This article throws light upon the five paragraphs relating to the forms of cost audit report.
Cost Audit Report: Form # 1. Paragraph 1:
The cost auditor is asked to state specifically (positively or negatively):
(i) Whether all information and explanations necessary for the purposes of Cost Audit were obtained or not;
(ii) Whether proper cost accounting records as required under Section 209(1)(d) of the Companies Act, 1956, were maintained or not;
(iii) Whether proper returns from the branches not visited were received or not;
(iv) Whether the books of accounts and records give the information in the manner required by the Companies Act, 1956, or not;
(v) Whether the cost statements in respect of the product or activity under reference as specified in the Annexures/Proformae of Schedules I, II or III of the concerned cost accounting records rules duly audited are kept or not.
Against this sub-Para (v), some cost accountants opine that the word ‘activity’ covers “other than manufactured products such as mining, plantation, banking, insurance and other service sectors”. But a close and continuous reading of this sub-Para reveals ‘product or activity under reference as specified in …………..concerned cost accounting records rules’, and thus the connotation of the word ‘activity’ is limited and narrow in its meaning and extent and cannot embrace any area other than manufactured products under reference unless mining or plantation activities are envisaged under the rules for the product under reference. (For example: The Rules for Aluminium provide for a cost statement to determine the cost of ‘Bauxite’ raised and transported to Alumina Plant).
Cost Audit Report: Form # 2. Paragraph 2:
The cost auditor has to opine categorically (either positively or negatively) whether the cost accounting records of a company have or have not been properly kept so as to give a ‘true and fair view’ of:
(i) The cost of production,
(ii) The cost of sales, and
(iii) The margin of the product under reference as specified under the relevant rules.
For this Para, it is important to understand (what is ‘true and fair view’.)
The phrase has not been defined either by the Companies Act of 1956 or by the Council of the Institute of Cost & Works Accountants of India. According to the dictionary meaning, the word ‘true’ is “(agreement with reality, that which is true) according to the facts of the case, the true state of things or facts, etc.” and the word ‘fair’ is “free from blemish; impartial, just, equitable, etc.” By the use of this phrase, the underlying idea is definitely to put emphasis on the following two aspects in so far as the audit certificate is concerned —
(i) ‘True’-view, i.e., whether the true state of things or facts is revealed — the revelation may be true of truth or untruth, and
(ii) ‘Fair’-view, i.e., whether the attributes of impartiality, equitability and reasonability are revealed.
Let us assume that cost statements, which have been prepared on the basis of false vouchers and documents, are authenticated by the cost auditor in his audit certificate stating true and fair view of the cost of production of a product. In this case, the audit certificate is definitely false and issued perfunctorily as it has not revealed the true state of things or facts.
To cite another example, two firms P and Q operate under same conditions having the same amount of capital outlay initially. It is assumed that the incomes and real expenses are identical, but the reported profits by them are different as because different methods of valuation of closing stocks have been adopted.
In both cases, the audit certificate stating ‘true and fair view’ holds good as it has taken into account the concept of ‘truth’ under the doctrine of ‘disclosure’ relating to the choice of valuation method. Thus, the meaning of ‘truth’ as used in an audit certificate depends on the approach or method chosen.
In this respect, the Accounting Standards Committee in U.K. states that “accounts will not be true and fair unless the information they contain is sufficient in quantity and quality to satisfy the reasonable expectations of the readers (users) to whom they are addressed.” The concept, thus, refers not only to information that is quantitatively and qualitatively sufficient but also requires the accounting and auditing profession to specify the criteria or standards for the same.
Cost Audit Report: Form # 3. Paragraph 3:
With respect to Financial Accounts and Audit Reports, a ‘note’ may pertain to contingent liability, contractual liability, counter-guarantees executed, treatments of Capital Reserve, Statutory Gratuity, Value of import, Foreign exchange earnings, etc.
