Cost Audit


The definition of cost audit given by the Institute of Cost and Works Accountants of India. “It is an audit of efficiency of minute details of expenditure, while the work is in progress and not a post mortem examination. Financial audit is a fait accompli. Cost audit is mainly a preventive measure, a guide for management policy and decision, in addition to being a barometer of performance.”

The Official Terminology also defines cost audit as “the verification of cost records and accounts and a check on adherence to prescribed cost accounting procedures and their continuing relevance.”

“Cost audit is the verification of cost accounts and a check on the adherence to the cost accounting plan”, ICMA. The first function is the verification of the accuracy of cost account, statements and reports. 



  1. Definitions and Meaning of Cost Audit
  2. Objects of Cost Audit
  3. Need and Features of Cost Audit
  4. Propriety and Efficiency Audit
  5. Types of Cost Audit
  6. Functions of Cost Audit
  7. Cost Audit Programme
  8. Statutory Cost Audit
  9. Advantages of Cost Audit

What is Cost Audit: Definitions and Meaning, Objects, Scope  Need, Features, Types, Functions, Cost Audit Programme, Objectives, Advantages and More…

Cost Audit – Definitions and Meaning 

The term ‘audit’ has been defined by the Official CIMA Terminology as “a systematic examination of the activities and status of an entity, based primarily on investigation and analysis of its systems, controls and records.”

The Official Terminology also defines cost audit as “the verification of cost records and accounts and a check on adherence to prescribed cost accounting procedures and their continuing relevance.”

The definition of cost audit given by the Institute of Cost and Works Accountants of India. “It is an audit of efficiency of minute details of expenditure, while the work is in progress and not a post mortem examination. Financial audit is a fait accompli. Cost audit is mainly a preventive measure, a guide for management policy and decision, in addition to being a barometer of performance.”


The CIMA definition Cost audit is not a post-mortem examination. The work of audit being carried out while the work is in progress, cost audit acts as a check on efficiency. It is a preventive measure. It guides management in the work of policy formulation and decision making. It acts as a barometer indicating performance efficiency. 

“Cost audit is the verification of cost accounts and a check on the adherence to the cost accounting plan”, ICMA. The first function is the verification of the accuracy of cost account, statements and reports. 

Secondly, it is checking whether the costing principles, procedures and conventions, have been adhered to. It reveals errors, frauds and malpractices committed in cost accounts. The auditor gives suggestions for improvement. 

As could be seen from the definitions above, the scope of cost audit is limited to verification of cost records and accounts to ensure that they conform to cost accounting procedures. Verification of cost accounting records naturally implies checking the accuracy of entries there in.

Cost Audit – Top 3 Objects

Thus, the basic objects of cost audit can be stated as below:


(1) To verify that the cost accounts have been correctly maintained and compiled according to the cost accounting systems employed by the organization.

(2) To see that the cost accounting plan i.e., the prescribed routine of cost accounting is carried out.

(3) To detect errors, and prevent frauds and the misappropriations.

Cost Audit – Need and Features

Need of Cost Audit are as follows:


(i) Price fixation 

The need for fixing retention price for materials of national importance, e.g., steel, cement, etc., may necessitate cost audit. Moreover, to regulate excessive profiteering, cost audit may be conducted to know the true cost of production.

(ii) Tax assessment 


Where tax or duty is levied on products on the basis of cost of production, the levying authorities may go for cost audit to determine the actual cost of production.

(iii) Cost variation within the industry 

Where the cost of production differs appreciably from firm to firm in the same industry, cost audit may become necessary to find the reasons of such differences.

(iv) Trade disputes  

Cost audit may be conducted for settling trade disputes, e.g., claim for higher wages, bonus, etc.

(v) Inefficient management 

Where a company runs inefficiently and uneconomically, the Government may order the audit of its cost accounts before taking up any further action. 

Features of Cost Audit given below:

a) Cost books, cost records and cost accounts are maintained as per costing system adopted.

b) Verification of the cost plan. The prescribed forms and procedures have been adhered to.

c) Detecting errors and preventing frauds.

Cost Audit – Propriety and Efficiency Audit

Cost audit is, as pointed out, a preventive measure. As such, it includes both propriety audit and efficiency audit.

i. Propriety Audit:

Propriety audit is defined as “the audit of executive action and plans bearing on the finance and expenditure of the company.” This aspect of cost audit lays emphasis not only on the expenditure, i.e., whether it is properly authorised and supported by vouchers, but also whether it yields optimum results and whether better results could not have been achieved by any other alternative plan of action.

