SAI VIDYA INSTITUTE OF TECHNOLOGY

Module-05
Cost Audit& Reporting to Management

Cost Audit& Reporting to Management-objectives and advantages of Cost Audit, Cost Audit
report. Management Audit- Objectives and Scope. Reporting to Management – Purpose of
reporting- Requisites of a good report, Classifications of Report, Segment reporting, Cost Reduction
and Cost Control, Target Costing – its Principles, Balanced Scorecard: Features and Purpose (theory
only).

Cost-Audit
Cost Audit is the process for verifying the cost allocation of each product or Services comprising of
labour cost, manufacturing cost or any other item of cost as applicable. It is a critical review undertaken
to verify the correctness of Cost Accounts and to check that cost accounting principles and planning
have been efficiently followed.
Cost Audit has been defined by the Chartered Institute of Management Accountants (CIMA) of Landon
as ―the verification of cost accounts and a check on the adherence to the cost accounting plan.‖ Thus, the
Cost Audit is quite different from the Financial Audit.
It is to see whether the labour is efficient or not, whether the industry has provided efficient labour or
the labour which is required by that industry is less than what is required, whether every material and
every part of the machinery is used to the optimum, whether any material is wasted, etc. It is noteworthy
that India is the only country which has introduced statutory cost audit to regulate about 45 vital
industries of the country.
According to ICWA of India, ‗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.‘
The main objectives of cost audit are as follows:
1 to serve as an effective tool of control;
2 to safeguard the interest of the members of the company, consumers of its product and the
Government
3 to verify the accuracy of costing data
4 to satisfy that the principles of cost accounting have been properly adapted and applied
5 to assist the process of decision-making on the basis of cost considerations
6 to offer suggestions for a more efficient organisation of the costing operations

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7 to ensure that the suitable system of costing has been maintained in accordance with the needs and
characteristics of the industry and the supporting procedures help the attainment of the goals of the
organisation
8 to examine whether the cost statements give a true and fair view of the cost information
9 to help ascertainment of quotations for future contracts based on correct cost estimates
10 to look into the cost practices as an effective aid to pricing decisions
11 to act as a moral check on the employees associated with cost accounts. Cost audit, thus, is a
valuable tool of verification of cost information and its control.
Advantages of Cost Audit
1. A close check will be maintained on all wastages—materials in store, labour, etc. and they will be
promptly located and reported.
2. It also helps in pointing out any inefficiencies in the production process. Solving such inefficiencies
will help the company save a lot of money.
3. A cost audit actually helps the statutory auditor with his job as well. Audited costing data helps him
determine the value of stocks, managerial remuneration, and other such aspects.
4. Cost auditing also allows fixing individual responsibility. This will allow the management to
effectively manage their staff. Through fixation of individual responsibility, management by exception
will be possible.
5. The system of budgetary control and standard costing will be greatly facilitated with cost audit at the
hands of a qualified cost accountant.
6. Records will be up-to-date and information for various purposes will be available.
7. Cost audit may unearth a number of errors and frauds which may not be revealed otherwise. This is
because a cost auditor examines expenditure minutely and compares it with standards and ascertains
exact reasons for discrepancy.
8. Cost audit can serve to measure performance of managers and better performance can be rewarded.
9. Inter-firm comparisons can be made with ease and this might be a very useful proposition if industrial
intelligence is good.
10. If the cost auditor is an outsider and is an expert, he can certainly give some practical and sound
advice to streamline costing systems and organisation.
Disadvantages of Cost Audit
1. Holding a Cost Audit can be expensive. This is because a company will often bring in an independent
auditor who are normally charging higher price.

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2. A Cost Audit can be a long process which will likely involve more time. This extra time and effort
can impact an employee's day to day routine work.
3. If a Cost Audit is carried out in order to find fraudulent activity it can take a long time by which time
people stealing could have covered their tracks.
4. Cost Audits involve a large amount of estimation and so there is the possibility that figures will be
incorrect and if record keeping from the company is not good to start with then inaccuracies will be
arising.

