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Aligning cost audit and corporate governance
April, 19th 2007
India can be the trend-setter in aligning the cost audit framework to enterprise governance which anyway have considerable synergies.

At a recent international conference at Chennai in January, the Confederation of Indian Industry (CII) chief, Mr R. Seshasayee, felt that the country should go beyond the legal framework of corporate governance. A co-speaker from the Securities and Exchange Board of India echoed him, stating that the Indian corporate governance framework provides only the minimum and that it should move forward and, constantly, raise the bar of best practice.

Going by the proceedings of the Conference, the country is on the threshold of raising the bar on independent directors. The International Federation of Accountants (IFAC) has published a paper on the topic through its committee on the Professional Accountants in Business (PAIB) and, as usual, all eyes are on this umbrella organisation for harmonising accounting practices and auditing standards and anything else.

Interestingly, the Indian experience on cost audit fits well with the IFAC framework and India can provide a blueprint for better enterprise governance.

IFAC on Governance

In 2002, the IFAC Board asked PAIB to explore the emerging concept of enterprise governance with a particular focus as to why corporate governance often fails in companies and what must be done to ensure that things go right.

The PAIB brought out a report which defined Enterprise Governance as, "the set of responsibilities and practices exercised by the board and executive management with the goal of providing strategic direction, ensuring that objectives are achieved, ascertaining that risks are managed appropriately and verifying that the organisation's resources are used responsibly."

The report observed that "... heavy emphasis on corporate governance issues has been necessary in the light of recent scandals, it is important to remember that good governance on its own cannot make a company successful. Companies need to balance conformance with performance.

"This is a fundamental component of corporate governance."

IFAC framework

The PAIB report states that there are two dimensions to Enterprise Governance conformance and performance and these need to be in balance. Conformance, or corporate governance, addresses issues such as board structures and roles and executive remuneration.

Performance focuses on strategy and value creation. The focus is on helping the board make strategic decisions, understand the risks and the key drivers of performance and identify the major points of decision-making.

It is desirable to develop a range of best-practice tools and techniques, such as scorecards, that can be applied effectively.These can help the board focus on strategic direction. But these are not often dealt with as a coherent whole by the board, and there emerges what we would term an "oversight gap". The Task Force then proceeds with the mechanism of oversight with a framework of performance management system. According to IFAC, the following four pillars will raise governance beyond the legal conundrum:

Strategic oversight,

Enterprise risk management framework,

Process of mergers and acquisitions, and

Board performance.

The Task Force felt that there is no equivalent mechanism to the Audit Committee in the conformance dimension to ensure adequate oversight of the business dimension. This was supported by the findings of the case studies where strategic failure was the major issue. A strategy review committee can be set up for regular review of strategy and to access external advice. But the ultimate responsibility for strategy will be with the board.

On risk management, a more integrated approach has been favoured instead of a compliance or conformance orientation. This recognition of a performance-driven approach reconciles both:

The assurance requirements of the board and external stakeholders, that is, the business understands its risks and manages them actively, or conformance. The need to better integrate risk management in decision making at all levels, or performance.

Acquisitions and mergers should happen as part of a planned strategy identifying target business in identified markets. The following were identified as the key requirements for success:

Effective experienced full-time project management

Rigorous evaluation of synergies and effective implementation,

Effective due diligence,

Specialists with recent deals experience,

Early identification of risks with mitigating action, and

Clear integration plan.

The board needs to ensure that it is making the most effective use of the limited time and knowledge to achieve the stated objectives rather than simply complying with the letter of the corporate governance code. Consequently, attention is given to issues such as:

Performance evaluation for the board including the use of:

Performance measurement systems,

Board dynamics, and

Board design.


The cost audit methodology, as structured originally under Section 233B of the Companies Act, had two perspectives:

the attestation of the cost structure, and

the efficiency review perspective, which is more methodology driven.

In the era of price control and administered interventions, attested cost structure had a major role to play and hence the emphasis on that aspect. The profession had to play the key role of verifying and validating the cost figures in select industries before they were submitted to the government.

The emphasis was relatively less on efficiency review and, therefore, did not receive much impetus in the form of new auditing techniques and methodology. But now a new vision and strategy for cost audit mechanism are necessary.

According to the report of the working group on Companies Act, on corporate governance, desirable practices need legal support as well as evolution of internal standards where the more progressive elements and the best practices are constantly updated to complement and enhance legal provisions.

Nations that have good corporate practices do not rely exclusively upon law. Conversely, those with poor records have never evolved internal codes of best practices. The question is how the objectives of cost audit can be revisited to suit corporate governance and evolve related practices with or without the required legal support.

Cost audit is a mechanism that verifies if the resources have been responsibly utilised and identifies in what processes resource wastage occurs.

The audit profession and the industry should accept the challenge of evolving a framework where there is a convergence of the objectives between enterprise governance and cost audit mechanism. Annually unitised cost structure attestation and its review will not be meaningful for the industry, which is now focussing even on hourly variations in process for cost control. Such concepts as Zero defect, PPM and Six Sigma are gaining credence in the manufacturing sector. There is a need to revisit the current methodologies and reporting frameworks.

Most organisations have well-oiled cost and management accounting systems mainly used for budget formulation, performance review reporting and identifying cost leaks and price fixing. Cost audit is selective in the sense that it is not applicable to all industrial units, as statutory audit, and to that extent can be construed as an infirmity.

Independent of this, the Cost Practitioner should be fully equipped to subserve the management's objectives of ensuring the operational effectiveness and make risk assessment and compliance control a part of the internal process. In its broad scope, the focus is not only on improving operational efficiencies, but strategic as well, having to cull out and provide information for managerial decisions on optimum utilisation of resources on a continuous basis and aid the organisation's growth objectives. Thus the cost audit methodology and deliverables can be aligned with the performance governance process.Cost audit reports todayfocus on addition or deletion to the net worth of shareholders.Value erosion happens when products and processes contain wasteful spending resulting in uneconomic cost structures and this can impact negatively on the net worth of the shareholders.

In essence, cost audit has a perfect synergy with the enterprise governance framework conceptualised by IFAC. India can be the trend-setter if it can align the existing cost audit framework to the requirements of the governance process. Industry leaders should take the lead in this rather than jettisoning the concept for short-term advantages.

A. N. Raman
(The author is a Chennai-based cost accountant.)

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