Why the fuss about cost audit?

The latest debate in certain quarters on the Draft Companies (Cost Records and Cost Audit) Rules, 2013, issued by the Ministry of Corporate Affairs (MCA) shows a clear lack of conceptual understanding of the issue and challenges the very concept of corporate governance.

The key word is ‘accountability’. A strong auditing system — both financial and cost — ensures an efficient corporate reporting system. Cost audit, supported by cost accounting standards, provide relevant and credible cost and revenue data to regulators as well as revenue authorities to support their decisions. Cost audit provides relevant reports to the board of directors to strengthen its oversight function.

The J J Irani Committee “felt that Cost Records and Cost Audit were important instruments that would enable companies make their operations efficient and exist in a competitive environment”.

Then what is the issue? Why is its applicability periodically questioned by interested quarters?

Just a myth Few will disagree that the discipline of cost accounting was not invented just to bolster administered pricing. ‘Free market’ does not mean an unregulated market that throws away all societal control over enterprises, leading to automatic self-regulation.

It is a myth to claim that “what form of accounting records and controls need maintaining is best decided by the shareholders through the board of directors”. Otherwise there would not have been such a much hue and cry about corporate governance and we would not have experienced Satyam, for example.

The International Federation of Accountants has observed that financial reporting satisfies compliance requirements but falls short of performance-based reporting for improved governance. Costing methodologies applied in organisations measure the consumption of economic resources and support the accountability of business performance. The argument that cost audit is not a global practice is, at best, ill-made or has mischievous intent.

Each country’s cost and management accounting practices depend upon the maturity level of its economy. When framing laws and regulations, governments take into account the ground reality prevailing in the country.

Nuisance quotient Honestly, all audits — financial, cost or management — are a nuisance. No one wants his business to be audited by others, leave alone by a professional agency. For that matter, who wants to pay taxes, indirect or direct, to the government? Companies accept financial audit and tax audit because it is mandatory, and not as a voluntary act. Assuming that Indian industry will do something voluntarily is a utopian idea.

Only a statutory diktat will ensure the maintenance of structured cost records, and cost audit will ensure the availability of certified cost data to all stakeholders. Possibly, making such data available to revenue and other authorities is bothersome to some. The disclosures made in any annual report is pursuant to some mandatory provision of law and is not voluntary.

As far as small and medium enterprises (MSMEs) are concerned, it is important to note that the maintenance of cost accounting records prior to June 2011 was applicable to companies with a turnover of ₹10 crore in prescribed sectors; excluded SSIs.

In June 2011, uniform cost accounting records rules and new cost audit report rules were introduced after detailed deliberations in the expert group consisting of all national-level industry associations and professional bodies.

The group endorsed the new mechanism under which cost records were mandated for the manufacturing sector with a turnover of ₹20 crore or more. SSIs got automatically excluded.

New mechanism The mechanism moved away from the strait-jacketed formats of the controlled regime and introduced the dynamic, forward-looking mechanism of integrated accounting with no additional compliance cost of a separate set of cost accounts.

Cost audit was ordered for companies in specified products/industries with a turnover of ₹100 crore or more. This totally excluded medium enterprises from the ambit of cost audit.

The suggestion that cost audit covers umbrellas, sticks, chappals, honey extraction and so on emanates from a complete lack of understanding of the rules.

The draft rules show coverage of 28 sectors only in name. It’s mainly government and semi-government bodies, trusts and/or societies outside the application of the Companies Act that are engaged in a majority of these sectors. Most surprisingly, the draft rules nullify the application in other sectors and excludes almost the entire private sector. This goes against the spirit of the Companies Act, 2013. Cost audit data is used to deal with the following cases: valuation of goods under anti-dumping; verifying transfer pricing adopted in related party transactions; checking cases of predatory pricing and unfair trade practices such as price-rigging, cartelisation, over-charging, discriminatory pricing, profiteering, siphoning of funds, and so on. Both the Central Excise and Income Tax authorities use cost audit reports extensively to prevent tax evasion.

With the introduction of Revised Schedule VI, the cost audit report is the only source of authentic quantitative data of production and sales which is essential to safeguard revenue. Cost accounting records and audit ensure a structured and systematic inventory valuation; it is a potent tool for detecting and preventing frauds essential to support the functions of the Serious Fraud Investigation Office (SFIO), which has been strengthened by the Companies Act, 2013.

No matter how a section of industry looks at it, the absence of cost audit will make a mockery of corporate governance. It will put well-governed companies in a disadvantageous position vis-à-vis undergoverned entities within the same industry.

(The writer is the former president, The Institute of Cost Accountants of India, and member of the task force, The Institute of Cost Accountants of India)

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