What are the Types of Cost Audit?

A cost audit is an independent examination of an organization’s cost accounting records and procedures.

It is used to ensure that the organization is following sound cost accounting principles and practices. Cost audit can also be described as “the verification of cost records and accounts and a check on the adherence to the prescribed cost accounting methods and the continued relevance of such procedures.

It also helps identify cost centres and is beneficial in planning future strategies. Also, an excellent technique to discover fraud, if any. Internal auditors of a suitable-sized firm generally do this for onward reporting to the top management.

External auditors conduct financial cost audits to ensure that an organization’s financial statements are accurate and free from material misstatement. Managers within an organisation conduct managerial cost audits to assess the accuracy and reasonableness of the organization’s cost accounting records and procedures. Government agencies conduct compliance cost audits to ensure that an organisation is complying with applicable laws and regulations.

Objectives and Functions of Cost Audit

A key purpose of a cost audit is to verify the accuracy and completeness of a company’s cost accounting data. This includes confirming the correctness of cost data, assessing the efficiency of cost accounting systems and procedures, and determining the overall dependability of cost data. Companies can take corrective action to enhance their cost accounting systems and practices by finding flaws and inconsistencies in cost data.

An additional purpose of a cost audit is to discover areas of inefficiency and waste in a business’s operations. This may entail analysing manufacturing processes, supply chain management, and other operational areas to discover cost-cutting and process-improvement options. Companies can establish methods to simplify their processes and decrease costs by identifying inefficiencies and waste, resulting in increased profitability and competitiveness.

Lastly, cost audit tasks include giving recommendations for process enhancement and cost reduction. This may entail suggesting modifications to manufacturing processes, supply chain management, and other operational areas in order to increase efficiency and minimise costs. By applying these suggestions, businesses may optimise their cost structures and increase their nett income.

There are five types of Cost Audits. A brief explanation of each of these five types is given below:

Cost Audit on behalf of the Government

Such audits are initiated on order from government agencies if they think the entity needs a cost audit. The government may appoint a cost auditor to conduct a cost audit where necessary.

• To ascertain correct cost-specific units when Government is approached for protection  or financial help;
• To determine the accurate cost of the contract given to a private firm under a cost-plus basis;
• To fix reasonable prices for certain items of production to prevent undue profiteering.

Cost Audit on behalf of a Customer

Sometimes, the audit may be conducted on behalf of a customer when he agrees to pay the price for a particular product on “ cost-plus”.

In such a case, the customer gets cost accounts of the product concerned audited to establish the correct cost so that he may be able to pay the price based on the correct cost plus an agreed margin of profit.

On behalf of Trade Associations

Sometimes, a trade association may appoint a cost auditor to conduct a cost audit-

• To ascertain comparative profitability of its members;
• To determine the minimum  price to avoid cut-throat competition  among its members;
• To maintain prices at a certain level to prevent undue profiteering

On behalf of Tribunals

Occasionally, labour tribunals may order an audit of cost accounts to resolve a trade for increased pay, bonuses, and profit-sharing, among other things. Similarly, Income-Tax Tribunals may order an audit of cost accounts to ensure that assessments are made appropriately.

Cost Audit under Statute

These are also called compulsory audits, and specified companies must undergo a cost audit process. Under Section 233-B of the Companies Act, 1956, the Central Government may mandate that certain companies that are obliged to keep appropriate records of materials utilised, labour, and other expenditures under section 209 have their costs audited. The aim of such types of audits is that the Government wants to ascertain the relationship between cost and prices.