Propriety audit questions the wisdom of management in incurring expenditure. This is obviously to find out if the managerial decision in relation to expenditure was unsound due to any error in judgment.

In this case, the cost auditor is in the position of a financial adviser to safeguard the interests of shareholders by coordinating the results of action of the various departmental heads. He also assists the chief executive in arriving at a sound judgment on the financial plans and performance of the concern.

Propriety audit can thus be conducted only by a professional expert with in depth knowledge of theory and a practice of financial management and mature wisdom and sound judgment.

ii. Efficiency Audit:

This is also known as ‘performance audit’. Efficiency audit is intended to reveal the real efficiency and character of management. It ensures the application of the basic economic principle that resources flow into the most remunerative channels. It focuses attention on the efficient execution of the plan adopted.

It includes not only a careful examination of the plan itself but the achievements also. It ensures that performance is in consonance with the plan and the amount invested yields adequate return. Such an assessment is of paramount importance in capital planning and investment in the area of which a wrong decision is bound to have a serious repercussion on the future of the concern.

Thus, efficiency audit is of particular significance to industrial concerns. It is intended to ensure that ‘every rupee invested in capital or in other fields gives the return, and that the balancing of investment between different functions and aspects of the company is designed to give optimum results.’

Cost Audit Types – On Behalf of Management, Customer, Government, Trade Association and Statutory Cost Audit

The various types of Cost Audit generally depend upon the circumstances and the officiating persons who take the actual initiative for conducting such a cost audit.

The usual types of cost audit undertaken for a company on behalf of the following:

Type # 1) Cost Audit on Behalf of the Management:

The principal object of cost audit is to ensure that the cost data placed before the management are verified and reliable and will assist in decision-making.

The objectives of cost audit on behalf of the management are as follows:

i) Establishing accuracy of the costing data.

ii) Ascertaining abnormal losses/gains along with the relevant causes and the person responsible.

iii) Determination of the cost per unit of production.

iv) Establishing suitable overhead absorption rates to minimise over/under recovery of expenses.

v) Fixation of the selling price and any additional charges.

vi) Obtaining audit observations and suggestions of the cost auditor.

Type # 2) Cost Audit on Behalf of a Customer:

In case of cost plus contracts, the buyer or contractee may insist on a cost audit to satisfy himself about the correct ascertainment of cost. Sometimes, the agreement between the two parties may contain a stipulation in this regard.

Type # 3) Cost Audit on Behalf of Government:

The Government, when approached for subsidies or cash assistance, may require to be satisfied about the genuineness of the cost of production or the efficiency of the company. The Government, at its own may also initiate cost audit, in public interest to establish the fair price of any product.

Type # 4) Cost Audit by Trade Association:

Sometimes, trade association may take the responsibility of fair pricing of the products manufactured by the member units or where there is a pooling or contribution arrangement between the members. For this, they may require the accuracy of costing data checked and may seek full information on the costing system, level of efficiency, utilisation of capacity, etc.

Type # 5) Statutory Cost Audit:

Section 22B of the Companies Act provides for statutory cost audit. This is ordered by the Government whenever it feels necessary to do so. Cost audit is ordered from year to year. The company concerned is required to maintain statutory cost audit is usually prescribed industry wise, it is possible that the company might be manufacturing or selling two or more products but, only one product might come under the purview of cost audit.

Cost Audit Functions – Protective and Constrictive Functions

Cost Audit is mainly a preventive measure for guidance of management in policy and decision.

There are two functions of Cost Audit:

i. Protective Functions

ii. Constrictive Functions

i. Protective functions include; detecting errors, errors of omission, commission and verifying the cost accounts with cost accounting principles.

ii. Constructive functions of cost audit are known as proprietary audit in which auditor’s acts as an advisory body to the owner of the company.

The functions of auditors will include:

a. To verify the return on Capital Employed

b. To verify the money invested.

Cost Audit Programme – Meaning and Main Items to be Covered

Cost audit programme is a plan of audit to be carried out. It should be chalked out on the basis of the nature and size of the business. An auditor must have a specific programme for the industry concerned.

It should be drawn by bearing in mind the following points:

a. Purpose of audit,

b. Comparison of actual sales with budgeted sales,

c. The procedure of financial audit—vouching, checking, ticking, audit-notes, question­naire etc., to be followed,

d. Detailed analysis of variances,

e. Reconciliation of cost accounts with financial accounts,

f. Decisions taken at managerial level,

g. Details of existing cost system,

h. Critical examination of existing routines and systems,

i. The form of reports and statements to be reviewed, if necessary.

