to be fixed for a product, whether the wastages are avoidable whether to reorganise sales or inventory system to make work more efficient and effective. Cost audit, apart from all the normal ingredients of audits. i.e. vouching, verification etc has been within its domain elements of efficiency audit and proprietary audit. Statutory audit of accounts is to examine whether P/L A/c Balance Sheet of a company provides a true and fair view of profits (in the relevant financial period) and financial position on a particular date. Question 7 Discuss the purpose of cost Audit, and circumstances under which a cost audit is desirable? (Nov., 1999, 2003, 3 marks) Answer Purpose of Cost Audit: Cost Audit is conducted to examine whether the costs compiled as per the cost records are correct or not. It involves not only the verification of basic cost records relating to material, wages and overheads to ascertain the correctness of the cost of production, but also to make technical estimates, etc. to know what the cost should have been. Cost records are the basis of costs and reformulating plans etc on the basis of these findings during the course of ascertaining cost, determining price and taking various other decisions. It is therefore, necessary that the accuracy of these records is examined by an independent person who can bring into light the errors, omissions or fraud if any, committed in the maintenance of cost records. Broadly cost audit has protective as well as constructive purpose. Under protective purpose, it aims at examining that there is no undue wastage or losses and the costing system brings out the correct and realistic cost of production or processing. The cost

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12.7

auditor plays a constructive role by providing management of the company with information useful for regulating production, choosing economical methods of operation, reducing operations cost audit. Circumstances under which a cost audit is ordered / desirable are as follows: (i) (ii) Price fixation specially in the case of materials of national importance like steel cement etc. Cost variation within the industry cost audit is essential for that industry where cost variations is significant from unit to unit to ascertain reasons for such variations. Inefficient management cost audit helps to provide information to government about inefficient units for taking further necessary action. Tax assessment cost audit determines correct cost of production so as to facilitate correct tax computation. Trade disputes cost audit is useful in setting trade disputes about the claim for higher wages, bonus etc.

(iii)

(iv) (v)

Question 8 As a cost auditor what will you verify on the area of overheads and indirect expenditure? (Nov., 1995, 3 marks) Answer A cost Auditor must verify the following aspects in the area of overheads and indirect expenditure. (i) (ii) (iii) that allocation of indirect expenditure production, sales, and distribution is logical and correct; over

that compared with the value of production in a production shop, the overleaf charges are not excessive; that the actual indirect expenditure does not exceed budgets or standard expenditure significantly and that any variations are satisfactorily explained and accounted for; that the relation of indirect expenditure in keeping with the load on individual production shop is appropriate; correctness of appropriate allocation of overhead expenditure (both production and sales) will be certified by Cost Auditor;

(iv) (v)

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Cost Accounting

(vi)

that allocation of overheads between finished products and unfinished products is in accordance with correct principles.

Question 9 Define Cost Audit. Indicate the circumstances under which a cost audit is ordered? (Nov., 1994, 8 marks) Answer Cost Audit is defined as the verification of cost accounts and a check on the adherence the cost accounting plan. The cost audit, therefore, comprises: (i) The verification of cost accounting records such as accuracy of the cost accounts, cost reports, cost statements, cost data, costing techniques; Examining these-records to ensure that they adhere to the cost accounting principles, plans, procedures and objectives.

(ii)

In other words, the Cost Auditor ensures that the cost accounting plan is in accordance with the objectives established by the management and in conformity with the appropriate system of cost accounting. Circumstances under which Cost Audit is ordered Section 209 of the Companies Act, 1956 empowers the Government of India to order companies engaged in production, processing, manufacturing or mining activities to maintain cost records in the prescribed manner relating to utilisation of material, labour and other items of cost. This would enable the management to identify the areas of inefficiencies and high costs and take immediate corrective action. In exercise of these powers, the Department of Company Affairs, Government of India, has issued the Cost Accounting (Records) Rules in respect of a number of products/industries which are consumer oriented and earners of high profit margin. Apart from the aforesaid reasons for going in for cost audit, the under mentioned circumstances may warrant the introduction of cost audit: (i) Pricing Fixation: The need for fixation of retention price in the case of materials of national importance like steel, cement etc. may cause a

Cost Audit

12.9

necessity for cost audit. Also to check excessive profiteering, cost audit may be useful in knowing the true cost of production. (ii) Cost variation within the industry: Where the cost of production varies significantly from unit to unit in the same industry, cost audit may be necessary to find the reasons for such differences. (iii) Inefficient Management: Where a factory is run in-efficiently and uneconomically, institution of cost audit may be necessary. It may be particularly useful for the Government before taking up any further action. (iv) Tax assessment : Where a duty or tax is levied on products based on cost of production, the levying authorities may ask for cost audit to determine the correct cost of production. (v) Trade Disputes: Cost audit may be useful in settling trade disputes about claim for higher wages, bonus etc. Question 10 What are the areas of activity, which a Cost Audit Programme is expected to cover? (Nov., 2000, 3 marks) Answer Cost audit offers valuable assistance to the management in its decision making process by examining the reliability of cost accounting data and information. Due to the assistance provided by cost audit, management is in a position to know what price is to be fixed for a product, whether the wages are avoidable, whether to reorganise sales or inventories systems to make the work efficient and so on. Also, cost audit is of great help in maintaining internal control and internal check and can be of advantage even to the statutory financial auditor. Cost audit programme apart from having all the normal ingredients of audit i.e., vouching, verification etc., is expected to cover within its domain the areas of activity which are concerned with efficiency and propriety audit of the concern as well.
(i)

Efficiency audit: It is directed towards the measurement of whether corporate plans have been effectively executed. It is concerned with the utilisation of the resources in economic and

12.10 Cost Accounting

most remunerative manner to achieve the objectives of the concern. It comprises of studying the plans of organisation, comparing actual performance with plans and investigating the reasons for variances to take remedial action. For example, the effective utilisation of capital in an organisation can be guaged by determining the return on capital employed.
(ii)

Propriety audit: It is concerned with the executive actions and plans bearing on the finances and expenditure of the company. The cost auditor has to judge: (a) whether the planned optimum results; expenditure is designed to give

(b) whether the size and channels of expenditure were designed to produce the best results; and (c) whether the return from expenditure on capital as well as current operations could be bettered by some other alternative plan of action.