COST AUDIT

(An Overall Understanding)

Cost Audit-Definition & Purpose)
Cost Audit is defined as the verification of cost accounts and a check on the adherence of Cost
Accounting Plans. 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. The purpose of Cost Audit can be viewed as essentially two fold in nature.

It examines that there is no undue wastage or losses and the costing system
Protective Purpose followed brings out the correct a realistic cost of production or processing.

Constructive Purpose It provides management with information useful in regulating production,

choosing economical methods of operation etc.

Cost Audit vis- a- vis 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 the cost audit,
management is in a position to know what price may be fixed for a product, whether the wastages are
avoidable etc. On the contrary, the primary purpose of Statutory Audit of Accounts is to examine
whether the financial statements, namely Profit & Loss Account, Balance Sheet, Cash Flow Statement
as constructed by the company management reflects a true & fair view of the state of affairs of the
concerned company.

Circumstances under which cost Audit is ordered

Section 209 of the Companies Act 1956 (as amended over the years) empowers the Government of
India to order companies engaged in production, processing, manufacturing or mining activities to
maintain cost records in prescribed manner relating to utilization of material, labour and other items of
costs. This enables the management to identify areas of inefficiencies and institute immediate
corrective actions. The Department of Company Affairs (GOI) has also issued the “Cost Accounting
(Records) Rules” in respect of a number of products / industries, which are consumer oriented and
earners of high profit margins. These specified companies are required to maintain cost accounts as per
prescribed structure and they are also required to undergo Cost Audit as per rules.
Circumstances under which Cost Audit is desirable
Apart from the specific legal requirements as clarified in the previous page, Cost Audit is also
desirable under the following circumstances.

The need for appropriate fixation of prices in case of materials

of national importance like steel, cement, etc. may cause a
necessity for conducting Cost Audit. Cost Audit may also be
Price Fixation
employed as an important tool for checking excessive
profiteering as it aids in arriving at the true cost of production.

Where the cost of production varies significantly from unit to

Cost Variation within the industry
unit in the same industry, Cost Audit may become necessary in
order to identify the reasons for such differences.

Where a factory is run inefficiently and uneconomically,

institution of Cost Audit may become necessary. It may be
Inefficient Management
particularly useful for the Government or other Regulatory
Authorities before initiating appropriate actions.

Where a duty or tax is levied on products based on cost of

production, the levying authorities may ask for a Cost Audit to
Tax Assessment
be conducted in order to determine the correct cost of
production.

Cost Audit may also prove to be extremely useful in settling

Trade Disputes
trade disputes about claim for higher wages, bonus etc.