Apart from the above, before taking up the work, the auditor should have to read the memorandum and articles of the firm, costing system existing, cost accounting manual if any, various forms used in costing etc. 

A cost audit programme should be drawn in such a manner as to cover all the areas of the concern such as production, sales etc.

The main item covered under cost audit programme are as under:

1. Materials:

A cost auditor should examine the following things regarding materials:

i. The various documents relating to materials.

ii. Material returned to supplier should have been accounted.

iii. The reasonableness of various types of materials losses.

iv. The computation of material variances should be examined.

v. Checking the reasonableness of various types of material losses.

vi. Checking the method of pricing issue.

vii. Checking whether materials are purchased to economic order quantities.

viii. Checking the quantity received as per goods received.

ix. Verifying the authority for issue of materials.

x. Checking whether the valuation of stocks is in accordance with the prescribed procedure.

xi. Checking reduction of inventory cost consistent with production needs.

xii. Checking the calculation of rates of issue.

xiii. Checking the quantity received as per goods received.

2. Labour:

Cost audit regarding labour includes the following:

i. Checking in the physical calculation of wages.

ii. Verify the correctness of classification of labour cost.

iii. Checking the system of payment of wages.

iv. Verify the accuracy of calculation of wages.

v. Check the job time, attendance and time records.

vi. Check the records regarding overtime work.

vii. Compare the performance efficiency of labour.

viii. Reconcile the amount of wages paid with the attendance record.

3. Overheads:

Regarding overheads, cost audit includes the following:

i. Verify the amount of over and under absorbed overheads.

ii. Compare the actual amount of overheads with the standard amount.

iii. Check the items not included in cost.

iv. Check the accuracy of overheads.

v. Check the classification, and allocation of overheads.

vi. Investigate the causes of over or under-absorbed overheads.

vii. Step to remove variance from the standards.

viii. Check that the selling and distribution overheads are within reasonable limits.

Cost Audit – Statutory Cost Audit: With Objectives and Salient Features

Besides the business entities themselves, the government is also interested in assuring itself of the reliability of the cost data. The government uses the data provided by the business firms to take decisions relating to regulatory prices, export subsidies, levy of excise duties, and degree of protection to be afforded to the domestic industries, etc.

The government is also interested in ensuring that the prices charged to the consumers in respect of essential goods and services are not unreasonable and exploitative.

To achieve these ends, the government of India has made cost audit compulsory for companies in certain selected industries like cement, caustic soda, rayon, paper, nylon, polyester, sugar, bulk drugs, infant milk foods, etc.

The provisions relating to statutory cost audit do not apply to non-corporate form of business organizations and to such corporate entities, whose scale of operations falls within the purview of the definition of a small scale undertaking. In case of multi-product companies, the provisions relating to statutory cost audit will be applicable only to those product lines that fall within the scope of the selected industries.

The primary objective of statutory cost audit is to ensure that the company’s cost accounting records provide a true and fair view of the cost of production and cost of sales of the product under reference.

The cost auditor is also expected to comment upon the adequacy of the cost accounting system in general and on the process of accounting for various elements of product costs – material, labour, and overheads in particular.

The legal provisions relating to statutory cost audit are contained in Sections 209(1) (d) and 233B of the Companies Act, 1956. Under the provisions of Section 209(1) (d), the central government has the power to order companies engaged in production, processing, manufacturing or mining activities to maintain certain prescribed particulars relating to the utilization of material, labour, and other items of costs.

In exercise of this power, the government has selected about 25 industries and framed cost accounting record rules for each such industry. These rules provide guidelines relating to maintenance of cost accounting records and cost statements, the details of which vary according to the nature of the industry. Companies falling within the scope of the selected industries are bound by these rules.

Under Section 233 B of the Companies Act, the government has the powers to order an audit of the cost records of the companies in selected industries by qualified cost accountants. The cost auditor is required to submit his report to the central government within 120 days from the end of the financial year to which the cost audit report relates.

Unlike financial audit which is statutorily required to be carried out every year, cost audit needs to be conducted only when the government requires the company to do so.

The report of the cost auditor is required to be framed in accordance with the Cost Audit (Report) Rules, 2001. These rules specify the format of the report and the information required to be reported in the annexure to the report.

An analysis of the information required to be reported in the annexure to the cost audit report reveals that the emphasis is more on reporting facts like cost of consumption of raw materials, royalty payments, value of sales, etc., than on the cost auditor’s analysis of the cost information system per se.

