Cost audit is the name of cost and benefit analysis or more appropriately cost performance review of the companies engaged in manufacturing, processing and mining. The cost auditor helps those who help themselves to identify grey areas of cost inefficiency including invisible losses inherent in the industrial units. Cost audit gives advance signals for cost control to avoid industrial sickness.
---- Cost audit versus financial audit
---- Cost audit begins where financial audit ends:
---- In financial terms: 2 + 2 = 4
---- In contrast to the above said financial equation, cost audit means that it should be either 5, 4 or 3.
Because In case of 5, benefit of 1 is the reward of input cost and efforts made by the entrepreneur.
Or In case of 3, loss of 1 is the cost of inefficiency in cost control, whereas in case the equation is 4, money is saved but efforts are lost. The duty of the cost auditor is to analyse the reasons and probe the areas of cost performance in either case.
The financial auditor will be satisfied if 2 + 2 equate 4 (ie debits and credits are equal); but the cost auditor will not be satisfied unless the equation ends up at 5; and even if it is 5 he will find out why it was not 6.
Financial audit rests on historical data whereas cost audit peeps into the future to assess opportunities and benefits to be availed by proper planning. By all means cost audit is forward-looking which helps the management to evaluate the future opportunities for availing cost benefits.
INVISIBLE/HIDDEN LOSSES It is pertinent to point out that most of the invisible losses of financial implications are not reflected in the books of account or in the financial statements, as such these losses escape the attention of the auditor in financial audit. Example of such losses are as follows:
i) Loss arising from non-utilisation of full plant capacity.
ii) Loss arising from over-capitalisation and high mark-up.
iii) Loss arising from unfavourable input/output ratios.
iv) Loss arising from liquidity problem due to:
a) Blocking of funds in slow-moving and debt inventories, trade debts and other held up assets.
b) Slow recovery of receivables.
c) Poor management of funds
d) Uneconomical procurement planning.
v) Loss arising from lack of budgetary controls and non-existence of costing procedures of products or services and variance analysis thereof.
vi) Loss arising from unfavourable ratios of utility consumption of gas, electricity and power etc.
vii) Loss arising from low yield of inputs.
viii) Loss arising from hidden losses such as evaporation of gas, inefficiency of boilers, loss of steam and power.
ix) Loss arising from loss of output due to plant bottlenecks.
x) Loss arising from non-existence of R & D and non-switchover to alternate process/technology.
xi) Loss arising from inefficient use of human resources.
COST AND MANAGEMENT ACCOUNTANTS HAVE AN EDGE OVER CHARTERED ACCOUNTANTS Cost audit is an exclusive domain of cost and management accountants. In the neighbouring country India, only the cost and works accountants (an equivalent cadre to Pakistan's cost and management accountants) are authorised by law to act as the sole cost auditors of companies.
However, in Pakistan, this condition is relaxed to the extent that if any firm of chartered accountants wants to engage itself as a cost auditor; in order to become eligible for its appointment, it will have necessarily to appoint a cost and management accountant to work with them on the cost audit assignments.
The firms of cost and management accountants in Pakistan are however not bound by this restriction, they are appointed as cost auditors of companies without any precondition. They enjoy the trust and confidence of the industry people and help them immensely also on post-audit consultancy assignments.
COMPULSORY MAINTENANCE OF COST ACCOUNTING RECORDS Under section 230 of the Companies Ordinance, 1984 every company shall keep at its registered office proper books of account with respect to:
a) all sums of money received and expended by the company and the matters in respect of which the receipt and expenditure takes place;
b) all sales and purchases of goods by the company;
c) all assets of the company;
d) all liabilities of the company; and
e) in the case of a company engaged in production, processing, manufacturing or mining activities, such particulars relating to utilisation of material or labour or to other inputs or items of cost as may be prescribed, if such class of companies is required by the [Commission] by a general or special order, to include such particulars in the books of accounts:
LEGAL PROVISIONS UNDER COMPANIES ORDINANCE, 1984 SECTION 506 (Power of the federal government to make rules) In addition to the powers conferred by any other section, the federal government may, by notification in the official gazette, make rules:
(a) for all or any of the matters which by this Ordinance are to be, or may be, prescribed by the Federal Government; and
(aa) for establishment and regulating the activities of any Company or class of companies;
(b) generally to carry out the purposes of this Ordinance.
Provided that, before making any such rule, the draft thereof shall be published by the Federal Government in the Official Gazette for eliciting public opinion thereon within a period of not less than fourteen days from the date of publication.
Any rule made under sub-section (1) may provide that a contravention thereof shall be punishable with a few, which may extend to two thousand rupees and, where the contravention is a continuing one, with a further fine which may extend to one hundred rupees for everyday after the first during which such contravention continues.
