1.4 Planning and Structuring the Cost Audit 1.4.1 Need for Planning an Audit 1.4.1.

1 (a) The Cost Auditor should always plan to conduct an effective cost audit in an efficient and timely manner. This is very necessary to attain objectives of the cost audit. Audit plan for new client will be generally more detailed than in case of a repeat audit. In case of new audit, the cost auditor has to collect all information about the company like nature of business, organization structure, key personnel, accounting system etc. Similarly, he has to also collect information about other peers in the industry, nature of problems etc. The details required shall be much less in case of a repeat audit. The proper planning helps in: (a) appropriate attention to all the areas for comprehensive audit; (b) identification of key areas needing more attention; (c) timely completion of work; (d) optimum utilization of assistants; (e) no overlapping and proper co-ordination between the work done by different assistants,other auditors and experts. 1.4.2 Elements of Planning 1.4.2.1 Planning of cost audit involves: (a) Familiarization about the company and applicable cost accounting record rules; (b) Collection of all relevant information; (c) Evaluation of internal control procedures and the system; (d) Preparation of appropriate cost audit programme; and (e) Audit of working papers and cost sheets. 1.4.2.2 Familiarization about the Company and Applicable Record Rules 1.4.2.2(a) It is very necessary for the cost auditor to familiarize himself with the requirements of Cost Accounting Records Rules for the class of the companies to which the company under audit belongs. Similarly, the disclosure requirements as contemplated under the Cost Audit Report Rules 2001 should also be seen before actually designing the cost audit programme. This is necessary to ensure that the audit programme includes the examination of all the relevant records required to be maintained. 1.4.2.2(b) In addition to these, the cost auditor should also familiarize himself with the company especially with respect to its organization, organization structure, product range, market share, major inputs, profitability, financial status, marketing set-up, method of inventory valuation and detailed cost accounting system etc. 1.4.2.3 Collection of All Relevant Information 1.4.2.3 (a) The following records, explanations and information may also need to be collected before finalization of audit programme and actual commencement of audit: (a) A brief history of the company and its business activities; (b) Memorandum of Association and Articles of Association; (c) Annual reports and accounts for the last three to five years; (d) A list including addresses of all factories, branch offices and depots with the names of managers-in-charge; (e) Organization chart with details of key personnel; (f) Collaboration agreements, if any, including agreements for payment of royalty; (g) Details of manufacturing capacity installed, licensed and utilization installed capacity for the last three years;

(h) A detailed note indicating the system and procedure followed in Cost department Financial accounting department Purchase, raw materials/packing materials stores, etc. Production department Sales department Management Information System Personnel Department Internal audit department Copies of budget manual; Flow charts and description of manufacturing process; Labor incentive schemes, if any Details of budgetary control and standard costing procedures with treatment for variances; Copies of industrial licenses if any, issued from time to time; Periodical reports submitted to Excise and other Govt. authorities; A broad idea of the cost structure of the industry Systems and procedures of the organization and accepted cost accounting principles; Follow-up based on earlier cost audit reports, if any. 1.4.2.3(b) In case of repeat audit engagements, most of the aforesaid information would be available with the cost auditor, which would then be appropriately updated. 1.4.2.4 Evaluation of Internal Control Procedures and System 1.4.2.4(a) The evaluation provides a reasonable assurance to the cost auditor. This evaluation helps in identifying the strong points as well as the weak points of the internal control system. This will facilitate setting up of materiality levels and designing of audit programme accordingly. The cost auditor may confine his checks and audit procedures to a representative sample, if these internal control procedures are effective. This will help in reducing the avoidable verification of each and every transaction, which will be not only very time consuming but costly as well. 1.4.3 Structuring the Cost Audit 1.4.3.1 The basic concept of audit may be looked at from the angle of planning the audit work. This may be elaborated under the following heads : 1. Cost audit programmes; 2. Cost audit working papers; and 3. Checking including test checking 1.4.4 Preparation of Cost Audit Programme A cost audit programme is the cost auditors plan of action indicating the tests and procedures to be followed to implement the cost audit plan. The programme should be comprehensive and detailed to serve as a manual to the assistants and as a means to effi ciently and effectively execute the audit of each of the element of cost of sales prescribed in the cost accounting records rules. The cost audit programme should then be discussed with the management to ensure that the programme does not clash with other audits as far as possible. This will also reveal the preparedness of the company for cost audit and any arrears in the

