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Cost auditing an avoidable cost
August, 22nd 2007
Is cost audit now a superfluous tool for scrutinising business practices? According to recent reports, the government has an open mind on this question, but has placed under review the present practice of mandatory (government-imposed) cost audit.

The review, according to a corporate affairs ministry official, would be a `broader one, meaning, the rationality of government imposing cost audit would be verified afresh, keeping in mind the current realities of doing business: the scenario of market forces largely having a free run and corporates voluntarily being vigilant enough about being financially prudent. He revealed that a large number of companies were petitioning the ministry over the compliance cost of this statutory requirement. He, however, hastened to add that no conclusive view would be taken, before the stakeholders the industry, the community of cost accountants and regulators were consulted. After all, in case of products whose prices are controlled by the government, there might still be a need for the government assessing the cost to fix the profits, he added.

In fact, a parliamentary committee on subordinate legislation, attached to the finance ministry, had in December 2004 called for enlarging the scope of mandatory cost audit by bringing essential services health, education, civic amenities, basic infrastructure (road, water, etc.) under its purview. The panels rationale was that with subsidies being knocked off, these sectors increasingly move towards free pricing, necessitating closer scrutiny of cost.

The committee later pulled up the ministry for not acting fast enough on this score, and this seems to have jolted the government into action. So the official version is that the proposed review would be without any prejudice and so might not necessarily result in a reduction in the scope of cost audit. But the undertones suggest otherwise.

At present, under Section 209 1D of the Companies Act, cost auditing is mandatory on certain classes of companies. In a recent communication to the parliamentary committee, the corporate affairs ministry defined the relevant criteria thus: companies making products that involve subsidies or whose prices are administered, companies engaged in production of defence equipment, companies in industries consisting of public sector enterprises and companies in regulated industries. This is but a very broad (almost all-encompassing) and rather vague criteria. Which means the government is not quite sure of where to apply Section 209 1D. In actual practice, cost audit is enforced through the cost audit record rules prescribed under the Companies Act 44 products (rather, sectors) have so far been notified as requiring compulsory cost audit. Virtually, all major industries petroleum, chemicals, textiles, engineering, cement, paper, electricity, steel, etc are covered. Of course, in terms of their products (goods). The only service industry that has to obligatorily include cost audit statements in its financial reports is telecom. The parliamentary panel wants more services to be covered for obvious reasons.

Ask Chandra Wadhwa, president, Institute of Cost and Work Accountants of India, why cost audit is required and he would wax eloquent. According to him, cost audit would come in handy to assess the necessity of anti-dumping duties, for deciding on the products to be covered under free-trade agreements, for the revenue department to estimate the excise and income tax liabilities of the industry concerned, for making transfer pricing rules, for the competition commission when it wants to detect anti-competitive practices, for courts when confronted with conflicting affidavits on industrial disputes, and of course for regulators that control/monitor prices of goods and services. In most developed countries, cost audit is in-built in the financial statements of public utility companies, he says, adding that it was fatuous to say it is a redundant exercise in the era of market-determined pricing of goods and services.
Of course, there are many emerging areas like transfer pricing and FTAs that require cost audit as a tool to unlock information. Segment reporting for regulatory awareness is difficult in the absence of costing records. Most companies, however, go by thumb rule in this regard. There isnt the need for imposing auditing requirement on them. Says Joy Jain, executive director, PwC: There are many methods to verify the tenability of transfer prices. Even the income-tax department has devised five methods for the same. Cost audit merely gives the costing-related information.

Audit reports could be called for by the respective agencies and regulators whenever required. But to legislate that any one industry in its entirety will get its costs audited and disclose the reports is doubtless a folly. Its a wasteful exercise. This has, however, been going on for some decades now. The system hasnt been corrected despite total decontrol of industries like chemicals, paper and steel.

The criteria for compulsory audit reported by the ministry to the parliamentary panel is not only ambiguous but also farcical. Consider the criterion that any industry which comprises a PSU would have to get its cost audited. This is virtually an all-compassing norm (even the auto industry has one Scooters India in the public sector).

Not surprisingly, even the cost accountants dont dispute the need for a review. Let us do away with the present ad hoc policy. Instead, all listed companies, irrespective of the industry they are in, could be covered. A threshold could be fixed to exclude smaller firms for which there could be less stringent norms, says Wadhwa.

But that, again, would amount to extravagance. The right approach could be to let companies decide autonomously whether they would want to get their costs audited and reported. Whenever such information is required from regulatory perspective, companies could be asked to disclose costing records.
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