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 Function of Cost Audit
The main object of cost audits is to make available accurate and prompt information to management to assist it in making critical managerial decisions.
The function of a cost audit is to ensure the accuracy of cost accounts. In these types of audits, a cost auditor suggests ways to reduce the cost of production and improve the cost accounting plan.
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 cost audit where it is 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 of 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 comparatively 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.