With respect to the Cost Accounts and Cost Audit Reports, the practice of ‘Notes on Accounts’ (as adopted for disclosure in financial accounts’ schedules, etc.) is not in vogue. But for some of the products to which the Cost Accounting Records Rules apply, the Cost Statements, statutorily prescribed, require disclosure of cost information of additional/extra nature in the form of a “footnote” wherever relevant and specifically mentioned, for examples: Textiles, Jute goods, etc. Illustration: For Jute Goods, the proforma D — ‘Statement showing the cost of production of pre-packed Yarn/Fabric/Bags/Other products etc.’, necessitates the following —
“Additional expenses incurred on any order towards cropping, mangling, extra calendaring, dyeing, etc., shall be shown in the relevant Cost Statement and the extra cost indicated in the form of a ‘footnote’ therein”.
The term refers to an expression of an opinion, on the part of an Auditor, disagreeing upon any point or making certain reservations so as to dissociate himself from assuming any responsibility for such points or matters which have been qualified by him in his Audit Report. That means ‘qualification’ constitutes an Auditor’s dissatisfaction upon any point (or objections on any matter) that may have the effect of distorting ‘true and fair view’ of the state of affairs of the company and that have been laid down as facts in his Audit Report, as a result of the examination of the books of accounts (Financial as well as Cost Accounts).
The fundamental distinction between the two terms ‘note’ and ‘qualification’ is that the former is concerned with disclosing material information on accounts so as to present the ‘truth and fairness’ of the state of affairs on the part of an entity for the knowledge of the readers of such accounts and also for the satisfaction of the Auditor, while the latter contains an element of Auditor’s disagreement with the Management with respect to the cost and/or financial statements or expresses the existence of other circumstances, and, in the Auditor’s judgement, the effect of the matter is or may be material to the Cost and/or Financial Statements.
Qualified Audit Report refers to that report in which an auditor indicates the extent to which he has to qualify by incorporating the reasons therefor.
Qualifications in cost audit report:
The cost audit report may contain qualifications or reservations. In terms of Note (3) below the Form of the Cost Audit Report [Extract of Note (3): “If as a result of the examination of the books of account, the Cost Auditor desires to point out any material deficiency or give a qualified report, he shall indicate the same against the relevant Para (i) to (vi) only in the prescribed form of the Cost Audit Report giving details of discrepancies he has come across.”].
Thus, where adequate records relating to power generation are not maintained, the qualification may include —
“Proper cost accounting records as required under S. 209(1) (d) have been kept by the company subject to: Non-maintenance of records on power generation.”
Considerations before ‘Qualification’:
The cost auditor should consider the following points invariably before he decides to ‘qualify’ any matter or point in his audit report:
(a) The principles of consistency, materiality and disclosure requirements.
(b) The truth and fairness of the cost accounts prepared and presented.
(c) Practical situations prevailing in the company which may not permit very rigid adherence to the rules prescribed but a general conformity is assured.
(d) Accounting and cost accounting policies selected and the method of their application.
(e) Quantification of the possible effects on the cost statements with reference to the substantive reasons or facts.
(f) Total disagreement (e.g., cost records and statements do not present a true and fair view of cost of production, etc.), partial disagreement (opinion about a few pertinent points or items), and the effect of disagreement (i.e., misleading or incomplete nature of cost accounts and statements).
The cost auditor must be very clear and specific as regards facts, items, and resultant effects and must not leave any room for doubt or misunderstanding or wrong impression of his opinion expressed in his audit report. Transparency with adequate and relevant data and information is the essence of any ‘qualification’ made in a report.
This paragraph constitutes the climax of the planning and operations undertaken by the cost auditor and his team. It is a comprehensive summary of the audit work done by the cost auditor. The contents in the form of opinions, observations, and conclusions on the matters and items to be reported in this paragraph reveal the cost auditors’ professional skill, care, competence, objectivity and the power of judgement.
