Cost Audit Auditing Help


Cost audit has been defined as “the verification of cost accounts and a check on adherence to the cost accounting plan.”

Cost audit thus involves an examination of costing records with a view to express an opinion on cost statements.


The cost audit is carried out to form an opinion as to the reliability of
cost of sales for the period and .cost of individual job orders or production reports. The purpose is to control, and if possible, reduce the operating costs. The cost .audit provides an evidence of reliability of the basis for inventory valuation. It also helps in establishing selling prices of various products.


Before commencing the cost audit, the auditor should obtain (a) overview of the industry in which the company operates, and (b) The company itself.

a) Overview of the industry

• Total annual production
• Value of exports
• General level of economic activity
• Growth potentials.
• Government policies
• Exchange controls
• Product technology
• Obsolescence risk
• Economic trends
• Operating statistics.
• Cyclical or seasonal industry
• Key ratios
• Specific accounting practices and standards
• Environment conditions
• Regulations affecting the industry
• Energy availability.

(b) The company

• Range of products
• Number of employees
• Location of factories
• Organization structure
• Manufacturing process.
• Important cost categories
Inventories location
• Research and development
• Laws and regulations that affect the company
• Key ratios
• Trends.

To the extent possible, the. auditor should obtain above details at the start of cost audit, as the audit progresses, the information should be updated and evaluated and more detailed information would be obtained.


The auditor should consider following matters in developing overall plan for cost audit.

• Terms of engagement
• Statutory requirements
• Assessing materiality levels
• Areas requiring special attention
• The degree of reliance that can be placed on cost accounting records.


Before performing detailed audit procedures, obtain understanding of client’s cost accounting and internal control systems.

The auditor should obtain sufficient knowledge of the design of the cost accounting and internal control systems. He should also ensure that such systems are actually being operated. The nature and extent of the procedures performed by the auditor to obtain understanding of cost accounting and internal control systems will depend upon the size and complexity of the business, nature of entity’s cost accounting records and documentation of costing procedures, Generally the auditor should review following records.

• Cost accounting records.
• Method of costing, i.e., jobs costing or process costing.
• Method of recording cost of materials procured.
• System of allocating material costs to cost centers.
• System of accumulation and distribution of payroll costs.
• System of accumulation of overheads.
• Basis of allocation of overheads
• Budgetary controls
• Inventory valuation policies.


1. Verify unit costs

Job order cost system

If a job order cost system is used, obtain the job order subsidiary ledger (or listings of job orders) and perform following tests for selected period:

a) Trace cost of direct materials from journal voucher summary.
b) Check quantities of materials used from the materials issues summary.
c) Determine unit cost and total cost of material used.
d) Ensure that basis of allocation of cost materials used has been consistently applied.
e) Trace cost of labour from payroll distribution summary.
t) Test hours worked on the specific jobs from time cards.
g) Ensure that the hourly rates have been properly determined.
h) Obtain a summary of applied overheads, test computations and check allocation of the jobs.
i) Review overhead allocation for reasonableness and consistent application bases.

Process cost system

In case process cost system is used, obtain cost of production reports for each operating department for selected periods and perform following tests:

(a) Check units received from previous departments and transferred to next departments.
(b) Check unit costs of quantities received, costs incurred by the department and cost transferred to next department.
(c) Check cost incurred by the department.
(d) Check reconciliation of units received, units lost in the process and units transferred to next department.
(e) Trace cost of direct materials from journal voucher summary.
(f) Check quantities of materials used form the materials requisition summary.
(g) Determine unit cost and total cost of material used.
(h) Ensure that basis of allocation of cost of materials used has  been consistently applied.
(i) Trace cost of labour from payroll distribution summary.
(j) Test hours worked on the specific departments from time cards.
(k) Ensure that the hourly rates have been properly determined.
(l) Obtain a summary of applied overheads, test computations and check allocation to the departments.
(m) Review overhead allocation for reasonableness and consistent application bases.

2. Select a sample of material requisitions and perform following tests:

(a) Check that the requisition has been properly authorized.
(b) Check posting to job order cost sheets, production reports, or the expense analysis sheets.
(c) Check posting to material ledger cards.
(d) Determine that all withdrawals result in debits to work in process or relevant expense control accounts.
(e) Determine that indirect materials, for example, screws, bolts, washers, ink, glue and other supplies have been charged to factory overhead control and credited to materials.

3. Select a sample of payroll distribution summaries and trace posting of totals to the debits of work in process control and individual posting to relevant jobs or departments.

4. Determine basis for application of overheads:

(a) Ascertain the base used (direct labour cost, direct labour hours, achine hours, or others).
(b) Ascertain activity level used (normal capacity or expected actual capacity)
(c) Ascertain inclusion or exclusion of fixed overheads (absorption costing or direct costing).

5. Test postings from expense analysis sheets, materials requisition
summaries and payroll distribution summaries, in total to factory overhead control and individual items to respective subsidiary ledger accounts.