Types of Cost Audit

The main types of cost audit are as follows
1. Cost Audit to Assist Management: The aim is to see that all information placed before management
is relevant, reliable and prompt so that management can discharge its duties well.
2. Cost Audit on Behalf of a Customer: Often contracts are placed on ―Cost Plus‖ basis. In other
words, the customer will determine the final price to be paid on the basis of exact cost plus an agreed
margin of profit. The customer, in such a case, usually gets cost accounts of the product concerned
audited to establish correct cost and, therefore, price.
3. Cost Audit on Behalf of Government: Sometimes the Government is approached with request for
financial help or protection. Before taking a decision on the request, the Government may choose to get
cost accounts of the applicant audited to establish whether the need for help is genuine or is a result of
mere inefficiency.
4. Cost Audit under Statute: The Amendment Act of 1965 has inserted a new section, 233B, in the
Companies Act, 1956 whereby the Central Government may order that certain classes of companies will
get their cost accounts audited by a member of the Institute of Cost and Works Accounts of India. Only
such companies as are required to maintain proper records regarding materials consumed, labour and
other expenses under Section 209 (as amended to date) and may be required to get their cost accounts
audited.
5. Cost Audit on Behalf of the Trade Association: Sometimes trade associations seek to maintain
prices at a certain level. For this purpose, the accuracy of costing information submitted by various
concerns has to be checked. The trade associations may seek to have full information about production
capacity and the relative efficiency of productive processes.

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Reporting to Management
The word ‗Report‘ consists of two parts. ‗Re‘ meaning again and ‗Port‘ means to carry. Thus the
word means ‗to carry information again‘. Reports are always written for an event, which has already
occurred.

Objects or Purpose of Reports:

1. Means of communication: It is a means of communicating information from one who has it to

someone that needs the information for carrying out the functions of management. Reports
provide information to shareholders creditors, customers, government and general public.
2. Serve as a record: They provide valuable records for future reference.
3. Legal requirements: Some reports have to be submitted to fulfill legal requirements. For
example: - Annual reports of the company‘s accounts must be furnished to shareholders as per
company‘s act of 1956.
4. To Develop Public Relations: Reports of the general progress of the business helps in increasing
the goodwill and developing public relations.
5. Basis to measure performance: Work performance reports of employees help the management to
measure performance and become the basis for promotion and incentives.
6. Control purposes: It is on the basis or reports that actions are initiated and instructions are given
to improve the performance.

KINDS OF REPORTS

I. According to object & purpose:

1. External Reports: Outsiders interested in the company‘s reports may be shareholders, creditors or
bankers. The company publishes the ‗Income Statement‘ & ‗Balance sheet‘ at the end of every financial
year and these statements are filed with the Registrar of companies and stock exchange.

2. Internal Reports: These are meant for different levels of management like the top, middle and lower
levels of management. Example of internal reports are periodical reports about profit/ loss and financial
position, statement of cash flow and changes in working capital, report about cost of production,
production trends, reports of sales, credit collection periods, stock position.

II. According to Nature:

1. Enterprise Reports: These are prepared for the concern as a whole and served as a channel of
communication with outsiders. These reports may include balance sheet, income statement, income tax
return, chairman‘s report etc.,

2. Control Reports: These are two types. The first type is used to judge the performance of the
managers and reasons for deviations in performance is also identified. The second type of control
reports is used to judge how well a responsibly centre has fared as an economic utility.

3. Investigative Reports: In case a serious problem arises then the causes are studied and analyzed.
These reports help the management to analyse the cause of the problem.

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III. According to period:

1. Routine Reports: These are prepared about the day to day working of the concern. They are
periodically sent to various levels of management, on a daily, weekly, monthly or quarterly basis.
Routing reports may relate to sales information, production figures, capital expenditure, purchases of
raw materials, market rents, labour situations etc.,

2. Special Reports: These are prepared according to the needs of the situation. Available accounting
information may not be sufficient, so data may have to be especially collected. Special reports may deal
with Technological changes in the industry. Market analysis and method of distribution of competitors;
Problems of purchase of raw materials; Political development at home and abroad having an impact on
business.

IV. According to functions:

1. Operating Reports: They provide information about the operation of the concern. Operating reports
may consist of Control reports, which are intended to spot deviations from the budgeted performance
without loss of time so that corrective action can be taken. Information reports which are prepared to
provide useful information, which will enable planning and policy formation for the future. Information
reports can take the form of trend reports or analytical reports.

2. Financial Reports: These reports can be either static or dynamic. Balance sheet is an example of a
static report, where as cash flow, fund flow statements and other reports showing the financial position
as compared to the budgeted one are examples of dynamic reports.