While reporting in this Para, the cost auditor should:
(i) Be aware of his liability to the profession, company, I.C.W.A.I., public and the Government;
(ii) Reassess his stand about material uncertainty, non-disclosure, and system deficiencies;
(iii) Use utmost skill in marshalling facts; and
(iv) Be well aware of his own deficiencies and pitfalls in audit steps.
In terms of Note (4), it is the duty and responsibility of the cost auditor to report facts based on verified data, and appropriate evidence and reference after the company has been afforded an opportunity to comment on them, wherever practicable.
Adequacy or otherwise of the cost accounting system including inventory valuation, etc.:
In case there are inadequacies, he should pinpoint each of the major aspects and offer specific suggestions for the improvement thereof. In these respects, the readers are advised to refer Paragraph 3(c) [discussed latter] which give various examples as to ‘wrong in principle’ or ‘apparently unjustifiable’.
The cost auditor should specifically mention about the persistent deficiencies in the costing system pointed out in earlier reports but not rectified. He should also state in brief the inventory valuation policies and systems for raw materials, and components, work-in-progress and finished goods by highlighting the distinguishing features and consistency or inconsistency in actual practices.
Adequacy or otherwise of budgetary control system, if any, in vogue in the company:
The cost auditor should give a brief note on the existing budgetary control system indicating its adequacy or otherwise. He has to indicate how such system can be improved.
Questionnaire for study of effectiveness of a Budgeting System of a company:
1. Are the company’s plans explicit and understood?
2. Are the company’s plans and the planning function accepted within the organisation?
3. Are the company’s plans able to adapt changes?
4. Are the plans and the stated objectives compatible with the internal and external environment and related constraints?
5. Can the plans be monitored in quantifiable terms?
6. Is the company’s level of activity expanding or contracting?
What are the effects on:
Capital equipment requirements?
7. Are the promising new products being constantly developed? What is the result of evaluation of consumer requirements in this respect?
What is the extent of consideration being given to the use of new materials, new process and new technology?
Who are going to be affected by such future plans? How will they be affected? How will the resistance be overcome?
8. Are the Budget targets (that is, planned resources and planned results) objectively attainable?
9. Do the Budget targets represent reasonably attainable goals? What is the extent of survey and study? What are the forecasting procedures? Have these been adequately developed and considered?
10. Is balance achieved between Budgeting for short-run operations and planning long- term strategy?
1. Do all employees, especially functional supervisors and managers fully understand- Budget implications?
Cost implications of their work? Cost expectations?
2. Does the Budgeting process have higher management sponsorship and support?
3. Is there any Budget officer? If not, why not? If so, are his terms of reference known to him and widely known to other functional heads?
4. Does the company have a Budget Committee? If so, how are the responsibilities defined? Are these adequate?
5. Is there any Budget manual? How does it define and outline the policies, systems, procedures, etc.?
6. Is the Budgeting process seen and used as being a major tool of management rather than an accounting function or a technique?
7. Is the staff function in the Budgeting exercise/process carefully distinguished from the line function?
8. Are the co-ordination and communication sub-systems adequately streamlined?
9. Do the responsible individuals (especially supervisors and managers) throughout the organisation accept team-work to meet targets and budgets? Are they able to help in developing cost targets for themselves and their subordinates?
10. Do the Budgets provide an element of flexibility in relation to changing conditions?
11. Is the system of classification and coding of accounts compatible with
b. Responsibility centre?
c. Budgetary classification of expense items?
12. Are the Budgeted expenditures classified in sufficient detail and cover sufficient headings to permit the estimating of costs by each major item and function under each department and/of responsibility centre?
1. Do the Budgets motivate responsible individuals (especially supervisors and managers) and also others in the desired direction?
2. Does the Budgeting process encourage participation and delegation?
3. Does the Budgeting cause human behavioural effects? If so, how are the symptoms analysed and averted?
1. Do the Budget Control Reports highlight reasons for significant variations as well as results?
2. Are the Budget Variance Analysis Reports issued in time?
3. Do the recipients complain about the delayed receipt of the Budget Variance Reports?
4. Is the control effort focused on significant deviations from plan and budget?
5. Does the Budget department periodically evaluate and modify the contents of Budget control information keeping in view the reactions of the recipient managers?
