Cost Audit and Management Audit | Meaning-Advantages-Limitations-Difference | CMA Final

Cost and Management Audit
Meaning – Objectives – Advantages – Limitations - Difference

Origin of cost Audit

In India, Cost accounting and cost audit techniques are followed before independence by those firms who got government contracts on cost plus basis. But in that time cost accounting and audit techniques was not very popular amongst other firms.

But with the formation of Cost and Works Accountants of India in 1944, costing techniques started to gain attention of the firms who are engaged in production of goods and services.

After independence, the institute of Cost and Works Accountants of India was incorporated as a statutory body by an Act of parliament in 1959 whose main objectives was to promote, regulate and develop the profession of cost accountancy in the country.

Cost Audit Meaning

It is an audit process for verifying the cost of manufacture or production of any article, on the basis of accounts as regards utilisation of material or labour or other items of costs, maintained by the company. In simple words the term cost audit means a systematic and accurate verification of the cost accounts and records and checking of adherence to the objectives of the cost accounting.

As per ICWA London’ “cost audit is the verification of the correctness of cost accounts and of the adherence to the cost accounting plan.”

The ICWAI defines cost audit as “system of audit introduced by the government of India for the review, examination and appraisal of the cost accounting records and attendant information required to be maintained by specified industries"

From above definition of cost audit, it is clear that cost audit is a systematic examination of cost accounts to verify correctness of cost accounting records.

As per the section 148 of the Companies Act’ 2013, Central Government has the power to make the rules in the area of maintenance of cost records by the companies engaged in the specified industries, manufacturing / providing such goods / services; and for getting such cost records audited by a qualified cost accountant.

Objectives of Cost Audit – Economic and Social

Objectives of cost audit can be classified into two categories – Economic and Social. The following are some of the economic objectives for which cost audit is under taken:

a)      To establish the accuracy of costing data. This is done by verifying the arithmetical accuracy of cost accounting entries in the books of accounts.

b)      To ensure that cost accounting principles are governed by the management objectives and these are strictly adhered in preparing cost accounts.

c)       To ensure that cost accounts are correct and also to detect errors, frauds and wrong practice in the existing system.

d)      To check up the general working of the costing department of the organization and to make suggestions for improvement.

e)      To help the management in taking correct decisions on certain important matters i.e. to determine the actual cost of production when the goods are ready.

f)       To reduce the amount of detailed checking by the external auditor if effective internal cost audit system is in operation.

g)      To assist in inventory valuation.

h)      Periodical reconciliation between cost accounts and financial accounts.

i)        Detection and prevention of abnormal loss of material and wages.

j)        Ensuring optimum utilisation of human, physical and financial resource of the enterprise.

Apart from the economic objectives, following are the social objectives of cost audit:

a)      Facilitation of fixation of reasonable prices of goods and services produced by the enterprise.

b)      Find out the areas of inefficiency and mismanagement and suggest measures to improve them.

c)       To improve the productivity of human, physical and financial resources of the enterprises.

Advantages and Disadvantages of Cost Audit

Following are the advantages of cost audit

To The Management

a)      Cost audit helps in detection of errors and frauds.

b)      The management gets accurate and reliable data based on which they can make day-to-day decisions like price fixation.

c)       It helps in cost control and cost reduction.

d)      It facilitates the system of standard costing and budgetary control.

e)      It helps the management in inter-unit / firm comparison.

f)       It enables the management to identify loss making propositions.

To The Government

a)      Cost audit ensures efficient functioning of the industry. This in turn, nurtures a healthy competition among the different companies and paves a path for fast progress.

b)      It helps in identification of sick units and enables the Government to make relevant decisions.

c)       It helps in fixing prices in the case of essential commodities and checking undue profiteering.

d)      It enables to take decisions as to granting of subsidies, incentives and protection to various industries.

e)      It helps to take decisions as to levies, duties and taxes.

To the Society

a)      Cost audit enables the Government to fix prices of essential commodities. This safeguards the interests of the society.

b)      Cost audit enables the Government to keep a check on undue profiteering by the manufacturers and avoids artificial price rise due to monopolistic tendencies.

To the Shareholders

a)      Cost audit reveals whether any of the products of the company are making losses. Thus though the company making an overall profit, a loss making line may eat up the company’s profits. This is brought to the notice of the shareholders and the management is forced to take remedial measures, thereby making optimum utilisation of resources.

b)      Cost audit ensures that the shareholders get a fair return on their investments.

Following are the disadvantages of cost audit (Criticism against cost audit)

a)      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.

b)      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.

c)       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.

d)      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 arises. 

a)      It is an interference with the management over matters on which the management is the best judge.

b)      The field of financial audit and cost audit cannot be demarcated. This argument does not hold well as there sufficient distinction between financial audit and cost audit.

Management Audit

Management audit is a method of independent and systematic evaluation of the management activities at all levels of management to ascertain the functions, efficiency and achievement of' the management (i.e. policies) as compared to standards set by the company.