General Principles Of Good Reporting Systems

1. Proper flow of information: A good reporting system should be such that information flows from
the proper place to the right levels of management. Flow of information is a continuous activity
and affects al levels of the organization. For example, orders, instructions and plans may flow
from the top to the bottom. Reports, grievances, suggestions etc, may flow from bottom to top.
Notifications, letters and complaints may flow from outside. Information also flows sideways
from one manager to another at the same level through meeting and discussion.
2. Proper timing: Since reports are used as a controlling, device they should be presented at the
earliest after the happening of an event. The time required for the preparation should be
minimized.
3. Accurate Information: The information should be as accurate as possible; otherwise it may result
in making the wrong decisions. However, it would be better to have approximate figures at the
proper time rather than delayed information prepared accurately.
4. Basis of comparison: The information supplied through reports will be more useful when it is
supplied in comparison with past figures standards set or objectives laid down. The comparison
of information with past or budgeted figures will enable the reader to find out trends of
variations.
5. Reports should be clear & simple: The information presented should be relevant, important and
presented in a clear manner. Supporting information should be given in the appendix.
6. Cost: The benefit derived from the reporting system must be at least equivalent to the cost
involved.

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7. Evaluation of responsibility: The record of actual performance monitored should be along with
standards set to enable the management to assess the performance of different individuals.

Structure of report
 Heading
 Address
 List of contents
 Terms of preference
 Body of the report
 Recommendations
 Reference and appendices
 Signature

1. Heading: It should be short, clear and meaningful. It should indicate the subject matter of the
report.
2. Address: The report must be addressed to some person or a body of persons.
3. List of contents: It is a list of chapters of the report arranged logically along with the page no, on
which such contents are to be found.
4. Terms of preference: It gives the reason for writing the report. Brief description of the problem is
stated. The object & scope of the investigation are also given.
5. Body of the report: Here the facts and data collected are presented. Use of tables, graphs and
diagrams can be made here or in the appendix.
6. Recommendations: This is the summary of the report and consists of conclusions and
recommendations. Conclusions are made on the basis.

Illustrative Reports: -

1) Productions manager of Raju Co. Ltd., is experiencing difficulties like power shortage, high
labour absenteeism & non-availability of raw material in time. These have caused decline in
production. As a management consultant of the company make as in-depth study of these
problems and report to the management, suggesting suitable suggestions,

17-12-2009
Production Manager,
Raju Co. Ltd.,
Bangalore-16.

Dear Sir,
Reasons for Decline in Production & Suggestions to Improve the same.

In accordance with the instructions given by production manager, Raju Co. Ltd., we have made
an in-depth study for the causes for decline in production & suggestions to remedy the situation.

Inadequate production and supply of thermal power in the state, which is mainly due to the
shortage of coal, required for thermal power generation. Another reason is the short supply of
hydroelectric power by the KEB mainly due to failure of monsoon, bad working conditions &
inadequate remuneration.

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Non-availability of raw materials due to dependence on just one supplier & also due to general
scarcity of raw materials, which is demanded by many competing firms. Also the company does not
place orders with suppliers well in time due to lack of coordination between production department,
stores department & purchases department.

Suggestions: -
In our opinion the following suggestions will go a long way to overcome the above problems.
Company should have additional source to supplement the present supply of electricity by the
installation of generators. High labor absenteeism tackled by providing better working conditions,
higher wages & non-monetary incentives. Non-availability of raw materials can be rectified by ensuring
that orders are placed well in advance & there is proper co-ordination between production, stores &
purchases department. Installation of effective inventory control method & also finding sources of
working capital.

Thanking you,

Yours sincerely

2) Directors of Anitha steel ltd are facing the problem of working capital. They are not in a
position to coordinate the inflow or outflow of cash. Examine the existing management of working
capital & submit the report to the management on your findings & recommendations to correct
the situation.

7/1/2010
Directors
Anitha Steel Co.
Bangalore – 56.

Reasons For Inadequacy Of Working Capital Or Shortage Of Cash

1. Absence of sound liquidity management i.e., Lack of coordination between inflow and out flow
of cash.
2. Unsound inventory management resulting in huge inventories of poor setting lines, thus blocking
capital.
3. Ineffective credit policy resulting in inefficient recovery process from debtors and huge increase
in sundry debtors.
4. Company is not able to obtain sufficient period of credit from suppliers. Average credit period
allowed to debtors is 75 days, where as credit obtained from suppliers is 30 days. This has
resulted in shortage of working capital.

