Performing Cost Audit – Background Knowledge and Audit Procedures


After checking the stock-in-process at the end of the financial year with the production records and after adjusting the opening stock-in-process or last year’s closing stock-in-process, “production in quantities of each type of product under reference should be worked out, as required in para 3(a) of Appendix III (sub-rule (3) of Rule 4) of the Companies (Audit of Cost Accounts) Rules 1998”.
The “percentage of production of the product under reference” should be seen “in relation to the installed capacity” If there is any shortfall in production as compared to the installed capacity, brief comments as to the reasons for the shortfall, shall be offered in the cost auditor’s report. While laying down particulars to be included in cost auditor’s report to the Directors of the Company, para 3(c) of Appendix III to the Companies (Audit of Cost Accounts), Rules 1998, further provides that “if there is any addition to the production capacity during the year under review or in the immediately preceding two years, this may also be mentioned”.

Gathering Cost Audit Evidence:

The cost auditor has to follow the International Audit Standards (ISAs) and related technical pronouncements issued by International Federation of Accountants. Cost audit, like any other audit, involves: (a) planning (b) carrying out audit procedures or gathering cost audit evidence and (c) drawing reasonable conclusions on which to base the audit opinion. The principles and planning have generally been explained in previous lectures. During the course of audit, the cost auditor should obtain sufficient appropriate audit evidence for arriving at reasonable conclusions. Audit evidence is the documented information obtained by the cost auditor in arriving at the conclusions, on which the audit opinion is based. Audit evidence will consist of source documents, cost accounting records, cost accounting statements, company representations and corroborating information from other sources.
Cost audit procedures mean tests to obtain cost audit evidence to detect material misstatements in the statements and in the information provided by the entity. The tests may be performed on the details of transactions and balances, following analytical procedures. When obtaining cost audit evidence from substantive procedures, the cost auditor should consider the sufficiency and appropriateness of audit evidence from such procedures, together with any evidence from tests of control to support the cost and other information asserted by the management of the entity. If unable to obtain sufficient appropriate cost audit evidence, however, the cost auditor should express a qualified opinion or a disclaimer of opinion.

How Cost Audit Evidence is obtained:

Cost audit evidence is obtained by following procedures such as: inspection, observation, inquiry and confirmation, computation and analytical procedures noted below:

  1. Inspection consists of examining records, documents, or tangible assets. Inspection of records and documents provide cost audit evidence of varying degrees of reliability, depending on their nature and source and the effectiveness of internal control over their processing. Documentary cost audit evidences may be created by third parties and held by third parties or held by the entity or created by the entity and held by the entity.
  2. The cost auditor may observe the procedures being performed, say the counting of inventories by the entity’s personnel. Inquiry consists of seeking information from knowledgeable persons inside or outside the entity. Inquiries may be written or oral, providing new or corroborative information. Confirmation is the response to an inquiry.
  3. Computations consist of checking the arithmetical accuracy of source documents and cost accounting records or of performing independent calculations. Analytical procedures consist of significant ratios and trends, including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or deviate from predicted amounts. Analytical procedures include the consideration of comparison of the entity’s cost information for prior periods, anticipated results of the entity, such as budgets or forecasts or expectations of the cost auditor, such as an estimation of depreciation. The entity’s cost performance may also be compared with similar industry cost information.
  4. Analytical procedures also include consideration of relationships among elements of cost information that would be expected to conform to a predictable pattern based on the entity’s experience, such as contribution analysis. Relationships also exist between such direct and indirect costs as payroll and employee related costs. Various methods may be used in performing analytical procedures, ranging from simple comparisons to advanced statistical techniques. Choice of procedures, methods and level of application is a matter of professional judgment. The cost auditor should apply analytical procedures, when
    forming an overall conclusion as to whether the cost statements as a whole are consistent with the auditor’s knowledge of the business. The conclusions drawn from the results of such procedures are intended to corroborate conclusions formed during the audit of individual components or elements of the cost accounting statements and assist in arriving at the overall conclusion as to the reasonableness of the cost statements. They may also identify areas requiring further procedures. The extent to which analytical procedures may be relied upon would depend on the materiality of the items involved.
  5. Cost audit evidence is obtained from an appropriate mix of tests of control and substantive procedures. The type of tests to be performed is important to an understanding of the application of audit procedures in gathering cost evidence. The cost accounting system is tested to identify the characteristics or attributes that indicate performance of a control, as well as possible deviations and conditions which indicate departures from adequate performance. The cost auditor should perform audit procedures appropriate to the particular test objective on each item selected.
  6. The cost auditor should obtain sufficient appropriate audit evidence as to whether the standard cost, planned cost, budget cost or cost estimate, being used for cost accounting and control purposes, is reasonable in the circumstances. An understanding of the procedures and methods, including the cost accounting and cost control, used by the management in making the control yardstick is important for the cost auditor to plan the nature, timing and extent of the cost audit procedures. The cost auditor should either review and test the process used by the management to develop the standard; use an independent standard for comparison with that prepared by the management or review subsequent events which confirm the standard made.
  7. The cost auditor should make a final assessment of the reasonableness of the standard estimate, based on the auditor’s knowledge of the business and whether the yardstick is consistent with other audit evidence obtained during the audit. After an evaluation of results of cost audit procedures, the auditor should feel convinced of their being reasonable. Vouching, testing, examining, analyzing, comparing, confirming, inspecting, reconciling, tracing, verifying the details, the cost auditor collects audit evidence to form his opinion not only about the production and capacity utilization, but also on the cost accounting system (Section VII), inventories and the cost accounting statements prepared by the management in accordance with cost accounting records order/rules, applicable to the industry. Cost statements differ from industry to industry and reflect how production and auxiliary services are generally organized.

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