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Cost Audit: expert body's advice can be considered
May, 31st 2010

Regulations regarding maintenance of cost accounting records and cost audit are likely to change. If the recommendations of the expert committee appointed by the Ministry of Corporate Affairs are accepted, all manufacturing companies with a paid-up capital of Rs 50 crores (500 million) or more will be required to get their cost accounting records audited by a statutory cost auditor. Some business managers argue that there is no business case for statutory cost audit. They also question the justification for government intervention. It is the time to debate these issues.

It is well established that a robust management accounting system is the backbone of enterprise governance. But, unfortunately, India is not at the highest maturity level of management accounting practices. According to a survey, India is at the maturity Level II, which is above the lowest level (Level I) but below the highest level (Level III). This implies that, in India, all the players are not conscious about their responsibilities; and a well developed self-discipline mechanism, which is necessary to achieve the objectives of the whole economy and as well as those of stakeholders, does not exist. At this stage government intervention is necessary to strengthen management accounting practices. It may be withdrawn later when India reaches Level III.

There is a view that cost audit does not add value. It presents the information, which is already being used by managers, in a prescribed format. It does not provide any additional input that has the potential to improve decision making. This argument is flawed. Audit of any kind creates value by providing a reasonable assurance that important matters correspond to pre-set criteria. For example, internal audit provides an assurance that the risk management system is adequate and effective. It is inappropriate to expect something beyond that from statutory cost audit.

Those who do not support statutory cost audit build their argument as follows. Management accounting system fulfils information needs of managers, who pursue the goal of creating shareholder value. Managers are keen to strengthen the competitive position of the company thorough innovations, both continuous and revolutionary. Continuous improvement in the product quality and attributes, and elimination of wastes in business processes are norms rather than exceptions.

Therefore, they have a vested interest in the management accounting system. The board and the management design and implement internal control system to ensure that the management accounting system is adequate and effective. Therefore, statutory cost audit is redundant.

If, the above is a valid argument, statutory audit of financial statements is unnecessary. This is so because the board, by designing and implementing an appropriate internal control system ensures that financial accounting records are accurate and complete and that financial statements provide a true and fair view. Therefore, statutory financial audit is redundant. All will agree that this is a foolish argument. This is foolish because statutory financial audit adds credibility to the information provided through financial statements. Withdrawal of the system of statutory financial audit will reduce the confidence of shareholders in this information and the cost of capital will increase. Therefore, there is a business case for statutory financial audit.

Till recently, financial statements were at the centre of annual report. But things have changed. Shareholders and other stakeholders seek the information which is being used by the board of directors in directing and controlling the company. This is evidenced by the segment reporting requirement under GAAP. Companies are meeting those needs by disclosing additional information in the annual report (e.g. in board of directors reports, MD&A, and through voluntary disclosures) or in guidance to analysts. Audit of such information is beyond the scope of the statutory financial audit.

Therefore, it is considered that the creditability of the additional disclosures is lower than the credibility of financial statements. Cost audit will indirectly add credibility to such additional disclosures because most of these are captured by the management accounting system. Moreover, cost audit will provide an assurance to stakeholders that the company has a world class management accounting system to support enterprise governance. This will reduce the cost of capital. Therefore, there is a business case for statutory cost audit, which is as strong as the business case for statutory financial audit.

The government should accept the recommendations of the expert committee.

 
 
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