Cost audit

 

COST AUDIT

Cost audit may be defined as “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.”

—  Cost audit is the verification of the correctness of cost accounts and a check on the adherence to the cost accounting plan.

—  This is, it involves not only the examination of cost accounts but also the fact that the plan prepared in this connection has been duly executed.

—   Cost audit as an audit of the efficiency of minute details of expenditure in which the work is in progress and not a post-mortem examination.

—  The first function of cost audit is the verification of cost accounting records according to the cost accounting system, and the second function is the checking on the adherence to the cost accounting plan.

—  A cost audit, therefore, includes verification of correctness of the cost accounts, cost statements, cost reports, cost data, and costing techniques applied and finally checking these data to see that they adhere to cost accounting principles, plans, procedures, and objectives.

Objectives of Cost Audit

—  To establish the accuracy of costing data. This is done by verifying the arithmetical accuracy of cost accounting entries in the books of accounts.

—  To ensure that cost accounting principles are governed by the management objectives and these are strictly adhered to in preparing cost accounts.

—  To ensure that cost accounts are correct and also to detect errors, frauds, and wrong practice in the existing system.

—  To check up the general working of the cost department of the organization and to make suggestions for improvement.

—  To help the management in taking correct decisions on certain important matters

—  To determine the actual cost of production when the goods are ready.

—  To reduce the amount of detailed checking by the external auditor, its effective internal cost audit system is in operation.

—  To find out whether each item of expenditure involved in the relevant components of the goods manufactured or produced has been properly incurred or not.

Advantages of Cost Audit

Advantages of Cost Audit to the Management

—  It provides necessary information for prompt decision decisions.

—  It helps management to regulate production.

—  Errors, omission, fraud, and mistakes can be detected and prevented due to the effective auditing of cost accounts.

—  It reduces the cost of production through plugging loopholes relating to wastage of material, labor, and overheads.

—  It can fix the responsibility of an individual wherever irregularities or wastage are found.

Advantages of Cost Audit to the Shareholders

•      It ensures that proper records are maintained as to purchases, utilization of materials, and expenses incurred on various items i.e., wages and overheads, etc. It also makes sure that the industrial unit has been working efficiently and economically.

•      It enables shareholders to determine whether or not they are getting a fair return on their investments. It reflects managerial efficiency or inefficiency.

•      It ensures a true picture of the company’s state of affairs. It reveals whether resources like plant and machinery are properly utilized or not.

•      It creates an image of the creditworthiness of the concern.

Advantages of Cost Audit to the Society

§  It tells the true cost of production. From this, the consumer may know whether the market price of the article is fair or not. The consumer is saved from exploitation.

§  It improves the efficiency of industrial units and thereby assists in the economic progress of the nation.

§  Since the price increase by the industry is not allowed without justification as to an increase in the cost of production, consumers can maintain their standard of living.

Advantages of Cost Audit to the Government

•      It assists the tariff board in deciding whether tariff protection should be extended to a particular industry or not.

•      It helps to ascertain whether any particular industry should be given any subsidy to develop that industry.

•      It provides reliable data to the government for fixing up the selling prices of the various commodities.

•      It helps in fixing contract prices in a cost-plus contract.

•      It determines whether differential pricing within the industry is desirable.

•      It helps the government to take necessary measures to improve the efficiency of sick industrial units.

•      It can reveal the fraudulent intentions of the management.

•      Cost statements may be helpful to authorities in imposing tax or duty at the cost of finished products.

•      It facilitates settlement of trade disputes of the companies.

Disadvantages of Cost audit

1. Expensive

One primary disadvantage associated with cost audits is the excessive fees. Auditors are typically independent contractors who can charge relatively high prices for services rendered.

In addition to initial charges, auditors may increase fees in the middle of the project if companies fail to prohibit such action in the contract. A person or corporation can essentially go from paying $4,000 to $6,000 for an audit.

2. Lengthy

Cost audits are also lengthy processes that require employee devotion.

Although the auditor may be an outside contractor, employees must provide requested information and be accessible in case further explanation of documents is necessary.

3. Lost time

Although thorough, an auditor’s report is usually given three to five weeks after the balance sheet is released. This means people who have been stealing from an establishment have nearly a month to form an excuse or leave the company.

4. Uncertainty

—  Because a major part of the process involves estimating, there’s the possibility of numerical figures being wrong.

—  Besides, if receipts and other forms of record-keeping are skewed, an auditor relying on such documents may produce an inaccurate report.

Circumstances under Which Cost Audit is Desirable

—  Price Fixation.

—  Cost variation within the industry.

—  Inefficient Management.

—  Tax Assessment.

—  Trade Disputes.

Types of Cost Audit

1. Efficiency Audit.

Efficiency Audit is directed towards the measurement of whether corporate plans have been effectively executed. It is concerned with the utilization of resources in an economical and most remunerative manner to achieve the objectives of the concern.

For example, the effective utilization of capital in an organization can be gauged by determining the return on capital employed.

2. Propriety Audit.

          The propriety Audit is concerned with executive actions and plans bearing on the finance and expenditure of the company. The auditor has to judge whether the planned expenditure is designed to give optimum results.

3. Statutory Audit.

          It is the compulsory audit that required maintaining the related books and accounts of specified establishments. The chief aims of this type of audit are that the government wants to ascertain the relationship between costs and prices.

SPECIAL AUDIT

A special audit is a tightly-defined audit that only looks at a specific area of an organization's activities. This type of audit may be initiated by a government agency, but could be authorized by any entity, or even internally. Examples of special audits are:

—  Compensation audits

—  Compliance audits

—  Construction audit

—  Controls audits

—  Information systems audit

—  Royalty audits

—  Tax audit

Need for a special audit

1)   Special Audits are mostly needed when some abnormal behavior is suspected within the organization.

2)   Mostly, they are called for when it is suspected that the laws and regulations have been overlooked pertaining to finances, or financial management within the organization. However, they are not only restricted to cases pertaining to fraud.

3)   They can also be conducted when there are other institutional violations that might include pertaining to duties, authorizations, internal control procedures or responsibilities of the Senior Management. In the same manner, Special Audits can also be related to corporate reorganization or bankruptcy.

Scope of Special Audit

Special audit is conducted out of routine, with a special purpose, special purposes are quite varied in their nature, and the overall outcomes based out of those special audits.

—  Compliance Audit – This is mainly conducted when there is a need to examine the policies and procedures to check if they follow internal or regulatory standards.

—  Construction Audit – This analyzes the costs that occur for a given construction project. In the same manner, this also tracks down the actual amount that is paid to contractors, suppliers, and other reimbursement that takes place in this regard.

—  Information Systems Audit. Information System Audit is mainly conducted when there is a need to review the overall controls present in software development. Additionally, it also involves a review of controls regarding software development, data processing and the overall access to computer systems.

—  Investigative Audit. Investigative Audits take place when there is a need to find details of a specific event or an incident within the company, which was suspicious.

—  Tax Audit. This Audit is mainly initiated to analyze the overall tax returns that are submitted by an individual or business entity. The main rationale is to see if the paid tax is actually valid.