In the section on auditor’s observations and conclusions, the cost auditor is required to offer his comments, if any, on various aspects ranging from utilization of corporate funds to inventory management practices and give his suggestions for improvement. Given the time constraint relating to the submission of a report, the cost auditor often has insufficient time to make an in-depth analysis of these aspects for offering his comments and suggestions.

Salient Features of Statutory Cost Audit:

As per Section 233 of the Companies Act, 1956, the central government can order that an audit of the cost records maintained by a company under Section 209(1) (d) of the same act shall be conducted.

The salient features of statutory cost audit in India are as follows:

(a) The cost auditor has to be a cost accountant within the meaning of the Cost and Works Accountant Act, 1959. However, if the central government is of the opinion that a sufficient number of cost accountants are not available for cost audit of companies, it may by notification direct that chartered accountants possessing prescribed qualifications may also conduct cost audit for a specified period.

(b) Unlike audit of financial accounts under the companies act, cost account is not an annual feature, i.e., it is not to be conducted every year unless central government so directs.

(c) The cost accountant is to be appointed by the board of directors of the company with the previous approval of central government. He has the same powers and duties as the auditor of financial accounts has.

(d) Cost auditor has to send his report to the central government in prescribed form and forward a copy of the report to the company. The time limit for sending the reports to the central government is 120 days from the date of closing of accounts relating to the period to which the report relates.

(e) The cost auditor has to submit a detailed report in the form specified in the Cost Audit (Report) Rules, 1968. Apart from the statutory affirmations and records, receipts of proper return and true and fair view of the cost of production, etc., the cost auditor has to provide information and comments in an annexure which forms a part of the report.

(f) The annexure to cost audit report has to state general information about the company under audit.

Cost Audit Advantages – To Management, Consumers, Shareholders, Government and Statutory Financial Auditor

The important benefits derived from cost-audit are:

(A) Benefits to Management:

(1) It helps to detect errors, frauds, inconsistencies, etc. This improves the morale, makes the staff more watchful and helps them to improve the accuracy in their work.

(2) It ensures a high degree of reliability of cost data, e.g., price fixing, decision-making, etc., which helps the management to improve the quality of cost reports.

(3) It highlights the weaknesses in the systems and procedures. Inefficiencies in the working of the company are brought to the notice of the management by comparing actual achievements with the target performances for corrective action.

(4) It improves cost accounting methods and the effectiveness of cost control and cost reduction schemes by pointing out avoidable losses.

(5) It establishes a reliable check in the valuation of closing stock and WIP.

(6) Audited cost data is more suitable for inter-firm comparison.

(7) It makes management by exception possible through allocation of responsibilities to individual managers.

(8) It reduces wastes by continuous checking and reporting to management.

(9) Budgetary control and standard costing system will be greatly facilitated.

(B) Benefits to the Consumers:

(1) Cost audit helps the Government to fix the fair selling price of consumer goods. Thus the consumers get the benefits of fair price for the products of the company.

(2) Cost audit does not allow the producers to make excess profits by increasing the price at regular intervals. This helps the consumers to maintain a higher standard of living and saves them from unreasonable price hike.

(3) It helps to reduce and control cost and make proper use of scarce resources.

(C) Benefits to the Shareholders:

(1) Cost audit helps to make proper valuation of closing stock and WIP and reveals the true picture of profitability of each product vis-a-vis for the entire company. It also highlights whether the management is making optimum utilization of resources by eliminating inefficiencies.

(2) It helps the shareholders to assess whether they are getting adequate return on their investment.

(D) Benefits to Government:

(1) When the Government enters into a cost-plus contract, cost audit helps to fix the price of the contract accurately. This helps the Govt, to settle the cost claims of bills under cost-plus contract quickly.

(2) Cost audit helps the Government to fix selling prices of essential commodities accurately and thus prevents undue profiteering.

(3) Cost audit data is considered more reliable for giving protection to certain industries in public interest.

(4) Cost audit helps the Government to focus its attention on inefficient units and increase their productivity by taking effective measures. This improves the national income of the country.

(5) It helps the Government to settle industrial disputes regarding wages, bonus, fringe benefits, etc., through conciliation.

(6) Accuracy in price fixation generates a healthy competition among the different units in an industry. This checks inflationary trend automatically.

(E) Benefits to Statutory Financial Auditor:

(1) Cost audit generates reliable data by maintaining constant internal check. Costing data, e.g., closing stocks of raw materials, WIP and finished stock, etc., is of great help to the statutory financial auditor.

(2) It helps to prepare profit and loss account easily. 

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