Alternative Phrases That May Be Used

Debtor‘s turnover ratio indicates that there has been a steady rise in credit sales and poor
recovery of debts. The huge amount of o/s debtors has resulted in shortage of working capital and also
excessive amount of bad debts.
During the last three years the current ratio of the company has been deteriorating. In 2006-07 it
was 1:3:1 and 2007 – 08 it was 1:1:5 & 2008-09 it was 1:2. During the past financial year, current
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liabilities increased by 30%, current assets increased only by 10%. This deterioration in current ratio has
resulted in an actual shortage of working capital or cash.
Investment in fixed assets has been financed partly by working capital. The company has used
the entire profits for dividends without creating reserves. These wrong financial policies have resulted in
acute shortage of working capital or cash.

Suggestions: -
Greater emphasis on cash sales & proper inventory management. This will help to reduce the
amount of sundry debtors & bad debts.
Proper inventory management will ensure purchase of fast selling lines in the required quantities.
Special efforts must be made to dispose existing poor selling lives of goods. Efficient collection debts.
The collection department must make efforts to calculate the outstanding amount due from debtors on
time. This will ensure timely intimation to them and collection of debts will be faster.
Payment of creditors efforts must be made to obtain sufficient credit period from suppliers that is
from the existing 30 days to at least 45 days.
Improving financial policies. The company must pay attention to the creation of reserves instead
of disturbing the entire profits by way of dividend. Fixed assets should not be financed from working
capital but the company should find other sources of long-term funds. These steps would improve cash
management of the company & help to coordinate inflow & also outflow of cash & thus overcome the
problem of shortage of working capital.
Thanking you,

Target costing
Target costing is a system under which a company plans in advance for the product price points, product
costs, and margins that it wants to achieve. If it cannot manufacture a product at these planned levels,
then it cancels the product entirely. With target costing, a management team has a powerful tool for
continually monitoring products from the moment they enter the design phase and onward throughout
their product life cycles. It is considered one of the most important tools for achieving consistent
profitability.

The primary steps in the target costing process are:

1. Conduct research. The first step is to review the marketplace in which the company wants to sell
products. The team needs to determine the set of product features that customers are most likely to buy,
and the amount they will pay for those features. The team must learn about the perceived value of
individual features, in case they later need to determine what impact there will be on the product price if
they drop one or more of them. It may be necessary to later drop a product feature if the team decides
that it cannot provide the feature while still meeting its target cost. At the end of this process, the team
has a good idea of the target price at which it can sell the proposed product with a certain set of features,
and how it must alter the price if it drops some features from the product.

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2. Calculate maximum cost. The company provides the design team with a mandated gross margin that
the proposed product must earn. By subtracting the mandated gross margin from the projected product
price, the team can easily determine the maximum target cost that the product must achieve before it can
be allowed into production.
3. Engineer the product. The engineers and procurement personnel on the team now take the leading
role in creating the product. The procurement staff is particularly important if the product has a high
proportion of purchased parts; they must determine component pricing based on the necessary quality,
delivery, and quantity levels expected for the product. They may also be involved in outsourcing parts,
if this results in lower costs. The engineers must design the product to meet the cost target, which will
likely include a number of design iterations to see which combination of revised features and design
considerations results in the lowest cost.
4. Ongoing activities. Once a product design is finalized and approved, the team is reconstituted to
include fewer designers and more industrial engineers. The team now enters into a new phase of
reducing production costs, which continues for the life of the product. For example, cost reductions may
come from waste reductions in production (known as kaizen costing), or from planned supplier cost
reductions. These ongoing cost reductions yield enough additional gross margin for the company to
further reduce the price of the product over time, in response to increases in the level of competition.

Balanced Scorecard:
Balanced scorecard was made popular by Kaplan and Norton. It is a management tool that presents a
holistic view of the company measures. It is a reporting tool that shows the financial and non-financial
metrics of a company. It can be used for real time monitoring of the company metrics. The balanced
scorecard is a single report consisting of mainly four perspectives. The idea is to monitor not only the
financial but also the non financial parameters that are critical to a company's success.

