Performing Cost Audit – Important Elements of Cost

1. Raw Materials:

  • Raw materials and other materials which can be directly identified with production would normally constitute major part of the cost. The cost of raw materials, both in quantities and value, as given in the statements, should be verified. In case the transport cost of raw materials is a significant element of cost, as in the case of cement and sugar industry, the transport cost is determined separately. In case of imported raw materials, the various elements are: FOB value, ocean freight, insurance, custom duty, clearing/forwarding and inland freight. Withholding income tax and sales tax would be separately accounted for.
  • Raw materials are the materials which directly go into the process of manufacture and physically constitute a part of the product; whereas there may be some direct materials, which are directly identifiable with the production process but only help production. Materials which are relatively of insignificant value viz. material although may be directly conducive to production also classified as indirect material. Data for raw materials consumption have to be provided for the year under audit, as well as for the previous two years, for comparison.

Material Consumption:

Components and parts in the case of engineering industries are referred to as direct materials. Material consumption would normally refer to material consumed in production. Every cost auditor knows how the figure of material consumption is worked out by deducting closing inventories, from the receipts and adding opening balance. Consumption of materials should be carefully checked with the issues to production processes. The use of the term “major raw materials”, in para 4 of Appendix III to the Companies (Audit of Cost Accounts) Rules 1998, indicates all direct materials; some of which may be small in quantity and value but large in number, which may not be reported as required in this same para. Provisions of the cost accounting record rules should be kept in mind, as the rules also specify accounting requirements for raw materials and other direct and indirect materials.

Comparison with Standards or Estimates:

Various clauses of para 4 of Appendix III provide for comparison of the consumption of major raw material with the standard requirement, if any. If standards have not been worked out, there should be estimates on the basis of which management of the entity exercises control. In the absence of an estimate, the cost auditor should arrive at a standard or estimate, on the basis of his knowledge of the industry, as mentioned earlier. Variances from the standard or estimate and from the figures of the “preceding two years”, should be looked into and commented upon by the cost auditor in his report.

Maintenance of Raw Material Quantity and Cost:

The relevant cost accounting record rules generally provide the manner in which the record of cost and quantity of raw materials shall be maintained and how the cost is arrived at. The cost of raw materials includes all direct charges up to works, such as freight, inward transport handling, insurance etc. The basis of “costing of raw material should be consistently followed”, and should be commented upon by the cost auditor.

Components of Cost of Materials:

Cost accounting record orders/rules may provide the manner in which cost of purchases, cost of inspection and receipt should be included in the cost of the raw materials. The cost auditor should examine the procedures being followed in procuring, planning, purchasing, transporting, receiving, inspecting, that is all procedures and costs involved in making the materials available at the point of the production process. Moreover, realizable value of any waste material or by- product, which may have adjusted the cost of raw materials, be carefully considered and treated in accordance with the normal or standard cost control practice followed by the industry, according to the knowledge the cost auditor may have.

2. Wages and Salaries:

Para 5 of Appendix III of the Companies (Audit of Cost Accounts) Rules 1998, provides that the following particulars relating to wages and salaries be included in Cost Auditor’s Report to the Director of the company:

  1. Total wages and salaries paid for all categories of employees, separately in respect of each of the following namely:
    i. direct labour cost on production;
    ii. indirect employees cost on production;
    iii. employees cost on administration;
    iv. employees cost on selling and distribution;
    v. bonus to workers and employees;
    vi. other employees cost, if any (including taxes and levies); and
    vii. total employees cost (total of items (i) to (iv) above)
  2. Salaries and perquisites of directors and chief executive.
  3. Total man-days of direct labour available and actually worked for the year.
  4. Average number of workers employed for the year.
  5. Direct labour cost per unit of output of the product (give information in respect of each).
  6. Brief explanation for variances in item. (e) above, if any, as compared to the previous two years.
  7. Comments on the incentive schemes, if any, with particular reference to its contribution towards increasing productivity and its effect on cost of production.


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