compilation of cost accounting records could be taken care of well in advance before the actual commencement of cost audit. The planning the cost audit would inter-alia include : (a) Deciding on the audit team of persons having adequate training, experience and competence in cost auditing (b) Briefi ng the personnel on the requirements, coverage and documentation of audit evidence (c) Deciding on areas of cost audit, quantum to be covered, types of checks and techniques to be used, methodology of collection of facts and on recording the progress of cost audit (d) Laying down time targets for completion of different segments of cost audit. A cost audit programme is usually subdivided in the following stages : (a) Review of cost accounting records (b) Verifi cation of cost statements, proformae and annexures (c) Preparation of cost audit report. The cost auditor prepares the cost audit report under the Cost Audit Report Rules, 2001 after reviewing the cost accounting records and detailed verification of the cost proformae, annexures, cost statements and other financial data submitted by the company to the cost auditor. 1.4.5 Working Papers The Audit working papers contain the basic records including audit programme, nature of queries raised in course of audit, important information about the business of the company and audit findings. Such audit working papers help to locate audit findings. The working papers are the important aid in planning and performance of the cost audit. It facilitates the supervision and review of the audit work. It also provides supporting evidence of the audit work performed. Audit of working papers usually consist of: (a) evidence obtained during the audit exercise; (b) details of methods and procedures followed during such exercise; and (c) conclusions derived by the cost auditor as regards objectives of the cost audit. 1.4.5.2 The working papers should record the cost audit plan, the timing, nature and extent of the audit procedures performed and the conclusions derived from the evidence obtained. The working papers serve as an important proof regarding the way evidence was found, analyzed and verifiable conclusion drawn. 1.4.5.3 Whenever any question is raised or a clarification is desired by the Central Government regarding any point, the cost auditor can reply properly if the audit working papers are properly kept. Such working papers will help the cost auditor in cost audit of that company during subsequent years also. The working papers should be cross-indexed in such a manner that required information could be obtained with minimum delay. The working papers may be arranged properly according to Para numbers of the Annexure to the Cost Audit Report Rules. 1.4.5.4 The audit working paper may be kept in two files a permanent file for all the years and a variable file for each year of audit. Thus copies of Memorandum of Association, Articles of Association, collaboration agreement, process flow chart, cost manual etc. may belong to the permanent file.

1.4.5.5 It is advisable that detailed comments on verification of supporting statement are kept attached to that statement. This would enable the cost auditor to know at any time how a figure was arrived at, what examination he made to satisfy himself, what queries he raised, what replies were received and what comments he finally decided to put in his report. 1.4.6 Verification of Records and Reports 1.4.6.1 Details of Cost Accounting Records 1.4.6.1(a) The records contemplated under Section 209(1)(d) of the Companies Act, 1956 would include all cost accounting records maintained by the company and made available for audit. The following records are considered as part of the cost accounting records(1) Production (a) Consumption register of raw material, packing materials, etc. (b) Production reports. (c) Scrap, wastage, spoilage and defective reports. (d) Machine utilization report and idle time report. (e) Details of production hours, labour and machine hours. (2) Raw materials stores etc. : (a) Goods received register. (b) Bin cards and stores ledger. (c) Material consumption and stock reports. (3) Utilities (Steam, power & water) : (a) Records of inputs and outputs. (b) Records of cost centre-wise allocation of products. (c) Records for own generated power and purchased power. (4) Wages and Salaries : (a) Attendance registers. (b) Payroll. (c) Leave wages and gratuity payments. (d) Overtime and idle time records. (5) Overheads : (a) Overheads analysis/distribution registers. (b) Overhead absorption details. (6) Repairs and maintenance : (a) Work order register (7) Work-in-progress and fi nished goods : (a) Cost centre-wise/product-wise stock register. (b) Product-wise fi nished goods register. (8) Cost accounts, records and statements : (a) Cost centre-wise assets register. (b) Product ledger. (c) Annexures and proformae as per Cost Accounting Records Rules. (d) Reconciliation of profi t/loss as per costing and fi nancial records. (9) Sales : (a) Sales register including export sales register. (b) Sales analysis by products (quality, size, variety-wise). 1.4.6.1 (b) The above mentioned cost records shall be maintained on a regular and continuous basis and not at the end of the year only.

1.4.6.2 Review of Cost Accounting Records by Cost Auditor 1.4.6.2(a) The cost auditor during the course of audit will thoroughly review the cost accounting records. Such review and verifi cation may include : 1. Methods of costing in use batch, job, process etc. 2. System of fixation of cost centres. 3. Procedures for accounting of raw materials, packing materials, and spares, etc. 4. Methods of accounting of wastes, rejections and defectives. 5. System of recording of wages, salaries and overtime and their allocation. 6. Incentive schemes in vogue. 7. Basis of allocation/apportionment of utilities. 8. Method of accounting for depreciation and charging depreciation to cost centres. 9. Method of apportionment/allocation of service department expenses. 10. Basis of reapportionment of service department expenses to production departments. 11. Basis of absorption of overheads to products. 12. Basis of absorption of interest, bonus, gratuity and selling and distribution cost to products. 13. Treatment of research and development expenses. 14. Budgetary control system. 15. Internal audit system. 16. Method of accounting of production and sales. 17. Method of evaluation of work-in-progress. 18. System of stock-taking. 19. Method of valuation of inventories. 1.4.6.2(b) If the company has manual for cost accounting, the cost auditor should study the manual thoroughly. 1.4.6.3 Verification of Cost Proformae and Annexures 1.4.6.3(a) The cost auditor has to examine all the cost accounting records, cost statements, other books and documents, annexures and proforma to the report and other relevant data in course of his audit work. Such examination of the cost and financial statements by the cost auditor may include the following 1. Financial position including financial ratios as required to be stated in Para 24 of the Annexures to the Cost Audit Report Rules. 2. Licensed capacity, installed capacity, production and capacity utilized (Para 4). 3. Consumption of raw materials, power and fuel, salary and wages, stores and spare parts, provision for depreciation, expenditure on overheads, royalty and technical know-how charges, quality control expenses, pollution control expenses, abnormal non-recurring costs and other items. 4. Sales realization local and export unit and total for each variety of product. 5. Cost proformae maintained by the company as per cost accounting records rules. 6. Reconciliation with financial books. 1.4.6.3(b) As mentioned earlier, the examination of cost proformae as per provisions contained in relevant cost accounting records rules and other items mentioned above may commence only after the end of the accounting year when all the closing entries are passed through the books of account.