SUBJECT: -

CONTEMPORARY AUDIT

SUBMITTED TO: - DR. JAYA TRIPATHI

SUBMITTED BY: - HARSH SINGH

[Link] (HONOURS) 6th SEMESTER

ROLL NUMBER: - 180400545022

 ACKNOWLEDGEMENT

I would like to express my special thanks of gratitude

to my teacher DR. JAYA TRIPATHI who gave me the
golden opportunity to do this wonderful project of the
subject TECHNIQUES AND PROCEDURES OF COST
AUDITING Who helped me in completing my project
and helping me come across several facts during the
completion of the project.

Secondly, I would also like to thank my Parents and

friends who helped me a lot in finalizing this project
within the limited time frame.

NAME – HARSH SINGH

[Link]. (HONS.) – 3rd YEAR (6th SEM)
ROLL NUMBER - 180400545022
 AUDITING

When we try to ascertain the meaning and definition of the word ‘auditing’ we come across
a lot of definitions and elucidations available in a variety of formats to us. Well, in simple
terms - Audit is the examination or inspection of various books of accounts by an auditor
followed by physical checking of inventory to make sure that all departments are following
documented system of recording transactions. It is done to ascertain the accuracy of
financial statements provided by the organisation.
“An audit is an examination of accounting records undertaken with a view of
establishing whether they correctly and completely reflect the transactions to
which the purport to relate.” –

Lawrence R. Dickey

“Audit is defined as an investigation of some statements of figures involving

examination of certain evidence, so as to enable an auditor to make a report on the
statement.” –

Taylor and Perry

The term audit is derived from a Latin word “audire” which means to hear authenticity of
accounts is assured with the help of the independent review.

Audit is performed to ascertain the validity and reliability of information. Examination of

books and accounts with supporting vouchers and documents to detect and prevent error,
fraud is the primary function of auditing.

Auditor has to check the effectiveness of internal control systems for determining the
extent of checking out the audit.

Initially its meaning and use were confined merely to cash audit, and the auditor has to
ascertain whether the persons are responsible for the maintenance of accounts had
adequately accounted for all the cash receipts and the payment on behalf of this principle.

But the word audit has an extensive usage, and it now means a thorough scrutiny of the
books of accounts and its ultimate aim is to verify the financial position disclosed by the
balance sheet and profit and loss accounts of a company.

In short, an audit implies an investigation and a report. The process of checking and
vouching continues until the study is completed and the auditor enables himself to report
under the terms of his appointment.
 COST AUDITING

Cost Audit can be defined as a searching examination of cost records made by a competent
person. It is a system of identification and communication which signals –
(i) whether there are errors in cost accounts, cost statements and cost data, and
(ii) whether the procedure laid down is adequately followed.

A cost audit, therefore, includes verification of correctness of the cost accounts, cost state-
ments, cost reports, costs data, and costing techniques applied, and finally checking these
data to see that they adhere to cost accounting principles, plans, procedures, and objectives.

Cost Audit is a critical review undertaken for the purposes of –

(i) verification of the correctness of cost accounts, and
(ii) checking that cost accounting plan is adhered to.

Cost Audit can be defined as a searching examination of cost records made by a competent
person.

It is a system of identification and communication which signals –

(i) whether there are errors in cost accounts, cost statements and cost data, and

(ii) whether the procedure laid down is adequately followed.

In the terminology of CIMA. London cost audit has been defined as “The verification of cost
records and accounts and a check on adherence to the cost accounting procedures and their
continuing relevance”.

A cost audit, therefore, includes verification of correctness of the cost accounts, cost state-
ments, cost reports, costs data, and costing techniques applied, and finally checking these
data to see that they adhere to cost accounting principles, plans, procedures, and
objectives.

According to the Institute of Cost and Works Accounts of India (ICWAI), cost audit checks
the minute details when the work is still in progress. It is a preventive measure, a barometer
of performance, to guide management policies and decisions. Cost audit is the process of
detecting errors and faults in the cost accounts, thereby preventing possible frauds and
misappropriations.

