Cost Audit

Cost auditing is a term that refers to “the verification of cost records and accounts and a check on the adherence to the prescribed cost accounting procedures and the continuing relevance of such procedures.”

In their book ‘Advanced Cost Accountancy,’ Smith and Day describe “cost audit” as “the detailed checking of the costing system, technique, and accounts to verify their correctness and to ensure adherence to the objective of cost accounting.”

1. W. Dobson According to Smith and Day’s book Introduction to Cost Accountancy, “Cost audit is the verification of the correctness of cost accounts and the adherence to the cost accounting plan.”

A cost audit verifies the accuracy of cost accounts and monitors adherence to the cost accounting strategy.

This means that it entails not only the inspection of expense accounts, but also the fact that the strategy developed in this regard has been properly performed. Cost auditing is defined as an audit of the efficiency of minute aspects of spending while work is in process, rather than a post-mortem study.

The first role of a cost audit is to verify cost accounting records in accordance with the cost accounting system, and the second is to ensure adherence to the cost accounting strategy.

A cost audit consists of verifying the accuracy of the cost accounts, cost statements, cost reports, cost data, and costing methodologies used, as well as validating this data to ensure that they correspond to cost accounting principles, plans, policies, and goals.

Objectives of Cost Audit

The following are some of the purposes for which cost audits are conducted:

To determine the correctness of cost data. This is accomplished by ensuring the numerical correctness of cost accounting entries in the books of accounts.

To guarantee that cost accounting standards are guided by management goals and carefully adhered to while creating cost reports.

To guarantee that cost accounts are valid, as well as to discover mistakes, fraud, and improper practices in the current system.

To assess the overall performance of the organization’s cost department and give recommendations for improvement.

To assist management in taking accurate judgments on some crucial problems.

Determine the true cost of manufacturing once the items are ready.

To limit the amount of comprehensive verification performed by the external auditor, an excellent internal cost audit system is in place.

Determine if each item of expenditure associated with the relevant components of the items made or produced was legitimately incurred.

Advantages of Cost Audits

• The key benefits of cost auditing are briefly outlined below:
• Advantages of Management
• It gives the required information for rapid decision-making.
• It assists management in regulating production.
• The proper auditing of expense accounts allows for the detection and prevention of errors, omissions, fraud, and blunders.
• It lowers manufacturing costs by addressing waste of material, labor, and overheads.
• It may hold a person accountable for any inconsistencies or waste that are discovered.
• It increases the overall effectiveness of the organization, and the costing system in particular, by constantly reviewing, revising, and verifying regular operations and methodologies.
• It aids in comparing actual outcomes to planned results and identifies areas where management intervention is most required.
• It also allows for a comparison of various production units to determine their profitability.
• It has a moral impact on workers, keeping them productive and aware.
• It guarantees that the cost accounts are kept in accordance with the costing concepts used in the relevant industry.
• It facilitates good internal communication.
• It contributes to an improvement in overall productivity.
• Inefficiency may be reduced with appropriate remedial efforts.
• It enables cost management and reduction.
• It aids in the appraisal of material inventories, works in progress, and completed items.
• It ensures best exploitation of the available resources.
• It helps management to choose cost-effective ways of operation and hence make profits to please shareholders and investors.
• It helps management to design future policies based on the cost auditor’s report, particularly in terms of labor, raw materials, plant, and so on, in order to optimize output while lowering production costs.
• It assesses the efficiency of cost-cutting measures and their benefits to the company.

Advantages for shareholders

• It guarantees that correct records are kept on purchases, material use, and costs made on different goods, such as salaries and overheads. It also ensures that the industrial unit has been operating effectively and economically.
• It allows shareholders to decide if they are receiving a reasonable return on their investment. It indicates management efficiency or inefficiency.
• It guarantees that the company’s current situation is accurately represented. It displays if resources such as plant and equipment are being used correctly or not.
• It conveys an impression of the company’s creditworthiness.