Cost audit SECP notifications
Following notifications are applicable to the specified companies engaged in manufacturing, processing and mining.
1. Audit of Cost Accounts by the Cost Auditor
---- Companies (Audit of Cost Accounts) Rules, 1998
SRO No 846(1)/98 dt. July 24th 1998
2. Maintenance of cost accounting records by the companies
i) Cost Accounting Records Order, 1990
SRO No 1131(1)/90 dt. November 1st 1990
---- Vegetable Ghee & Cooking Oil Companies
ii) Cost Accounting Records Order, 1994
SRO No 386(1)/94 dt. May 14th 1994
---- Cement Industry
iii) Cost Accounting Records Order, 2001
SRO No 97(1)/2001 dt. February 13th 2001
---- Sugar Industry
iv) Cost Accounting Records Order, 2012
SRO No 243(1)/2012 dt. March 08 2012
---- Chemical Fertiliser Industries (New Addition)
v) Draft Cost Accounting Records Order, 2012
SRO No 302(1)/2012 dt. March 26 2012
---- Electric Power Generation Industries (Draft for seeking public comments before finalisation)
vi) Draft Cost Accounting Records Order, 2012
SRO /1/2011 dt. March 19 2012
---- Automobiles Industry Companies (Draft for seeking public comments before finalisation)
3. Companies Cost Accounting Records (General Order), 2008
SRO No (1)/2008 dt. September 26th 2008 in respect of companies engaged in:
i) Fertiliser
ii) Thermal Energy
iii) Petroleum Refining
iv) Natural Gas, and
v) Polyester Fiber
SECP defers the applicability of companies cost accounting records (general order), 2008
(SRO.(I)/2008 dt, September 26, 2008)The Securities and Exchange Commission of Pakistan vide its subsequent SRO 371(1)/2011 dated May 9, 2011, deferred the applicability of the Companies Cost Accounting Records (General Order), 2008 (SRO.(I)/2008 dt, September 26, 2008) to the companies engaged in fertiliser, thermal energy, petroleum refining, natural gas and polyester fibre industries. It shall be applicable in the next financial year, starting July 1.
This decision has been taken by the SECP in view of the practical difficulties being faced by the companies in these industries and to facilitate compliance with the Companies Cost Accounting Records (General Order) in future. This deferment shall not affect special cost orders previously issued by the SECP for other industries namely ghee/cooking oil, cement and sugar.
The SECP is actively involved in consultation with the Institute of Cost and Management Accountants of Pakistan (ICMAP) and the Institute of Chartered Accountants of Pakistan (ICAP) to develop industry-specific guidelines/ reporting format. Further, the SECP has also sought feedback from various industry stakeholders to bring uniformity to the cost record and cost audit report.
The format and guidelines for fertiliser have now been issued under SRO No 243/I/2012, dt. March 08, 2012; whereas the draft format and guidelines for thermal energy vide SRO 302(I)/2012, dt March 26, 2012 and for the automobiles industries vide SRO No /I/2011 dt March 19, 2012 have also been issued for seeking public comments before final notification.
The work regarding the remaining sectors, ie, petroleum refining, natural gas and polyester fiber, has also commenced and special order in their respects shall be also be issued in due course.
4. Total types of industries placed under cost audit There are now eight types of industries which are placed under cost audit by the SECP.
Circulation and distribution of reports (SRO No /I/2008, dt September 26, 2008)
It has been mandated by SECP that:
(1) Each company which falls within the industries specified in paragraph 1(3) above, shall be required to circulate the cost auditor's report to the Directors prescribed in sub-rule (3) of rule 4 of the Companies (Audit of Cost Accounts) Rules, 1998 together with the Reconciliation stipulated in 3 (b) above within 6 months of the close of the financial year to members, directors and shareholders of the company, the Commission and the Registrar concerned. Such reports may be disseminated to its shareholders by posting the same on the company's website within six months of the close of the financial year. The cost audit report shall not be required to be printed and it shall be permissible to circulate photo-copies thereof.
(2) Every company in respect of which a special order has been issued by the Commission prior to this notification that is to say companies engaged in production of cement, vegetable ghee and sugar industries shall be required to comply with the requirements of this paragraph and paragraph 2 and 3 above.
(3) It shall be the duty of every person referred to in sub-section (7) of Section 230 or sub-section (2) of section 246 of the Companies Ordinance, 1984 (XLVII of 1984), to comply with the provisions of this Order in the same manner as they are liable to maintain books of financial accounts required under section 230 of the said Ordinance.