6. Does the Budget Committee hold meetings? What is the frequency? Are the decisions on contemplated actions minuted, circulated and reviewed further?
The words: ‘If any’ clearly indicate that the operation of Budgetary Control System is not a must for a company. It is optional. And, therefore, the Cost Auditor need not furnish any comments under this sub-Para when the system itself is non-existent.
However, should the Cost Auditor desire to offer any suggestion about the introduction of a budgetary control system, he may do so — not under this sub-Para, but under Paragraph 5 which calls for other observations and conclusions, if any. Here also, his suggestions should not be for the company as a whole but restricted to the ‘product’ under cost audit.
Determining Adequacy of Budgetary Control System:
In determining and concluding the adequacy of a Budgetary Control System of a company, the Cost Auditor needs to evaluate its coverage and effectiveness; that means, whether the system in operation encompasses all functions and is capable of being used as a major tool of management control rather than an accounting exercise or a technique.
The Cost Auditor can conclude as to the adequacy of the system by an appraisal and examination of the following major points:
Whether the system contributes towards accomplishing the basic tasks of planning, co-coordinating and controlling the activities of the enterprise in relation to the product(s) under cost audit.
These are as follows:
(a) In the area of planning:
(i) Whether it covers all inter-related functions like marketing & sales, manufacturing, purchasing, and finance for requirements of working capital and fixed capital;
(ii) Whether it establishes definite goals and limits for each of these functions well in advance, before the commencement of the year for which it is prepared, so as to assist the functional Heads to Understand-
a. What they are expected to operate,
b. What the needs will be for manpower, materials, equipment and funds, etc., during the Budget period, and
c. What could be the potential problems in critical areas etc.,
(iii) Whether it determines the scheme of departmentalisation and budget center subdivision linked with the concept of responsibility accounting.
(iv) Whether it has a monitoring cell (e.g., a Budget Committee) for operating the system right from the preparation and approval of the Budget (including Functional Budgets) and review of variance and control action, and for sorting out constraints.
(v) Whether it maintains a parity in levels of performance at which Budgets are monitored. That means, whether there are imbalances in the fixation of performance levels of Functional budgets in relation to Sales budget.
(vi) Whether there is uniformity between Budgetary classification and Accounting classification.
(b) In the area of co-ordination:
(i) Whether it provides the ways and means for co-ordination of efforts and of the use of facilities and materials and other resources by developing balanced budgets.
(ii) Whether it reveals timeliness in the process of preparation, approval and circulation of all functional, departmental and master Budgets.
(iii) Whether the Budget Committee holds its meetings regularly for performance evaluation, and ensures timely issue of minutes.
(iv) Whether it helps to prevent waste that results when different functional units work at cross-purposes or duplicate each other’s work. That means, whether the system is being used as a mechanism through which the nature, the direction, the size and the timings of the company’s efforts can be coordinated.
(c) In the area of control:
(i) Whether the system consists of:
a. Measuring the performance or results with reference to specific functions,
b. Comparing those results with expectancies in regard to quantity, quality, time use and cost effectiveness, which leads to
c. Approving or disapproving the results, in which latter case necessary corrective measures are applied.
(ii) Whether the Budget incorporates a degree of flexibility with a provision for its periodical review.
(iii) Whether the Variance Reports are timely issued, the control periods for variance reporting defined, and actions taken on the variances.
Matters which appear to be clearly wrong in principle or apparently unjustifiable:
The ICWAI guideline states that the expressions ‘wrong in principle’ and ‘apparently unjustifiable’ relate to the violations of cost accounting and general accounting principles. The cost auditor has to state whether the action taken by the management, in his opinion, is justifiable or not in the specific circumstances and in accordance with the provisions contained in the relevant cost accounting records rules.