Advantages for the Society

• It reveals the actual cost of manufacturing. This allows the customer to determine if the article’s market price is reasonable. The customer is protected against exploitation.
• It enhances the efficiency of industrial units, contributing to the nation’s economic prosperity.
• Consumers may retain their quality of life since industry price increases are not permitted unless justified by an increase in manufacturing costs.

Advantages for the Government

• It helps the tariff board decide whether to extend tariff protection to a certain sector or not.
• It helps in determining if a certain industry should be subsidized in order to grow.
• It gives dependable data to the government for determining the selling prices of different commodities.
• It helps in determining contract rates in a cost-plus agreement.
• It decides if differential pricing in the industry is desirable.
• It enables the government to take the required actions to enhance the efficiency of ill industrial units.
• It may disclose the management’s false intents.
• Cost statements may assist authorities impose taxes or duties on the cost of completed items.
• It helps the resolution of trade disputes between corporations.
• It establishes an automatic check on inflation.
• It supports the Tariff Board in determining whether to extend or remove protection.

The disadvantages of cost audit

Cost audits examine cost records and accounts. Audits also guarantee that accountants and bookkeepers adhere to ethical standards.

Effective cost audits offer a comprehensive overview of expenses, providing financial clarity for a company’s finances. Although they give such openness, there are several drawbacks to performing cost audits.

Expensive

Excessive fees are one of the key disadvantages of cost audits. Auditors are often independent contractors who might charge a premium for their services.

In addition to the original costs, auditors may raise fees in the course of a project if corporations fail to restrict such conduct in the contract. A individual or organization may basically spend anywhere from $4,000 to $6,000 for an audit.

Lengthy

Cost audits are also extensive procedures that need staff commitment.

Although the auditor may be an outside contractor, workers must supply requested information and be available if additional explanation of documentation is required.

Lost Time

Although detailed, an auditor’s report is typically issued three to five weeks after the balance sheet is published. This implies that those who have been stealing from a business have almost a month to provide an explanation or quit the firm.

Uncertainty

Because estimating is such an important part of the process, numerical statistics may be inaccurate.

Furthermore, if receipts and other forms of record-keeping are skewed, an auditor who relies on such records may create an incorrect report.

Types of Cost Audits

The primary forms of cost audits are as follows:

Cost audit as a tool for management

The goal is to ensure that all information presented to management is relevant, reliable, and timely so that management can do its obligations effectively. It should also be noted that no important or pertinent information is concealed.

Cost Audit on behalf of a customer.

Contracts are often arranged on a “cost plus” basis. In other words, the client will decide the ultimate amount to be paid by adding the precise cost to an agreed-upon profit margin. In such cases, the client generally has the product’s cost accounts audited to determine the true cost and, as a result, the price.

Government Cost Audits: The government may receive requests for financial assistance or protection. Before making a judgment on the request, the Government may opt to have the applicant’s expense accounts audited to see if the need for assistance is legitimate or the consequence of simple inefficiency.

Cost Audit Under Statute

The Amendment Act of 1965 added a new clause, 233B, to the firms Act of 1956, which allows the Central Government to mandate that certain kinds of firms have their cost accounts audited by a member of the Institute of Cost and Works Accounts of India. Only firms that are obliged to keep adequate records of materials spent, labor, and other costs under Section 209 (as modified to date) may be forced to have their cost accounts audited.

The cost auditor’s powers, responsibilities, and procedure of appointment are identical to those of the external financial auditor, and the same disqualifications apply. The cost auditor will submit his report to the business Law Board and provide a copy to the business. The cost auditor is presumably allowed the authority to examine all elements of cost accounting.

According to legislation, the goal of a cost audit is for the government to know the costs of different items in order to manage them. The government has the authority to specify the format in which cost audit reports should be prepared. These are intended to not only validate information, but also to send a significant amount of information to the government.

Cost audit on behalf of the trade association.

Sometimes trade groups try to keep prices at a given level. For this aim, the accuracy of costing information given by diverse companies must be verified. Trade groups may demand comprehensive information on production capacity and the relative efficiency of producing processes.