Conditions applicable to firms of chartered accountants for appointment as cost auditors
(Circular No 09 Reference No Co-258(2)RCP/91 dt July 29, 2000)Pursuant to provisions of section 258 of the Companies Ordinance, 1984 and Rule 3 of the Companies (Audit of Cost Accounts) Rules, 1998 the companies which are required to maintain cost accounting records prescribed by this Commission under section 230(1)(e) of the Companies Ordinance, 1984, are hereby, directed to furnish complete profile of the proposed Cost Auditors especially the following information with the applications seeking prior approval of the Securities & Exchange Commission of Pakistan for appointment of the Cost Auditor:
(i) In case, a firm of Cost & Management Accountant is appointed as Cost Auditor details of qualified as well as supporting staff.
(ii) In case, a firm of Chartered Accountant is recommended for appointment as Cost Auditor, in addition to details of qualified and supporting staff, the particulars of Cost and Management Accountant(s) associated with it.
(iii) In case, a firm of Chartered Accountants does not associate a Cost & Management Accountant as suggested in (ii) above, it would disclose the experience of cost audit and particulars of such partners/employees who have actually been working and maintaining the cost accounts in some organisations.
Sd/.
(Nazir Ahmed Shaheen) Joint Registrar
Suggested improvements in the contents of cost audit reports
Although cost audit is an useful tool which provides useful information for cost control and for profit maximisation; it has still not gained the acceptability of business entrepreneurs in Pakistan. In order to make it attractive and user-friendly it is suggested that formats of cost audits reports should be suitably modified and updated to include the following extra information.
i) Gross Profit Analysis Following three points need further analysis:
a) In case the company has more than one product including by products, GP from each product should be separately shown to asses profit contribution from each product.
b) In case the rate of G.P. varies from year to year, the reason for variation should be analysed.
c) Extraordinary items of profit / loss in the particular financial year should be separately considered as they may not be repeated in the future resulting in profitability variation between different periods.
ii) Break Even Analysis It is necessary to find out the break-even points of production / sales so that fixed cost of the industrial unit may be matched with contribution to set targets above break even points to get positive results.
iii) Ration Analysis The financial ratios show economic trends. Ratio analysis is therefore necessary of each financial year to workout trends of the financial position of the companies under consideration.
iv) Review of Actual Results of Capital Expenditure on Balancing, Modernisation and Replacement (BMR)The companies do spend funds on BMR. It is advisable to analysis the actual results of:
a) Return on investment (ROI)
b) Internal Rate of Return (IRR)
c) Payback period
d) Any other ratio which may be relevant under the given situation.
v) Cost comparison
Make comparison of actual performance with standard consumption norms (technical standards) of raw materials, utilities and other input cost in respect of:
a) Industrial average at the national level
b) Companies own last three/five years average
---- Give reasons for the variances
vi) Financial cost of blocked funds Age analysis of debtors is required to review the funds blocked in trade receivables. The slow-moving and dead inventories along with debtors viz a viz markup cost on borrowed funds may also be reviewed and analysed.
SYNTHESIS OF COST AUDIT RULES, 1998 SRO : 846(1)/98 Dated July 24, 1998
Companies (Audit of Cost Accounts) Rules, 1998.
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1. Legal Provisions Under Companies Ordinance, 1984.
- Powers of Government to
make rules (Section 506)
- Maintenance of Accounts (Section 230)
- Audit of Cost Accounts (Section 258)
2. Effective Date July 24, 1998
3. Application All Companies engaged in
(i) Vegetable Ghee & Cooking Oils
(ii) Cement
(iii) Sugar
(iv) Fertiliser
(v) Thermal Energy
(vi) Automobiles Industry Companies
(vii) Petroleum Refining
(viii) Natural Gas, and
(ix) Polyester Fiber
And all other companies as
and when notified
subsequently by special/
general order for
maintenance of cost accounting
records by Securities
Exchange Commission of
Pakistan (SECP).
4. Special / General Orders Maintenance of Cost Accounting
(SROs) Issued by SECP. Records by the Companies
i. Cost Accounting Records Order, 1990
SRO No 1131(1)/90 dt. November 1st 1990
Vegetable Ghee & Cooking Oil Companies
ii. Cost Accounting Records Order, 1994
SRO No 386(1)/94 dt. May 14th 1994
Cement Industry
iii. Cost Accounting Records Order, 2001
SRO No 97(1)/2001 dt. February 13th 2001
Sugar Industry
iv. Cost Accounting Records Order, 2012
SRO No 243(1)/2012 dt. March 08 2012
Chemical Fertiliser Industries (New Addition)
v. Draft Cost Accounting Records Order, 2012
SRO No 302(1)/2012 dt. March 26 2012
Electric Power Generation Industries
(Draft for seeking public comments before
finalisation)
vi. Draft Cost Accounting Records Order, 2012
SRO /1/2011 dt. March 19 2012
Automobiles Industry Companies
(Draft for seeking public comments before
finalisation)
In case of other industries,
SECP is in touch with
ICMAP and ICAP for drafting the industry
specific cost accounting rules.
