Mandatory cost audit..........

Arvind Sharma (ACA) (1432 Points)

01 June 2011  

Mandatory cost audit : A step in the right direction

The Ministry of Corporate Affairs has issued two circulars in May 2011 (attacehd here) making cost audit mandatory for some selected industries. All listed companies and companies with net worth exceedingfive crores or turnover exceeding20 crores, operating in any of the following industries, will be covered under mandatory cost audit effective from April 1, 2011: Bulk drugs, Formulations, Fertilisers, Sugar, Industrial alcohol, Electricity, Petroleum and Telecommunication. Similarly, all listed companies and companies with turnover exceeding100 crores, operating in any of the following industries will be covered under mandatory cost audit effective from April 1, 2011: Cement, Tyres and Tubes, Steel Plant, Steel Tubes and Pipes, Paper and Insecticides. This is a clear departure from the earlier government policy of directing cost audit of certain selected companies covered under Cost Accounting Record Rules issued from time to time by the government.

Many companies had opposed mandatory cost audit because they are reluctant to release sensitive cost information, which if gets leaked and reaches the competitor, might harm the interest of stakeholders as the companies might lose competitive advantage. Many oppose cost audit on the ground that such an audit does not add value to the company. It is heartening that the government has taken the right decision without succumbing to the pressure from companies.

The first concern of the companies cannot be wished away. Therefore, the government should address that concern adequately. It should explore mechanism to protect the interest of companies. One alternative is to direct the cost auditor to submit the cost audit report to the board of directors and the company should submit a compliance report to the government. The government or the regulator may call for the complete cost audit report, whenever required. This will protect the interest of companies while achieving the objective of taking India to the next maturity level in using management accounting tools.


The argument that cost audit does not add value is not tenable. In fact the cost audit report includes large number of items, which should be reported to the board of directors for better enterprise governance. For example the cost auditor has to report persistent deficiencies in the cost accounting system, adequacy or otherwise of the budgetary control system, the difference between the transfer price charged to related parties and the normal price, and reasons for considerable decline in profitability, if any. Those are in addition to the detailed cost information that is incorporated in the cost audit report. Cost audit adds value by providing assurance about the integrity of the cost data and drawing attention to the inadequacy or ineffectiveness of the cost accounting system. Moreover, The government requires the cost auditor to provide suggestions for making further improvements in the performance in respect of cost control and cost reduction. Thus, the company is benefitted from the expert opinion of the cost auditor.

Although, I have argued that that the cost audit provides value to the company, the management accounting profession should not ignore the views of the companies. The Institute of Cost and Works Accountants has allowed this negative perception to grow over number of years. It has failed to impress upon its practicing members that an effective cost audit require an innovative approach in conducting cost audit rather than a mechanical approach. Most cost auditors could not demonstrate innovativeness while providing suggestions for improving the overall productivity of respective companies. Therefore, while the government has reposed confidence on the profession, it is the responsibility of the profession to honour that confidence. They should strengthen the profession by enhancing capabilities of practicing members.

The simple argument in favour of mandatory cost audit is that almost in every company, managers install a cost accounting system, which vindicates the fact that information generated by that system is useful in decision-making by managers. In absence of monitoring, every system fails, particularly those, which operate in a dynamic environment. Therefore, cost audit is necessary to ensure that the cost accounting system is operating effectively.

At the macro level, cost audit will ensure improved productivity of resources at the aggregate level. Moreover, it will ensure integrity of information being used by regulators. Both of these will ultimately benefit consumers of goods and services being produced by different industries.


Sourse : Business Standard & MCA