6. Test postings of factory overhead applied as debits to work in process control, in total, and individual items to job order cost sheets or production reports; and credits to factory overhead applied.

7. Check valuation of work in process:

i) Select last month of the accounting period and carry out following tests:
ii) Check materials placed in process through material requisitions for the jobs.
iii) Check labour in process with time tickets
iv) Check factory overhead with reference to relevant overhead application rate.
v) Agree the totals of (I), (ii) and (iii) above with amount charged to. factory costs for the month per financial statements.
vi) Trace completed jobs to finished goods records.

(a) In order to determine that the work in-process has not been stated beyond its net realizable value, test value of finished goods with recent sales invoices or with latest customer orders.
(b) Determine reasons for jobs not transferred to finished goods for a prolonged period. Consider provision required for obsolete, slow moving or defective inventories.

8. Carry out analytical procedures:

(a) Compare percentages of following cost components to total cost, and investigate causes for unusual variations from budget: Materials
Direct labour – Factory overhead Selling and administrative overheads
(b) Tabulate percentage of profit earned on various jobs, compare with budget margins and inquire into reasons for unusual variances.
(c) Determine reasons for unusually high over or under applied overheads.

9. Ascertain production capacity of plant in terms of machine hours  and production units.

10. Verify actual utilization of the capacity and the reasons of differences between actual and installed capacity.

11. Ensure that proper cost accounting records have been maintained as required by Clause (e) of subsection (1) of section 230 of the Companies Ordinance, and as required by the cost audit rules ..

12. Verify salaries and benefits of directors and chief executive.

13. Compare total man-days of direct labour available and actually worked during the year.

14. Verify report data for:

– Direct labour costs on production;
– Indirect employees’ cost on production;
– Employees’ cost on administration;
– Employees’ cost on selling and distribution;
– Bonus to workers and employees;
– Other employees’ cost, if any (including taxes and levies); and
– Total employees’ cost (total of item (I) to (iv) above).

15. Verify direct labour cost per unit of output of the product.

16. Inspect the incentive schemes, if any, with particular reference to its contributions towards increasing productivity and its effect on cost of production.

17. Determine the proportion of closing inventory of stores representing items which have not moved for over twenty four months.

18. As regards depreciation, verify.

(a) The method of depreciation adopted by the company, e.g., straight line or diminishing balance, etc.
(b) The basis of allocation of depreciation on common assets to the different departments.
(c) The basis of charging depreciation to the cost of products.

19. Check total amount of royalty technical aid fees payable for the  year and the amount chargeable per unit of the product.

20. If there are any abnormal features affecting production during the year, e.g., strikes, lock – outs, major breakdowns in the plant,substantial power cuts, serious accidents, etc., ensure that they are wherever practicable, briefly mentioned indicating their impact on the cost of production.

21. If there are any special expenses which have been directly allocated to products under reference, ensure that the total amount as also the incidence per unit of product is disclosed.

22. Review cost per unit of different categories, varieties or qualities of each of the products under reference with comparative figures for the previous year and comments on the reasons of difference.

23. Verify the sales in quantities and net sales realization of the different categories, varieties or quantities of product under reference and the average sales realization per unit.

24. If product under reference is exported, verify quantity exported, net realizations per unit, countries to which exported indicating the profit or loss incurred in export.

25. Review the profit per unit earned on each category, variety or quantity of the products, comments on the comparative profits of different categories of the products per unit as well as in term of machine hour, etc., and comments on the adequacy or otherwise of product for maximization of profit.

26. Report following matters.

a) Items which appear to him to be clearly wrong in principle or apparently unjustifiable.
b) Cases where the company’s funds have been used in a negligent or inefficient manner.
c) Factors which could have been controlled, but have not been done resulting in increase in the cost of production.

d) (1) The adequacy or otherwise of budgetary control system, if any, in vogue in the company; and
(ii) The scope and performance of internal audit, if any.

e) Suggestions for improvements in performance, e.g., by

i) Rectification of general imbalance in production facilities;
ii) fuller utilization of installed capacity
iii) comments on areas offering scope for –
a) cost reduction,
b) increased productivity
c) key limiting factors causing production bottlenecks;
d) improved inventory policies; or
e) energy conservancy;
iv) State of technology whether modem or obsolete; and
v) Plant, whether new or second-hand when installed.

27. Reconciliation with financial account, – After the auditor appointed under section 252 of the Companies Ordinance, 1984, submits his report, the Cost Auditor shall submit a supplementary report on reconciliation with financial accounts to the directors before the date fixed for holding the annual general meeting of the company.

28. Cost statement – Copies of the cost statements on the formats prescribed by the Corporate Law Authority under clause (e) of subsection (1) of section 230 of the Companies Ordinance, 1984, duly authenticated by the chief executive and chief accountant of the company, and verified by the cost auditor, shall be appended to the report.

29. As far as practicable, comparison of all figures of cost and production shall be made with the figures of previous year.

Posted on November 3, 2015 in Cost Audit

Share the Story

Back to Top
Share This