Examples as to ‘wrong in principle or apparently unjustifiable’:
1. An Engineering Co. has five different production shops such as Sheet Metal, Foundry, Machine, Assembly and Finishing. A single factory overhead recovery rate based on direct labour cost in uniformly used in costing of the products.
2. During plant stoppages, the operational labour are being utilised by the company for cleaning, oiling and such other routine jobs of the same plant. Their wages for that period also are treated as direct wages in the cost of production.
3. Repair and maintenance, consumables, and depreciation in a machine intensive unit using different types of machines are apportioned to the various production shops on the basis of net value of assets.
4. A multiproduct drug unit used the same vessels for the manufacture of different products. All conversion cost are apportioned to different drugs based on budgeted production values of each drug.
5. Various raw materials such as rubber of different grades, nylon cord of different dimensions, carbon black of various grades, etc. are used in the manufacture of tyres for trucks, scooters, cars, etc. The company adopted a simple material variance % of total standard material cost and actual material consumed.
6. A company produces a variety of products of different sizes and shapes from the same raw material. In view of the non-homogeneous nature of finished products it has stated that capacity utilisation is not determinable.
7. Finance Director of a company of which you are the cost auditor justifies his stand of not providing depreciation in the cost records on the ground that the Companies Act permit every company not to provide depreciation unless the company proposes to declare dividend in the relevant year.
8. A company manufacturing bulk drugs and formulations has taken selling expenses as percentage of turnover of bulk drugs and formulations. There is a lot of competition in the trade in marketing the formulations necessitating the appointment of sales representatives, distribution of free samples, literature, etc. while it is not so in the case of bulk drugs.
Cost Auditor’s opinion:
1. The operational characteristics of production shops are most likely to be different. Some shops may be labour- intensive while others are fully mechanised. Again, all products may not pass through all production shops.
Therefore, a rational approach should be to determine shop-wise overhead recovery rate based on either labour hours or machine hours to have equitable charge of overheads to the products rather than single rate based on direct labour cost.
2. Oiling, cleaning and other routine jobs are for preventive maintenance and not for production. So, the wages paid for such work are indirect in nature and should be treated as an item of works overheads.
3. The apportionment of depreciation based on net value of assets is logical and acceptable. The apportionment of repairs and maintenance and consumables to production shops should be based on the factors like time spent, extent of use, etc.
4. Conversion cost is a function of production time and not of production values of products. Since the same vessels are used for the manufacture of different products, the conversion costs’ apportionment should be based on vessel occupancy hours of each drug having different batch and production cycle.
5. Raw materials variances analysed into price and usage for each item and grade of raw material (rubber, nylon cord, etc.) separately for each product (tyres for trucks, scooters, etc.) should be worked out for initiating corrective actions. The present practice adopted by the company is not acceptable.
6. In case of non-homogeneous nature of products, capacity should be determined in terms of standard hours or expressed in production units equivalent to a common unit of size. This way, capacity utilisation (i.e., the ratio of actual production and installed capacity) can be computed. The contention of the company, in this respect, is thus untenable.
7. In so far as the financial accounts are concerned the finance director is correct in his stand. But for cost accounts, finance director’s decision is wrong. The cost accounting records rules (for any industry) stipulate that depreciation has to be charged in cost accounts under Section 205(2) of the Companies Act so as to reflect the true and fair view of the cost of production, etc.
8. The selling and marketing activities involved in medicinal formulations are more competitive than those in bulk drugs. Further, bulk drugs are usually captivity consumed in the manufacture of formulation.
The best course for apportionment of selling expenses between them should be to:
(a) Identify the selling costs which are specific for bulk drugs and formulations, and
(b) Then apportioning the balance common selling costs between them on the basis of their respective turnovers.
Cases where price charged for related party transactions is different from normal price, impact of such lower/higher price on margin of the product under reference shall be specified:
This sub-Para finds relevance to the submission of a report under Transfer Pricing Regulations vide Sections 92 to 92 F of the Income Tax Act of 1961, for the purpose of computation of income from international transactions between associated enterprises on “arm’s length basis.”
