Business Standard

Is cost audit losing its relevance?

By introducing the concept of 'public interest', the government has made the 2014 Rules unnecessarily complicated

Asish K Bhattacharyya 

Cost audit is the independent audit of cost records maintained by companies. The concept of cost audit was introduced in 1965 when Companies Act, 1956 was amended to incorporate the provisions relating to the maintenance of cost accounting records and cost audit. Cost audit got an impetus in 2011 when its scope was expanded and the rules and reporting formats were simplified to address industry concern of confidentiality.

The Companies Act, 2013 has retained the provisions relating to maintenance of cost records and cost audit. The government has notified the Companies (cost records and audit) Rules 2014 on June 30, 2014. The 2014 Rules have severely curtailed the scope of cost audit. This U-turn in policy has dismayed the cost accounting profession and experts.

The new Rules mandate the maintenance of cost records in companies engaged in the production of specified goods in strategic sectors, companies engaged in an industry regulated by a sectoral regulator or a ministry or department of central government, companies operating in specified areas of public interest and companies engaged in the production, import and supply or trading of specified medical devices. The Rules also provide for a threshold in terms of net worth or turnover of companies, thus, restricting its applicability to large companies.

It appears that the government has mandated maintenance of cost records and cost audit only in those sectors, which might require policy intervention. For the first time, it has brought construction companies, companies engaged in health services and companies engaged in education services within the ambit of cost audit. The government has categorised those as companies operating in the area of public interest.

The government has excluded the industries in which the competition among companies is significant. Presumably, the government has taken the view that cost audit is not relevant in companies that operate in a competitive environment. It is argued that those companies maintain cost records voluntarily, as they are required to continuously analyse cost and revenue data for managing costs, in order to retain and enhance competitiveness on the face of competition from competing firms or competing substitutes. In those companies, the management information system draws data from cost records. Therefore, there is no need to mandate maintenance of cost records and cost audit. But there is a flaw in this argument. Cost audit is no less relevant for companies operating in a competitive environment.

Any audit provides reasonable assurance about the integrity of audited information. For example, financial audit provides assurance to shareholders and other stakeholders about the integrity of information provided through financial statements. Financial audit is mandated to protect the interest of minority shareholders from the opportunistic behaviour of managers. The underlying assumption in mandating financial audit is that managers are human beings and, therefore, are inherently opportunistic.

Managers show opportunistic behaviour even in presenting information before the board of directors. This is the reason why Sebi had to mandate the minimum information to be presented before the board of directors. It is not unknown that managers manoeuvre board process to get favourable board decisions.

Companies Act, 2013 aims to strengthen corporate governance by empowering the board of directors. It requires independent directors to get involved in critical decisions. They have been made responsible for strategy review, risk management, performance evaluation and key appointments. All these require analyses of cost and revenue data. If, we agree that managers are inherently opportunistic, the board of directors need an assurance from an independent agency about the integrity of cost and revenue information that is placed before it. Only cost audit by an independent cost auditor can provide that assurance.

Cost audit has not lost relevance, even for companies operating in a competitive environment. Benefits from cost audit outweigh its cost. If a company is already maintaining cost records, the incremental cost is the audit fee. The cost of regular staff, which support the audit, is fixed in nature. Therefore, while the cost is immaterial, benefits in terms of improved corporate governance are immense, may not be from the management's perspective. By introducing the concept of 'public interest', which is difficult to define, the government has made the 2014 Rules unnecessarily complicated and difficult to implement. Rules should be transparent and simple. The current Rules provides the scope for jockeying for inclusion and exclusion of companies from the ambit of cost audit. The government should bring all companies, except small companies, within the ambit of cost audit. It is also important that the cost accounting profession quickly upgrades skills in developing costing systems for emerging businesses, including those in the service sector.

Affiliation: Professor and Head, School of Corporate Governance and Public Policy; Advisor (Advanced Studies), Institute of Cost Accountants of India; and Chairman, Riverside Management Academy Private Limited

Dear Reader,

Business Standard has always strived hard to provide up-to-date information and commentary on developments that are of interest to you and have wider political and economic implications for the country and the world. Your encouragement and constant feedback on how to improve our offering have only made our resolve and commitment to these ideals stronger. Even during these difficult times arising out of Covid-19, we continue to remain committed to keeping you informed and updated with credible news, authoritative views and incisive commentary on topical issues of relevance.
We, however, have a request.

As we battle the economic impact of the pandemic, we need your support even more, so that we can continue to offer you more quality content. Our subscription model has seen an encouraging response from many of you, who have subscribed to our online content. More subscription to our online content can only help us achieve the goals of offering you even better and more relevant content. We believe in free, fair and credible journalism. Your support through more subscriptions can help us practise the journalism to which we are committed.

Support quality journalism and subscribe to Business Standard.

Digital Editor

First Published: Sun, July 20 2014. 22:34 IST