The Institute of Cost & Works Accountants of India defines ‘cost audit’ as “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’.

According to Smith and Day “By the term ‘Cost-Audit’ is meant the detailed checking of the
costing system, techniques and accounts to verify their correctness and to ensure
adherence to the objective of cost accounting”.

In the words of R.W. Dobson “Cost Audit is the verification of the correctness of cost
accounts and of the adherence to the cost accountancy plans”.

On the basis of the analysis of the above definitions, it can be said that cost audit is the
detailed checking as well as the verification of the correctness of costing techniques, system
and cost accounts. In any manufacturing concern or in a service organisation, it is generally
felt necessary to compute the correct cost of products or services so as to charge the
customers correctly. For this purpose, cost accounts or costing records are maintained.

Cost audit is an integral part of audit and hence cannot be side-lined while an academic
discussion on the latter is taking place.

The objects of cost accounting with reference to which the cost accounting plan must have

been drawn up have to be kept in mind to see whether or not the plan itself and the figures
collected will lead to the achievement of the goal or objective set. For instance, if the

objective is to achieve maximum efficiency, the plan and the analysis of data will be

different from the case where the only objective is to fix prices.

It has to be examined whether the methods laid down for ascertaining costs and other

relevant decisions are being implemented. Treatment and determination of abnormal losses

of gains or treatment of certain expenses as direct or indirect are cases in point.

The correctness of the figures has to be vouched.

‘Statutory Cost Audit is a system of audit introduced by the Government of India for the

review examination and appraisal of the cost accounting record and added information

required to be maintained by specified industries’ (ICWA of India).

TECHNIQUES OF COST AUDITING

There are no specific techniques being used by cost auditor in carrying out the cost audit
assignments. Techniques employed by a Cost auditor in effectively carrying out his audit are

Accounting or economic techniques

• Physical Verification.
• Comparison of data with Peer.
• Break-even analysis.
• Budgetary control including flexible budget system.
• Cost management techniques indicating how an organization’s assets should be
allocated over competing projects or to decide whether it is worth proceeding with
the investment, keeping in view proportionate value of expenditure on such
projects.
• Discounted cash flow and net present value methods.
• Cost benefits analysis.
• Standard costing and marginal costing.
• Activity based costing to test the relevance of cost to activities.
• Quality analysis of company transactions.

Scientific Techniques

• Computer Models: There are many types of problems which can be solved on a
computer e.g., decision on material mix, product mix, make or buy decisions etc.
• Network analysis: To analyse strings of tasks to arrange them in sequential or parallel
order so that the project is completed in a shortest possible time.
• Mathematical Programme solving by heuristic (trial and error) techniques to
determine the best material mix, best use of organization’s transport fleet, the best
mix of products to obtain or to maximize profits and optimum use of labour, finance,
equipment, etc.

Statistical Techniques

• Activity Sampling: It is one of the many ways in which the present workloads can be
measured to obtain controls to be exercised by management.
 • Monte Carlo Simulation: In this a number of variables are drawn from large statistical
population which have equal choice of being selected and obtain the best sample
possible.
• Exponential smoothing
• Inter firm comparison

Personnel Techniques

• Attitude survey
• Ergonomic (Man-machine relationship)
• Training methods
• Profitability and productivity measurement

General techniques

• Statistical theory of management is an attempt to emphasize what should be the

practical approach to a problem by –
• Analysing the problem to establish the basic difficulties and factors involved.
• Establish management by objectives.
• Identifying the likely ways of tackling the problems in the light of objectives
to develop a solution
• Determine the key factors affecting management decision-making.
• Evaluating alternative courses of action
• Evaluating each alternative in terms of economy, efficiency and best fit.
• Specifying the action required to exploit the situation to the best advantage
of the organization.