To sum up, a list of all contracts and agreements relating to sales, purchases, etc. should be obtained from the company and subjected to close scrutiny and examination by the cost auditor to see whether there are peculiar features or undue benefits or the directors are interested vide Sections 294 to 302 of the Companies Act, 1956, or related party transactions.
Charging higher/lower price:
A public company purchases a component from a firm in which one of the Directors of the company is a partner. The firm is the only supplier of the component and charges a higher price than that of the competitors and the management also justifies the higher price on account of better quality and extended credit terms available.
The position is that the Director of the company is a partner of another firm which has effected sales of components. If the Public company maintains a separate record, the Cost Auditor can verify the contents of the purchase contracts.
Even if such disclosure is not made, the Cost Auditor must proceed on with the work of verification in terms of the provisions contained under Sections 299, 300 and 301 of the Companies Act, 1956.
The Cost Auditor should take the following precautionary measures for the purpose of verification:
(1) Whether there is an adequate disclosure of interest on the part of the Director of the Public company (who is a partner in a firm) relating to the contract or agreement or arrangement for the purchase of components at a meeting of the Board of Directors at which such purchase agreement was considered and/or approved (Sec. 299),
(2) Whether the Director so interested has taken any part in the discussion of, or vote on, any such purchase contract or agreement or arrangement entered into or to be entered into with the firm (supplying the components) in which he is a partner, at such meeting (Sec. 300),
(3) Whether the Director so interested was present and whether his presence has been counted for the purpose of forming a quorum at the time of any such discussion or vote regarding the said purchase contract (Sec. 300),
(4) whether the company has kept a Register of Contracts in which shall be entered separately the particulars of all contracts or arrangements to which Section 297 or Section 299 applies including the following particulars to the extent they are applicable in each case, namely:
(i) The date of the contract or arrangement,
(ii) The names of the parties thereto,
(iii) The principal terms and conditions thereof,
(iv) In the case of a contract to which Section 297 applies or in the case of a contract or arrangement to which Section 299 applies, the date on which it was placed before the Board,
(v) Whether the particulars of such contract or arrangement, after approval of the Board, has been entered on the Register of contracts within seven days of its approval, and whether the Register has been placed before the next meeting of the Board, and whether the same has been signed by all the Directors present at the meeting (Sec. 301).
In addition to the above, the Cost Auditor should ascertain and verify as to:
(1) Whether there was any press advertisement,
(2) Whether enquiries were floated to the accredited suppliers or manufacturers of such components, (listed or not),
(3) Whether tenders or quotations were received from those suppliers or manufacturers other than the firm the partner of which is also a director of the company,
(4) whether the company has prepared an analytical comparative statement of the tenders in regard to the prices, specifications, quality, term of delivery and terms of payment, etc., and
(5) Whether there is an existence of Tender Committee and, if so, their recommendations, including ascertainment as to the recommendations of the Purchase or Contracts Manager of the company, and whether such purchase agreements were based on reasonable conclusions in keeping with other factors and practices normally followed.
That means, whether such agreement was concluded under normal or abnormal circumstances. Finn is the only Supplier: The Cost Auditor will have no choice or means to compare the price charged by the firm with those of others as no suppliers of the component are available.
In such a situation, in order to obtain reasonable assurance and to arrive at a reasonable conclusion, the Cost Auditor has to apply other ‘substantive audit procedures’, such as:
(a) Obtaining from the firm the details of the particulars of the component, for example:
(i) The price charged by the firm to other customers, and the price catalogue, if any,
(ii) The ex-factory price or selling price declared by the firm to the Excise authorities or to other Government authorities,
(iii) The total cost of the component and the margin of profit of the firm in selling it to the company with whom the contract is made and to other independent buyers; and
(b) Verifying the earlier Cost Audit Report or the Cost Accounting Records, if the firm’s component was at any time under Cost Audit or is converted by the Statutory Cost Accounting Record Rules, and ascertaining the reasonableness of the margin of profit made by the firm.
