Performing Cost Audit – Background Knowledge and Audit Procedures

Knowledge of the Industry and the Entity:

Before performing cost audit, the cost auditor must have or obtain knowledge of the industry and its business environments, sufficient to enable him, to identify and understand the events, transactions and practices that in the Cost Auditor’s judgment may have a significant effect on the cost accounting statements of the entity to be audited, or on the cost audit report. The cost auditor should also have a general knowledge of the country’s economy and the industry within which the entity operates. He should also have a clear understanding of the conditions that affect or may be affecting the cost and profit performance of the entity.

Updating of Knowledge of Industry:

The knowledge that the cost auditor obtains about the industry and the entity at the planning stage of the cost audit keeps increasing and updating, while taking up the assignment and at every stage throughout the performance of cost audit. The cost auditor keeps re-evaluating the knowledge and information gathered earlier.
Knowledge of the industry, which the cost auditor may already have, may be updated through discussions with the entity’s senior operating personnel, publications relating to the industry, government surveys, statistics, trade journals, visit to the entity’s premises and plant facilities. Knowledge of the industry and the entity is extremely important in cost performance evaluation.
The cost auditor should ensure that the assistants assigned to a cost audit engagement also obtain sufficient knowledge of the business to enable them to carry out the cost audit work delegated to them. It should be ensured that they understand the need to be alert for additional information and the need to share that information with the principal and other assistants.

Legal and Regulatory Framework:

When planning and performing cost audit procedures, the cost auditor should keep in view the legal and regulatory framework within which the entity has to operate. Although it is the responsibility of the management to ensure that the entity’s operations are conducted in accordance with the laws and regulations and the cost auditor cannot be held responsible for non-compliance by the entity; he should see that the provisions of the Companies Ordinance
1984, the relevant cost accounting record order and of the Companies (Audit of Cost
Accountings) Rules 1998 as far as they relate to the maintenance of cost accounting records and
providing of cost accounting information, are duly observed and followed by the entity. Non – compliance of such provisions by the entity would have a material effect on the cost accounting statements, in which case the cost auditor is specifically required to report whether or not the entity complies with the provisions of laws or regulations which are directly related to cost audit.

Organizational Set-up:

While taking up any new cost audit assignment, the cost auditor should, first of all, study the organizational set-up of the entity. He should get familiar with the administrative, financial, buying and selling, production and planning functions at the entity. He should be introduced to the functional heads, as he will be dealing with them during the course of cost audit. Each function and sub-function should be organized in a logical manner, according to its nature and size. The size of and the manner in which the various functions are organized have a direct bearing on the cost of each function performed at the entity. The cost auditor will do well in discussing the functional set-up with the top management, pass on the concept of activity-based costing and also offer comments on the set-up, if considered necessary, under the circumstances. Knowledge of the organizational set-ups of each function helps in obtaining knowledge of the industry and the entity, referred to in the foregoing paragraphs.
The cost auditor has also to verify and express opinion on the company representations made under the Companies (Audit of Cost Accounts) Rules 1998, and on the cost accounting information provided by the company, in the Schedules and Annexure prescribed in the cost accounting records rules applicable. He has also to evaluate and offer comments on the entity’s cost accounting system. He thus has to work, maintaining close liaison with the functional heads and with various levels of management.

Company Representations:

Under clauses (a) and (b) of sub-rule (1) of Rule 4 of the Companies (Audit of Cost Accounts) Rules 1998 every company shall, in addition to the records and statements specified in the order of the Securities and Exchange Commission of Pakistan, issued under clause (e) of sub-section (1) of Section 230 of the Companies Ordinance 1984, prepare:

  1. A statement of productions capacity of the plant, in terms of machine hours and production units, the actual utilization of the capacity and the reasons of difference between the two; and
  2. A statement of stock-in-trade of the company as at the end of financial year in terms of quantity and cost thereof, distinguishing between:
    i. stock of raw material and components;
    ii. stock of work-in-process;
    iii. stock of finished goods; and
    iv. other stocks.

Under sub-rule 2 of Rule 4 of the Cost Audit Rules, “(2) the statements specified in clauses (a) and (b) of subrule (1) shall be signed by the chief executive and chief accountant of the company”. Both the statements specified in clauses (a) and (b) shall be submitted along with the Cost Auditor’s report. Capacity as explained in para (1) of Appendix III of the Rules: “1” Capacity:

  1. Licensed, installed and utilized capacities of the factory or factories for the product under reference.
  2. If the company is engaged in other activities besides the manufacture of the product under reference, give a brief note on the nature of such other activities.

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