• Brain storming
• Transfer pricing
• Management by objectives
• Management by exception
• Corporate planning
• Information theory

To be very broad on checking the techniques of cost auditing we have three of them as the
mainstay in the fray of the field of study –

Audit Sampling and Statistical Sampling:

“Audit sampling is the application of a compliance or substantive audit procedure to less

than 100% of the items within an account balance or class of transactions to enable the
auditor to obtain and evaluate evidence of some characteristic of the balance or class and
to form or assist in forming a conclusion concerning that characteristic”.
The term ‘sampling’ denotes the selection of a part of the aggregate material representing
the total affairs of a system. The term ‘statistical sampling’ refers to the whole process of
carrying out a test on a scientific basis. It is designed to determine the degree of accuracy of
a particular set of transactions rather to discover individual isolated errors.

Factors to be considered for ‘Audit Sample’ design:

In designing an audit sample, an auditor should apply his judgement in consideration of
the important factors -

(i) Audit objectives,

(ii) Population,

(iii) Risk and assurance,

(iv) Tolerable error, and

(v) Expected error in the population.

Sampling, as the ‘process of learning about a lot by looking at a little’, helps the Cost Auditor
in forming an opinion or submitting recommendations on a particular audit area by
examining a small percentage of the transactions or operations.

It is a kind of audit tool that enables him to crystallize his thoughts into a recommendation.
But, in the application of a sampling technique in an audit work, the Cost Auditor has to
make sure, for sampling to be effective, that he has observed the three basic ingredients of
successful sampling.

These are:

(i) Selection of the sample items,

(ii) Number of items to be selected, and

(iii) Evaluation of the sample results.

Therefore, with a view to applying the technique of Statistical Sampling successfully in a

Cost Audit Assignment, the auditor needs to be cautious and should keep in his mind the
following important points:
1. He must be aware of the principles involved in a scientific sampling—which should be
used by him only when the audit objective necessarily so warrants depending on the
circumstances.

2. Audit opinions should be based only on the sampled population but he must not be
oblivious of the total population.

3. He must ensure that every item in the population has an equal opportunity of being
selected for the sample.

4. A personal bias should not influence him in the selection process of a sample.

5. The patterns in the population should not be permitted to influence the randomness of
the sample.

6. He should not come to his conclusion about the entire population from the ‘directed’
sample.

7. He should base his estimates of maximum-error rate on realistic grounds and not illusory.

8. Stratification should be resorted to by him, whenever necessary.

9. He should not set for himself unrealistic and unachievable goals. He should remember
that all controls seek to reduce the extent and degree of audit risks.

10. After the sample results have been obtained, he should try to find out the reasons for
the variances, and then recommend corrective measures or express his opinions.

Flow Charts:

It is one of the techniques used by an auditor for reviewing and evaluating internal
accounting control of a company. It is a graph showing the flow of any work activity from
start to end, into which the various stages of operation or work or process of the entire
activity or system are charted sequentially with the aid of certain symbols universally
adopted by the accountants and auditors.

There are two approaches in the preparation of a flow chart: vertical and horizontal. Most
auditors, who use this technique for audit flow chart, prefer ‘horizontal’ charting for the
purpose of making an intensive analysis of the movement of documents and accounting
information between different employees and departments.

This way, they can obtain an understanding of how the ‘logic’ of a system operates, and can
trace out the system’s weaknesses or inefficiencies. Special graph papers are used for the
preparation of flow charts. Generally, four steps arc involved in flow charting technique—
designing, symbolizing, outlining and completing.

The designing, it’s a first step, is very important as because the overall system of the
organisation is carefully studied for dividing it into a number of appropriate logical sections.
If the auditor designs a flow chart, he has to visualize the information flow and the
documents being processed. If, however, he uses a client-constructed flow chart he should
not only interpret the symbols but also draw useful conclusions about the system depicted
in it.

Accounting or auditing flow charts may be drawn (for examples) to show:

(a) The flow of material from material stores through departments to the finished goods go
down.

(b) The flow of inward mails in office through different sections to the filing section.

(c) The processing of vouchers and bills at different stages of recording up to finalization of
accounts.

Thus, a system’s flow chart is one that gives “a pictorial image of the general flow of
information from one document to another from one location to another, and, if
applicable, from one machine to another”.

By viewing this documentation, the auditor is able “to arrive at some tentative conclusions
about the order or lack of order in the system”.