Charging and Justifying Higher price: The Cost Auditor should:
(a) Ask for a Certificate from the company’s technical personnel as to the quality of the component supplied by the firm;
(b) Engage another technical expert having knowledge of the component, (such technical expert should in no way be connected with the company or the firm) and obtain his opinion about the superiority of the component’s quality than those of the other competing firms or suppliers, and should also enquire from him that such quality component is necessarily required for the company’s production or for satisfaction of the customers’ specific choice or preference.
That means, he must arrive at a conclusive evidence that the company’s product will fail to meet the basic requirements had those quality components not been bought; and
(c) Ask for the information and opinion of the other competitors with respect to the quality and price of their products in relation to those of the firm.
As regards the extended credit terms availability with the firm, the Cost Auditor should, in addition to checking the provisions of such terms, scan through previous transactions to satisfy himself that the extended credit terms facility had actually been enjoyed by the company, and also compare the effect on cost had the limited credit terms offered not been considered.
Since this sub-Para stresses on ‘normal price’ for being compared with the ‘actual price’ charged, the ‘normal price’ determination is important. But such determination/ascertainment of ‘normal price’ is difficult in certain related party transactions, apart from the assessment of impact on the margin of the product, especially when 100% of a product variety/class is sold to a related party.
In such situation, the fact must be spelt out by the cost auditor in this sub-Para.
Areas where the company is incurring losses or where there is considerable decline in profitability the Cost Auditor should comment on the reasons thereof including indicative breakeven point. The Cost Auditor shall also comment on the default, if any, on the payments due to the Government, Financial Institutions and Banks, penal interest levied thereon and its impact on the Cost of sales and profitability:
This sub-Para has two parts:
(1) Reasons for decline in profitability and
(2) Default in Government dues and penal interest. Its main objective is to identify the weak spots with a view to bring about improvement of efficiency and results in future.
(a) Decline in profitability:
This may be due to various reasons such as inadequacy of profit/margin, deficiency in the activities of selling/marketing and production, drop in sales (domestic and/or export), abnormal increase in one or more cost elements, over-capitalisation, low debtors’ turnover, higher incidence of interest charges, defective price fixation, and so on.
So, it is for the cost auditor to devise and apply measurement techniques and yardsticks with regard to costs, profits, productivity, performance efficiency, etc., and make out systematic analysis and in-depth study of operational results covering all phases of business activity and of activities concerning the product under reference.
In short, the measurement of effectiveness in the management and utilisation of resources is called for.
For guidance and ready reference, the pyramid style of Ratio Analysis in an order which deals with, first, in terms of general business conditions/general management and secondly, in terms of measurement, is illustrated below.
The above nature of analysis would certainly secure a sequential picture of interdependent factors in business operations to locate reasons. In addition, the cost auditor should work out certain other ratios for performance measurement so as to facilitate him to conclude as to the few basic, yet major, reasons that contributed to a considerable decline in profitability in comparison to previous years and industry standards.
Performance measurement (illustrative only):
(1) Value of direct material/Value of production.
(2) Cost of raw materials/Quantity produced.
(3) Cost of Scrap or rejects/Cost of production.
(4) Output per worker (labour productivity).
(5) Cost of production per hour.
(7) Wages cost per employee.
(8) Fringe benefits cost per employee.
(9) Power Cost/Machine hours.
(10) Repairs & maintenance cost/Cost of production.
(11) Selling cost/Net Sales.
(12) Advertising cost/Selling cost, etc.
(b) Indicative breakeven point:
This requires a lot of assumptions. Yet, this can be incorporated in terms of capacity utilisation percentage rather than on absolute figures.
(c) Default in Govt. dues and Penal interest:
In order to comment on them, the cost auditor should better ask for a certificate (with full details) from the company management, on the basis of which he can work out their impacts on the ‘Cost of Sales’ and ‘Profitability’.