According to L. R. Howard, "Management audit is an investigation of business from the highest level downward in order to ascertain whether sound management prevails throughout, thus facilitating the most effective relationship with outside world and smooth running of internal organization."

According to J.G. Tokhe,”Management audit has been defined as a comprehensive critical review of all aspects or processes of management.”

From the above explanation, we can say that management audit is an attempt to evaluate the performance of various management processes and functions to examine, review and appraise the various policies and actions of management on the basis of objective standards.

Objectives of Management audit

Now a days, management audit is getting importance in various organisation especially large organisation. The following are some of the important objectives for which management audit is under taken:

a)      To reveal defects or irregularities in any level of management and suggest measures of improvement to obtain best results of the operation of the concern.

b)      To assist the management to achieve the most efficient administration of the operations.

c)       To help in forming a good relationship between the staff and the management.

d)      To examine the compatibility of management objectives with those of the organisational objectives.

e)      To compare the actual performance with the predetermined targets to judge the performance of management.

f)       To improve relationship between employees and employers.

g)      To review the efficiency and effectiveness of the management.

Advantages and Disadvantages of Management Audit

Advantages or Importance of Management Audit

There are several advantages of conducting management audit of an organization. When an organization grows in its volume and activities, there is a need for management audit for evaluating efficiency and effectiveness of the management at all levels of the organization. The advantages and importance of management audit are discussed below:

a)      Evaluates efficiency of the management: Management audit is a method of independent and 'systematic evaluation of the management activities at all levels of management to ascertain the functions, efficiency and achievement of the management (i.e. policies) as compared to standards set by the company.

b)      Scrutiny of the plans, policies and procedure: Management audit helps to determine how the management has implemented their plans, policies and procedure to reach the organizations goal.

c)       Helps for correction of plans, policies and procedure: Through management audit, it is possible to change or revise the plans, policies and procedure as per needs of the company.

d)      Aids for decision making: Management audit asses the ability of the managers to take important decisions and helps them to rectify the defects.

e)      Helps to get loan: Financial institutions who gives huge loan to the organizations are interested to know the efficiency of the management and the profitability. Management audit certainly gives a guide to them.

f)       Helps to get subsidy: Before granting subsidy by the government, to any entity they are interested to know the efficiency and functioning of the management. Management audit helps in this matter.

g)      Helps to increase profitability: Management audit helps the management to increase profitability by giving remedies to maximize the organization's resources in an efficient way.

Limitations of Management Audit

a)      The management audit is audit of the management, by the management, and for the management. The management auditors are selected by the management itself. Such auditors may or may not be able to handle the job assigned to them.

b)      The management auditors are generally familiar with the organization and the staff and employees. The personal aspects cannot be overlooked in such audits. Some may use this audit to level the score with someone while other may utilize it to favour someone.

c)       They are more likely to take the facts for granted and may not probe into depth to investigate the matter any further.

d)      Time and cost constraints may limit the scope, operation and extent of such audits.

e)      Instead of serving any useful purpose, it would discourage the initiative and dynamism of the management.

f)       It pays much attention to higher production.

g)      It always tries to find out some fault or another in order to justify its appointment and existence.

h)      The management audit team as selected by the management may not look, act and work as a team. Conflicting interests, attitude and inclination may jeopardize the entire objective of the audit.

Difference between Management Audit and Cost Audit

Management audit	Cost audit
a)       It is optional for the company.	a)      It is directed by Central Govt., therefore compulsory for the company.
b)      It can cover all aspects of management viz. planning, organising, control etc.	b)      It covers all aspects of a particular product for which audit is specifically ordered.
c)       It is independent appraisal activity of the management to ensure compliance with organizational objectives.	c)       It is dependent on order of the Central Govt. to ensure compliance with statutory requirements.
d)      It is carried out to evaluate the efficacy of the control system in the organization.	d)      It is carried out to evaluate the efficacy of the costing system of a specified product.
e)      It is intended to review all managerial aspects of the company so as to enhance efficiency and efficacy of the entire system.	e)      It is intended to review, examination and appraisal of cost accounting records so as to ensure true and correct cost of production.
f)        The scope is pretty wide as it includes review and appraisal of all the decisions taken by the management.	f)       The scope is narrow to activities relating to a particular product and includes review and appraisal of cost accounting system, variation in cost per unit, sales and export sales, abnormal and non-recurring costs, efficiency and adequacy of control of a particular product.
g)       Can be conducted by any suitable person acceptable to the management. Generally a team of experts is designated the task. The experts are qualified in different fields. The qualification is not prescribed in any Act.	g)      Can be conducted by a Cost accountant appointed by BOD after approvals of the Central Govt. Qualifications of Cost accountant are specified in Section 148 of Companies Act 2013.
h)      No fixed periodicity.	h)      Periodicity is as per directives of Central Govt., It is conducted on year to year basis.
i)         Report is submitted to the top management.	i)        Report is submitted to the Central Govt. with a copy to company.
j)        The copy of report need not be circulated to the shareholders of the company.	j)        The copy of report can be circulated to the shareholders of the company only when it is so desired by the Central Govt.