Key Performance Indicators (KPI) –

Key performance indicators are the metrics that may be the part of the balanced scorecard. KPIs are
used to present actionable results across the organization. The selection of KPIs is a tricky area and can
sometimes be an art. However, any KPI selected should be actionable and should be relevant. Here's one
way to select KPIs
1.List down the organizations vision and goals.
2. Prepare a strategy map that is in line with the company goals.
3. Divide the strategy map into different components (financial, non-financial etc).
4. List down business processes for each strategy.
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5. List down the critical success factors (CSF) for each business process.
6. Design metrics that monitor these critical success factors on an on-demand basis.

KPIs have the following characteristics: -> The KPI should be actionable. The management should be
able to use the KPI dashboard for decision making. The employees should use the dashboard to align
and modify their activities so that the activities are in line with the company goals. -> The KPI should be
mutually exclusive and collectively exhaustive - Two KPIs that give the same kind of information are
redundant. Each KPI should be responsible for causing a unique action. Each KPI should try and
encompass multiple Critical Factors.

Benefits Of balanced score card

1) Scorecards drive better performance.
The evidence is clear that solid feedback enhances performance—at all levels and across all
organizational units. When people people and groups throughout an enterprise know how they are doing
and what needs improving, they do better.
2) Scorecards implement strategy.
Scorecards translate your strategy into concrete terms and help you track its implementation. Though
scorecards also reflect operational issues, they are developed in a way that specifically directs attention
to your strategy and future direction.
3) Scorecards help ensure that you have the right measures.
A group of measures implemented without a well-thought-out performance model in mind or, worse yet,
imposed from the outside, seldom bring new focus or drive desired actions. Effective performance
scorecards are, by nature, consciously and purposefully constructed. In building one, you develop a
logical structure that helps everyone know what should be measured, what belongs on the scorecard and
what does not belong.
4) Scorecards encourage balanced performance.
Executing today‗s work is absolutely crucial, but so is implementing the strategic initiatives that prepare
the enterprise for tomorrow. The proper scorecard design keeps the right balance of operational and
strategic factors on your radar screen.
5) Scorecards point out what‘s missing.
Because your scorecard is designed to offer a comprehensive view of how the enterprise is doing and
where it‗s going, the scorecard will help you see if any key factors are missing—the gaps stand out.
Those who use unstructured measures without an underlying performance model have no way of
knowing what may be missing
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6) Scorecards encourage good management.
As noted earlier, scorecards make it possible to readily monitor all the measures in a complex
organization. As a result, reviews are more regular and more thorough. When performance issues stand
out on a top-level scorecard, it‗s possible to ―drill down‖ to layers of data that give further details. The
bottom line is that scorecards encourage thorough monitoring and timely corrective actions.

7) Scorecards communicate
Many individuals and groups take a keen interest in the performance of an enterprise.
Strong scorecards help you tell the full story of performance—how the complex variables are being
balanced and optimized as a group. This allows you to present a compelling picture of performance that
is undistorted by focus on an individual issue.

Segmental Reporting
Segment reporting is the reporting of the operating segments of a company in the disclosures
accompanying its financial statements. Segment reporting is required for publicly-held entities, and is
not required for privately held ones. Segment reporting is intended to give information to investors and
creditors regarding the financial results and position of the most important operating units of a company,
which they can use as the basis for decisions related to the company.
Under Generally Accepted Accounting Principles (GAAP), an operating segment engages in business
activities from which it may earn revenue and incur expenses, has discrete financial information
available, and whose results are regularly reviewed by the entity's chief operating decision maker for
performance assessment and resource allocation decisions. Follow these rules to determine which
segments need to be reported:
 Aggregate the results of two or more segments if they have similar products, services, processes,
customers, distribution methods, and regulatory environments.
 Report a segment if it has at least 10% of the revenues, 10% of the profit or loss, or 10% of the
combined assets of the entity.
 If the total revenue of the segments you have selected under the preceding criteria comprise less
than 75% of the entity's total revenue, then add more segments until you reach that threshold.
 You can add more segments beyond the minimum just noted, but consider a reduction if the total
exceeds ten segments.

The information you should include in segment reporting includes:

 The factors used to identify reportable segments
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 The types of products and services sold by each segment
 The basis of organization (such as being organized around a geographic region, product line, and
so forth)
 Revenues
 Interest expense
 Depreciation and amortization
 Material expense items
 Equity method interests in other entities
 Income tax expense or income
 Other material non-cash items
 Profit or loss
The segment reporting requirements under International Financial Reporting Standards are essentially
identical to the requirements just noted under GAAP.

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