Ratio Analysis:

It is the most common of all analytical review procedures (i.e., analytical audit). It involves
the following:
1. The computation of significant financial relationships.

2. The comparison of current period ratios with one or more of the following:
(a) Similar ratios of a prior period or periods,

(b) Similar ratios of the industry,

(c) Similar ratios designated as acceptable by bankers, other credit guarantors or the
auditor.

3. The analysis of unusual and significant deviations between current period ratios and
those with which they are compared.

Ratios may be classified based on their sources as follows:

1. Balance Sheet Ratios:

They deal with relationship between two items appearing in the balance sheet. These ratios
are also known as financial position ratios since they reflect the financial position of the
business. Examples are: Current ratio (=Current assets/Current liabilities) which measures
short-term liquidity and Inventory-Working Capital ratio [=Inventory/ (Current assets—
Current liabilities)] which measures excessive inventory or insufficient working capital.

2. Income Statement Ratios:

They express the relationships between two individual or group of items appearing in the
profit and loss statement. Since they reflect the operating conditions of a business, they are
known as operating ratios. Examples: Gross profit ratio (=Gross profit/Sales) which
measures pricing policy and Net Income ratio (= Net income/sales) which indicates
operating efficiency.

3. Mixed Ratios:

They express the relationship between two items each appearing in different statement,
i.e., one appearing in the balance sheet and the other in the income statement. These are
also called ‘inter-statement ratios. Examples: Inventory turnover ratio (= Cost of goods
sold/Average inventory) measures inventory liquidity, and Return on assets (= Net
income/Total assets) measures efficiency of asset utilisation.

In order to develop relevant and meaningful ratios, the auditor must use his knowledge of
the client and its industry. Ratio analysis has limitations in that it concentrates on the past
and deals in aggregates. Ratios serve as warning signs and indicators, and arc helpful in
discovering existing or potential trouble spots when applied in trend analysis and variance
analysis.

Ratios show a trend and may help in focusing attention to the more important areas where
detailed checking may be necessary. Such ratio analysis may identify anything abnormal or
anything which deviates from the expected and the known ratios highlight only symptoms.
It is for the cost auditor to study those symptoms properly, correlate them, and reach
definite conclusions or identify the areas for further enquiries.

PROCEDURE OF COST AUDIT

• ASSESSMENT OF THE AMOUNT OF WORK INVLOVED

step - 1

• DECIDING THE FREQUENCY OF THE AUDIT

step - 2

• NUMBER OF WORKFORCE REQUIRED

step - 3

• ASSIGNING WORK TO THE AUDIT STAFF

step - 4
 • ESTABLISHING A COST AUDIT CHECK PROGRAM
step - 5

• ATTENDANCE PROGRAM
step - 6

• REVIEW OF COST ACCOUNTING RECORDS

step - 7

• VERIFICATION OF COST
STATEMENTS AND OTHER DATA
step - 8

• PREPARING THE AUDIT REPORT

step - 9

The following are the main items of Cost Auditor:

1. Audit of Materials
Cost Auditor should observe the following while Auditing the materials:

He should check Material Ledger. He should see Bin Card to note Receipt and issue of
material.
All payments related to materials must be vouched from material receipt vouchers.

He should see the purchase of material, receipt, wastage and return of material if any.

He should also see what is the practice with regard to defective and out-dated materials.

He should also see whether cost calculation regarding the output is made after due note
of defective materials.

He should also see whether the materials issue price is more than the prescribed level.

He must also see what is the procedure of purchase and issue.

He must ensure that there is no misappropriation or theft of material.

2. Audit of Labour
The cost auditor should note the points while audit of labour

He should see Attendance Register, Supervisor Register, leaves, and Gate-keepers

Records.

When wages are paid according to piece Rate, Cost Auditor should the complete record
of each worker’s output and the same should be vouched from job card.

When time Rate for Wage payment is used, he must see what is the procedure of
recording over time and should be sanctioned by some responsible officer.

Incentive plans wage payment should be checked if any under use.

The total Direct cost should be verified from various labour cost tables.

The Wages Record, its payments are subject to Internal Audit. He should see that it is
satisfactory.