Steps required strengthening the company under the competitive environment, especially with regard to need for protection from cheaper imports, if any:
(1) Competitive margin against imports.
(2) It is rather difficult for a cost auditor to suggest steps in this regard. So, he should ask for a detailed ‘write-up’ from the company management.
Such ‘write-up’ should cover at least:
(i) Major exporting countries and their prices for the products imported into India,
(ii) Severity of competition faced,
(iii) Empirical evidences that construe dumping thereby affecting the market share of Indian manufacturers, and
(iv) Suggestive measures together with specific valid cases.
(3) The cost auditor, on his part, should ensure validity or otherwise of the management’s assertion keeping in view the ‘Statistical Records’ maintained in terms of the relevant cost accounting records rules.
Export commitments of the company vis-a-vis actual exports for the year under review. Also comment on comparative profitability and pricing policy of the company for domestic and export sales. Give impact of exports benefits/incentives offered by the Government on export profitability:
(1) This sub-Para requires the cost auditor to furnish information and comments on four parts:
(i) Export commitments vs. actual exports in order to show the position of outstanding export contracts (i.e., yet to be executed),
(ii) Pricing policy/strategy for domestic and export sales,
(iii) Comparative profitability, — export contract-wise and domestic sales, and
(iv) Impact of export benefits/incentives on export profitability.
(2) In this connection, it is relevant and important for the cost auditor to understand/ ascertain
(i) The company’s pricing policy/strategy separately for domestic and export sales; and
(ii) The kind and type of export benefits/incentives offered by the Government and availed of by the company, both in relation to the product under reference.
The scope and performance of Internal Audit of Cost Records, if any, and comment on its adequacy or other-wise.
Cost Audit Report: Form # 4. Paragraph 4:
Scope of Cost reduction:
Cost reduction is defined as the achievement of real and permanent reduction in the unit cost of products manufactured or services rendered without impairing their suitability for use intended or diminution in the quality of the product or services.
It implies the retention of the essential characteristics and quality of the product and consequently confined to permanent savings in the cost of manufacture and sales by elimination of wasteful and non-essential elements from the design of the product and from the techniques and practices carried out in connection therewith.
In this area, the cost auditor’s suggestions should include value analysis, variety reduction, standardisation, simplification, improvement in design, organisation methods or process, marketing, and finance.
The cost auditor should obtain a detailed plan of cost reduction from the company for the year of cost audit and, for immediate future, study it from the aspects of cost benefit and suggest specific schemes for further improvement in performance.
Since this area is broad and multifaceted, it calls for ingenuity and skill in marshalling the facts and figures on the part of a cost auditor while presenting his observations and suggestions on specific area or areas (each area being dovetailed separately).
Cost Audit Report: Form # 5. Paragraph 5:
Other observations and suggestions, if any, relevant to the cost audit:
It is this paragraph that constitutes the climax of reporting by offering observations and suggestions on various pertinent matters not covered/highlighted in the earlier paragraphs.
Under this paragraph, the cost auditor may touch upon or elaborate any or all of the following pertinent matters/cases based on verified data and documents after having afforded the company (wherever practicable) an opportunity to comment on them :
1. If there is any change in the share capitals due to merger, acquisition, buy-back of shares, bonus issue, etc.
2. If there are specific cases where the company’s funds have been used in a negligent or inefficient manner.
3. If there are certain factors which could have been controlled but have not been done resulting in an increase in the cost of production/cost of sales.
4. If there is no budgetary control system.
5. If there is no system of internal audit of cost records.
6. If there is general imbalance in production facilities.
7. If there is an under-utilisation of installed capacity.
8. If there are key limiting factors causing production bottlenecks.
9. If there is a scope for increased ‘productivity’.
10. If the inventory policies need further improvement.
11. If there is any ‘abnormal non-recurring cost’ in case of disagreement between him and the company.
12. Any other matter that the cost auditor may deem necessary.