Stifling controls or self-regulation

Written by Vijaya Sampath | Updated: Sep 3 2014, 06:55am hrs
There has been much noise amongst the cost accounting fraternity over the Cost Records and Cost Audit Rules 2014. The Institute of Cost Accountants of India (ICAI) stated that new rules defied logic, while certain academicians associated with ICAI stated that since managers are inherently opportunistic, it is necessary for independent directors to be made aware of the full details of costs so that managers do not manoeuvre board processes to get favourable board decisions.

Such an argument wrongly assumes that professional managers, in general, provide incorrect or incomplete information to the board and stakeholders.

Further, such statements go against the spirit of cooperation and openness propagated by the government, which has recognised the need for self-regulation in todays economic environment. While it is obvious that a strong system of checks and balances must remain in place to ensure compliance with statutory regulations, the answer lies in freeing up the entrepreneurial spirit of the private sector and providing a platform based on mutual trust and belief in a free market economy. Successive governments have realised this over years of economic liberalisation and this is manifest in legislations such as the Companies Act, 2013, which provides a comfortable degree of flexibility and autonomy to corporate entities in their operations while ensuring a framework of compliance with regulations.

The government recognises the right of board members to exercise their independence and seek information on matters as may be required by them. This does not translate to the need to impose a forced third-party authentication of all information placed before the board. Unlike shareholders, who need independent assurance from statutory auditors since the board acts in a fiduciary capacity on their behalf, professional managers are appointed by the board and work in the interests of the company while carrying out their responsibilities. Surely, the professional community is not going to risk its reputation and career by wilfully or negligently providing incorrect or incomplete information, neither can one imagine that they would all collude and conspire to misinform the board as the statement from some members of ICAI seems to be alluding. Internal controls prescribed by law and companies are responsible enough to ensure that they are followed in substance and spirit. The checks and balances for professional managers are exceedingly more complicated and rigorous than merely relying on an independent cost auditor to ascertain the correctness of information presented to the board.

In todays technology-driven environment, it is simplistic and incorrect to assume that all decisions taken by boards are based on product cost sheets in the format as prescribed by ICAI. In any event, the board of directors of a company have the right to seek external counsel. In case the board feels the need to have cost-related information reviewed by an independent person, it is within its rights to call for such an audit to take place. It is also at liberty to specify the format, methodology and nature of information to be presented in the manner in which it seeks to review such information. Decision making by the board is left to the judgement of the board, as also envisaged by law.

From a perspective of management decision-making, it is worthwhile to note that cost records and cost audit are not of any relevance in analysis of income/revenuesince the principles of revenue recognition are outside the scope of cost accounting, by definition. From the point of view of providing assurance to shareholders, government or the board of directors, any system of accounting/audit that does not cover the authenticity of revenue earned by any entity is ineffectual in providing any assurance in a comprehensive manner. This is only provided by financial audit.

Yet another fallacious argument has been espoused for mandatory cost audit that the costs of maintaining cost records are immaterial and benefits in terms of improved corporate governance are immense. This is again a case of overt simplification of corporate systems with a vague understanding of the ground realities in a professionally-managed corporate environment. All compliance processes have incremental costs for both large organisations (that need to maintain operations of separate cross-functional teams across multiple layers to ensure that regulatory requirements are being met) and smaller organisations (that may rely on external consultants and specialists since they are unable to maintain a full-time team for ensuring regulatory compliance). It is acknowledged even by the government authorities that the cost of doing business in India must be reduced for increased investment and growth. Moreover, there is no concept of a cost audit in any other part of the world. Further, every function needs to move from being a cost-centre to a profit-centre and needs to justify its existence in terms of benefit that is seen and understood. Unfortunately, mandatory cost audit does not fulfil this purpose and remains a legacy of the past that has become outdated.

Cost Rules 2014 focus on sectors that are of strategic importance to the economy and those under administered price mechanism. This is a well-thought out approach that focuses on cost optimisation and management in sectors that are not compelled by market forces to adopt such initiatives or those receiving resources from the exchequereither in the form of subsidies/administered prices or being owned directly by government. Other sectors have been rightly given the freedom to be governed by market forces in a self-regulatory regime, thereby ensuring enhanced levels of corporate governance. The Companies Act, 2013, has incorporated measures towards achieving this objective. Such a confidence-inspiring approach is forward-looking and all stakeholders of the economy would expect more such positive initiatives that open industry and accelerate the process of economic reform, away from an environment of stifling controls and regulatory shackles towards a regime of self-regulation.

The author is chairperson, Ficcis Corporate Law Committee, and senior partner, Lakshmi Kumaran & Sridharan