3. Audit of Over-Heads

The overheads are Electric Bill, Gas, Coal, Rent, Salary etc. The Auditor should see the
distribution of these expenses according to each department. The following other actions
should be taken into Account.

Whether the expenditure is desirable or not should be cheeked from production and sale
point of view.

These expenses should not be more than the proportionate output.

He should see that actual expenditure should not more than standard expenditure.

He should also see how overheads are allocated on semi-manufactured goods.

The Cost Auditor should be aware about Administration, sales and capital expenditure.

He should also see the budgeted overheads and comparison to actual overheads and
variation should be checked seriously.

4. Audit of Plant

Cost Auditor should note the following points while auditing of a plant.

The Cost Audit should see the plant capacity, whether the full capacity is exercised or
not.

He should see the method of depreciation whether the application of such method is
desirable or not.

The daily expenditure regarding plant must be checked seriously.

The present position of the plant be checked physically.

The sale of plant should be checked seriously.

5. Audit of Stock
The stock should be checked seriously and must be verified and physically counted.

The stock should be in proportion to proposed output.

The Cost Auditor should see the minimum or Maximum and order limit seriously.

CONCLUSION

As regards bringing Cost Audit Report in public domain there seem to be mixed opinion. This
point is also largely debated on various platforms. When the Cost Audit Report Rules were
amended in 2001. the intention was to make public only first part of the report that is the
Cost Auditor's Report per se. Possibly that was the reason why the format of the Cost
Auditors Report was more comprehensive covering various aspects including Cost Auditor's
suggestions on measures for making further improvement in the performance in respect of
Cost Control and Cost Reduction, Areas where the Company is incurring losses and the
reasons therefor, breakeven point and so on. However, no such bold decision was taken by
the Government to make Cost Auditor's Report public i.e., available to the Share Holders.
Since the companies very strongly feel that the Cost Audit Report is very confidential, it is
coming in the way of making it public. It is felt that the best alternative could be a separate
report can be structured for public exposure. Apart from certain statutory assurances it
should include performance and efficiency parameters along with some vital ratio analysis.
It must be remembered that the shareholders are the real owners of the company and as
the owners of the business they have every right to understand how their business is run or
managed. Here again it is the National Institute of Cost Accountants, industry and the
government can jointly discuss and come out with a structured format of Cost Audit Report
for public exposure, if such data is made available it will only help and assist the industry to
evaluate their performance with the most efficient companies in the industry so that
internal improvements can be met. This will also provide industry-wide data base so that
bench marking is possible 213 As regards confidentiality of information contained in the
Cost Audit there is mixed opinion of the surveyed companies. It may be said that at micro
level one max find that the data is confidential but looking at it from macro level, really
speaking no much confidential data is getting exposed especially after 2011 New
Mechanism. Most of this data is necessarily available or submitted to the government
authorities or available in public domain through financial audit reporting. It may also be
noted that at least as of today the Cost Audit Report is not a public document and only
company, Government and Cost Auditor have a direct access to the Cost Audit Report of the
Company'. The " secrecy or confidentiality" card is so overplayed by the companies that
they are tooth and nail opposing the system of Cost Audit itself. Nevertheless, it is a concern
of the Auditees which must be addressed and solutions found out by the apex bod\ of Cost
Accountants, Government and Industry Jointly to safeguard the Confidentiality of
information. it is disappointing to note that almost 80% of the companies opined that they
will not conduct the Cost Audit if there is no legal force. The reluctance of the companies
and the reasons behind such attitude are elaborately discussed in this paper earlier. This
appears to be more as an issue of mindset 'rather than a Judicious and unbiased view. it is
also a paradoxical situation that the Cost Audit is accepted as an effective tool for
performance evaluation. However, still there is lot of resistance to statutory Cost Audit.
Needless to say, if there is no statutory force or if it is diluted the companies will not carry
out Cost Audit. Such a situation will be disastrous considering the public good and social
cost benefits flowing through the system. It must be concluded on this point that how so
ever bitter it may be. medicine is a must for improvement.