Cost Audit – Objectives and Procedure

Cost audit is a powerful tool for management and statutory assurance. The auditor’s job is to verify that cost records reflect reality, supporting decisions that drive efficiency, competitiveness, and regulatory conformity. India’s Companies (Cost Records and Audit) Rules, 2014, set the statutory backdrop, requiring certain companies to maintain detailed cost records and undergo periodic cost audits.

Definition and Statutory Provisions

a. Definition of Cost Audit

Cost Audit refers to the systematic examination of cost records and accounts maintained by a company to verify their accuracy and ensure compliance with prescribed standards. Unlike a financial audit, which focuses on the truthfulness of financial statements, a cost audit scrutinizes the costing system, control mechanisms, and the application of cost accounting principles.

It’s typically conducted by a qualified cost auditor who assesses whether costs have been properly recorded, allocated, and reported.

b. Statutory Provision

The Companies (Cost Records and Audit) Rules, 2014, require specified companies (mainly those in regulated sectors or exceeding certain turnover thresholds) to maintain cost records as per prescribed formats. These records must be audited annually by a cost auditor appointed under Section 148 of the Companies Act, 2013.
The rules prescribe the format and contents of cost records, mandate appointment and rotation of cost auditors, and specify submission timelines for cost audit reports (CRA-3 format). Failure to comply can attract penalties and regulatory scrutiny.

Objectives of Cost Audit

a. Cost Control

One primary objective is Cost Control. By reviewing detailed cost records, auditors help management identify areas where costs exceed benchmarks or industry norms. This scrutiny ensures that wastage, inefficiency, and excess expenditure don’t go unnoticed. Effective cost control supports better budgeting and resource allocation, directly impacting profitability and competitive position.

b. Cost Reduction

Cost Reduction is about making systematic improvements along with cutting expenses. Through cost audit, organizations can pinpoint high-cost areas, analyze their root causes, and implement targeted measures to reduce costs without compromising product or service quality. Suggestions from the audit can lead to process improvements, renegotiation with suppliers, or technology upgrades.

c. Statutory Compliance

Another key objective is to ensure Statutory Compliance. Cost audit verifies that the company adheres to statutory requirements regarding maintenance of cost records, compliance with cost accounting standards, and timely submission of reports. This helps avoid legal penalties, regulatory interventions, and ensures the company can withstand scrutiny from authorities.

Procedure of Cost Audit

a. Review of Cost Accounting Systems and Internal Controls

The auditor starts by understanding the organization’s business, production processes, and internal controls. This includes examining the Memorandum and Articles of Association, past audit reports, and relevant company policies. Internal controls are reviewed to check for adequacy and effectiveness in capturing cost information without errors or omissions.
What happens if controls are weak?
Errors and fraud may creep in, undermining both management decisions and statutory compliance.

b. Verification of Cost Records and Supporting Documents

This phase involves detailed checking of records—raw material consumption, wage and salary allocation, overhead absorption, and other direct and indirect costs. The auditor uses techniques like vouching (matching entries to supporting documents), reconciliation (comparing cost accounts with financial accounts), and analytical procedures (studying trends and variances) to confirm accuracy.

Are costs properly allocated among products and departments? If not, profitability analysis and cost control will be unreliable.

c. Reconciliation with Financial Accounts

Cost records and financial accounts often show different profits due to factors like overhead absorption, inventory valuation, and expenses recorded only in one set of books. Auditors prepare a reconciliation statement to bridge these gaps, ensuring both sets of records are consistent and explainable.
Effective reconciliation strengthens management’s trust in the reported figures and prepares the company for external scrutiny.

d. Reporting: Cost Audit Report (CRA-3)

The final output is the cost audit report, submitted in the prescribed CRA-3 format. This report summarizes findings, highlights weaknesses and inefficiencies, and offers actionable recommendations. It’s presented to the Board of Directors and filed with statutory authorities as required.
The report structure typically includes:

• Executive summary of findings
• Detailed observations and analysis
• Recommendations for improvement
• Compliance checklists

Example

1. Collect cost records: Gather materials consumption reports, wage sheets, overhead allocation schedules.
2. Review internal controls: Check segregation of duties, approval hierarchies, and documentation procedures.
3. Verify entries: Match actual usage with purchase invoices; check wage allocation accuracy using payroll data.
4. Reconcile accounts: Compare cost profit with financial profit, analyze differences due to depreciation method or overhead absorption.
5. Prepare CRA-3 report: Summarize findings, highlight inefficiencies, recommend cost savings, submit to Board and authorities.