Cost of Production:
The cost per unit of each category, variety, or quality of the product under reference, with comparative figures in the previous year, and comments on the reasons for differences should be included in the cost auditor’s report. Such an analysis and comparison will also help in reconciling the total cost of the product under reference with the total cost of production, which can also be worked out from the figures given in financial accounts. Figures of financial accounts include provisions, allocation and appropriation of expenditure, which may have been paid in the previous year or may be paid in the next year, but relates to the current years production. If there are any such adjustment made in the financial accounts, these should become obvious as a result of reconciling the cost accounting information with financial accounts. Moreover, it is necessary to determine cost of different varieties, categories, qualities of each product in order to make an analytical study of the contribution made by each type of product.
Sales and Profitability:
Although cost of selling has been dealt with in an earlier chapter of the Handbook, according to para 12 of Appendix III of the Companies (Audit of Cost Accounts) Rules 1998, sales in quantity and net sales realization of different categories, varieties or qualities of product under reference, showing the average sales realization per unit, should be shown in the cost auditor’s report. If the product under reference is exported, net realization per unit, countries to which exported, indicating the profit or loss in export., should be specifically explained in the cost auditor’s report. Sales of different quantities and qualities of the product under reference can help to make an interesting and useful study of contribution analysis. If it is possible to increase the volume of sales of such qualities or quantities as are yielding a higher contribution, it should be possible for the company to increase its profits. In the case of export, it may be observed that export to every country, to which the product under reference was exported, may not be yielding the same amount of profit per unit. The reasons can be many such as a better price in one country or higher cost of packing and higher amount of freight incurred on exporting to another country.
Profit/(Loss) Per Unit:
According to para 13 of Appendix III, .the profit per unit on each category, variety or quantity of the products, comments on the comparative profits of different categories of the products per unit as well as in terms of per machine hour etc., and comments on the adequacy or otherwise of product for maximization of profit. should also be identified in the cost auditor’s report. This exercise would help in studying the contribution made by sales of different quantities and different varieties of the products, also profitability of different market segments. Larger quantities result in longer, continuous production runs and should normally yield a higher amount of profit compared to smaller quantity produced during intermittent production runs, bearing a higher incidence of setting up, test runs , wastages and other overhead costs.
Financial Ratio Analysis:
- In order to evaluate the company’s financial position and profit performance, the cost auditor performs checkups on various aspects of the company’s financial health. A tool frequently used during these checkups is working out ‘financial ratios”. Ratios provide a basis of carrying out both internal and external comparisons. A financial ratio, which relates to two accounting numbers, is obtained by dividing one number by the other. Ratios can be used for comparing changes within the company from period to period, or may be used for comparing the position with another company.
- Financial ratios may compare the financial position or profit performance of the company. For comparing the financial position, balance sheet figures are used and for comparing the profit performance, figures of the profit and loss account are used. From the balance sheet figures, financial leverage, or the gear ratio, which are from the debt ratios may be calculated. These ratios show the extent to which the company is financed by loans. Cost and Management Accountants are quite familiar with such gear ratios. Liquidity ratio measures the company’s ability to meet short-term obligations. From the profit and loss account figures, leverage ratio may be calculated which relates the financial charges of the company to its ability to service or cover them. Activity ratio measures how effectively the company is using its assets. Various profitability ratios are also worked out, which relate profit to sales and to investment.
Cost Auditor’s Observations and Conclusions:
Para 14 of Appendix III of the Companies (Audit of Cost Accounts) Rules 1998, is important, particularly insofar as it requires the cost auditor to make such observations and conclusions with which the management of the company may not agree. These observations and conclusions should be made on the basis of reliable cost audit evidence.
The provisions of the para quoted here should be carefully noted:
- Matters which appear to him to be clearly wrong in principle or apparently unjustifiable.
- Cases where the company’s funds have been used in a negligent or inefficient manner.
- Factors which could have been controlled, but were not controlled resulting in increase in the cost of production.
- (i). The adequacy or otherwise of budgetary control system, if any, in vogue in the company
(ii). the scope and performance of internal audit, if any.
- Suggestions for improvements in performance e.g., by-
i. rectification of general imbalance in production facilities;
ii. fuller utilization of installed capacity;
iii. comments on areas offering scope for-
- cost reduction;
- increased productivity;
- key limiting factors causing production bottle-necks;
- improved inventory policies; or e) energy conservancy;
iv. state of technology, whether modern or obsolete; and
v. plant, whether new or second-hand when installed.