If cost is key to pricing and competitiveness, there is little scope for any debate on the need for maintenance of cost records and conduct of cost audit across business, industry and government. This is apart from the fact that the principle of cost review is key to good governance, which the present government vows to deliver as India aspires to be globally known as an efficient and transparent society.
Mandatory maintenance of cost records and cost audit should not be viewed from the perspective of a regulated economy where prices are determined on cost-plus basis and there is least motivation to manage costs. It is most relevant even in market economy. A review by third-party provides assurance on the integrity of cost information.
The critical part of cost accounting is assignment of common costs to individual cost objects. An outside expert must review the principles and methods for assigning common costs and actual implementation of accepted principles and methods because, inherently, managers have the temptation to defend product-market decisions that they own, even by bending accounting principles and rules in their favour. The Companies Act, 2013, aims to strengthen the institution of independent directors in order to enhance the oversight function of the board of directors. Independent directors have no option but to rely on the information presented before the board. They need assurance from an expert about the reliability of cost information that they use to evaluate cost management, risk management and performance evaluation.
It cannot be said that a company that earns higher than the cost of capital is able to eliminate all wastes. Cost audit can be used gainfully in identifying wastes and areas, which have the potential for reducing costs. Therefore, cost audit enhances the productivity of resources not only at the firm level but also at the macro level.
A few may believe that information on product cost sheet has little relevance for the board of directors as they take decisions based on matters other than the product cost. This belief flows from the historical perspective, when product cost was being used for inventory valuation only. Today, in a competitive environment, board of directors are interested in product profitability. If the basic cost records are not maintained appropriately and accepted rules of assigning common costs are violated, the board will get incorrect information on product profitability. If product cost information is maintained adequately and appropriately, tailor-made information can be provided to the board of directors. Therefore, cost audit has immense value to the board of directors. Some argue that professionals employed by companies do not indulge in earnings management or bending the rules to present better picture than what it is because they care for their professional reputation. If it is so, even financial audit is not necessary. Professional knowledge and skills of corporate accountants match with the same of professional auditors. The only difference is the level of independence that the two groups of professional accountants enjoy in a given situation.
Therefore, review of accounting records, including cost records, by an independent expert is advisable to strengthen the institution of independent directors and to protect shareholders? interest and also to improve social welfare.
The cost of regulatory compliance is weighed against the benefits of the regulation. In most cases, costs can be measured more accurately than the benefits and more often benefits flow to those who are not directly responsible for incurring the cost. In case of cost audit also, benefits flow to shareholders as it improves overall enterprise governance, while the executive management is directly responsible for incurring the costs of compliance. If we assume that cost records are maintained appropriately by companies, the incremental cost of audit cannot be more than the benefits that accrue to shareholders.
Cost audit is not in conflict with the principle of self-regulation. In the context of companies, self-regulation implies regulation by the board of directors. The board of directors appoints cost auditor and the audit report is submitted to it. The mechanism is similar to the appointment of the internal auditor. However, cost audit, separate from internal audit, is required because only a cost accountant can carry cost audit effectively. The government has mandated internal audit to support the board. With the same logic, cost audit should be mandated to support the board, particularly independent directors.
The author is professor and head, School of Corporate Governance and Public Policy, Indian Institute of Corporate Affairs