5. Company Defined 'Company' as referred in the rules
means a company formed and registered
under the Companies Ordinance 1984
(XLVII of 1984). It means that all
the private / public companies whether
quoted or not are covered under these rules
6. Appointment of Cost Auditors Practicing Cost & Management Accountants
i Qualification Or
ii. Appointment Practicing Chartered Accountants
By the directors with prior approval
of SECP within sixty days of the close
of the financial year of the
Company. An application to SECP will
be submitted by the Company on a prescribed
form (Appendix I) not later than Thirty Days
before the date on which the cost auditor is
to be appointed.
It will be fixed by the directors and paid
by the company. It is presumed that the
auditors remuneration will be negotiable
between directors and auditors depending
upon volume of work.
7. Ineligibility of persons to a. person who has been appointed as (statutory)
become Cost Auditor auditor of the company of the respective period under
section 252 of the Companies Ordinance, 1984.
b. a person who is, or at any time during the preceding
three years was, a director, officer or employee of the
company.
c. a person who is a partner of, or in the employment
of, a director, officer or employee of the company.
d. a person who is a director of the company.
e. a person who is indebted to the company; and
f. a body corporate.
Explanation:- In this sub-rule reference to an "officer"
or "employee" shall be construed as not including
reference to a cost auditor.
8. Cost Statements In addition to the records and statements specified in
special / general orders (SROs). every company
shall prepare.
a. a statement of production capacity of the plant, in
terms of machine hours and production units, the
actual utilisation of the capacity and the reasons of
difference between the two.
[Rule 4(1)(a)]
b. a statement of stock-in-trade of the company as at
the end of the financial year in terms of quantity and
cost thereof distinguishing between:-
(i) stock of raw material and component:-
(ii) stock of work in process
(iii) stock of finished products; and
(iv) other stock.
[Rule 4(1)(b)]
9. Authentication of Cost Statements All the Cost Statements will be signed by the Chief
Executive and Chief Accountant of the Company.
10. Time frame for Cost Audit - Companies will obtain consent of cost auditors and
process it for approval from SECP within 30 days of
close of its financial year as under:
(i) Pass a BOD Resolution appointing the cost
auditors and fix remuneration.
(ii) Forward the resolution along with Appendix-I as
per rule 3(3) of SRO: 846(I)/98 dt. 24-07-1998 duly
filled in and signed within 30 days of the close of
financial year along with a paid challan of Rs 500/=.
- The SECP will approve the name of the cost auditor
and send the letter of confirmation within 30 days to
the cost auditors with a copy to the sugar company.
In short, the whole process shall be completed within
(30 + 30 days), ie sixty days after the close
of the financial year.
11. Cost Auditors Report The cost auditor will complete the audit of cost
accounts and send his report within 60 days after his
appointment. Copies of Cost Audit Report
will be sent to:
(i) Board of Directors of the Company
(ii) Director Enforcement, Securities and Exchange
Commission of Pakistan, Islamabad with paid
challan of Rs 500/-.
(iii) Registrar Joint Stock Companies, SECP
Company Registration Office at the designated place
in the province where the company has its
registered office with a challan of Rs 500/-.
12. Comments by the Company Company shall within thirty days from the date of
on Cost Auditors Report receipt of the copy of the Cost Auditors Report
furnish along with paid challan of Rs 500/ to the
SECP, Islamabad full information and explanation on
every reservation or qualification contained
in the Cost Audit Report.
13. Circulation and distribution Cost Auditors Report will be circulated and
of report distributed by the Company as under:
(i) Each company which falls within the industries
specified above, shall be required to circulate the cost
auditor's report to the Directors prescribed in the
sub-rule (3) of rule 4 of the Companies (Audit of Cost
Accounts) Rules, 1998, together with the
Reconciliation stipulated in 3 (b) above within 6
company, the Commission and the Registrar
concerned. Such reports may be disseminated to its
shareholders by posting the same on the company's
website within six months of the close of the financial
year. The cost audit report shall not be required to be
printed and it shall be permissible to circulate
photo-copies thereof.
(ii) Every company in respect of which a special order
has been issued by the Commission prior to this
notification that is to say companies engaged in
production of cement, vegetable ghee and sugar
industries shall be required to comply with the
requirements of this paragraph and paragraph
2 and 3 above.
(iii) It shall be the duty of every person referred to in
sub-section (7) of Section 230 or sub-section (2) of
section 246 of the Companies Ordinance, 1984
(XLVII of 1984), to comply with the previsions of this
Order in the same manner as they are liable to
maintain books of financial accounts required
under section 230 of the said Ordinance.
14. Penalties Non Compliance or contravention of the rules is
punishable, in addition to any other liability under
the Companies Ordinance, 1984.
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