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Cost audit under the Companies Act, 2017

The Companies Act, 2017, after much fanfare, has now been enforced in Pakistan. The finance minister acknowledged and appreciated the good efforts of Securities and Exchange Commission of Pakistan (SECP) and its entire team of senior bureaucrats for bringing out such a valuable law which will be a catalyst for progress and growth in trade commerce and industry more particularly under corporate sector. The Companies Ordinance, 1984 has now been repealed and replaced by the Companies Act, 2017.

It was claimed that the new law will reduce the cost of doing business and will be highly instrumental in profit maximization of the companies engaged in production, manufacturing, processing and mining. However, the authors of the Companies Act, 2017 lost sight of the effective use of cost audit by failing to give it proper importance in the new enactment.

Under the repealed Companies Ordinance, 1984, the role of cost audit was not only fully recognized but given due importance because cost audit is a good tool to identify areas of cost inefficiency including invisible losses which do exist but are not reflected in the books of account, hence such losses escape the attention of statutory financial auditors as well as management of the company.

Although the Companies Act, 2017, contains the provision of cost audit under its sub section 1 of section 250, it is maligned and made difficult by the insertion of sub section 2 of section 250 of the same Act. It manifests that the role of cost audit is recognized and admitted by sub section 250(1) in the company law by one hand and by insertion of section 250(2) of the same Act it is simultaneously taken away by the other hand.

It may be noted that cost audit under section 250(2) of Companies Act, 2017 is no more mandatory unless directed by the commission subject to the recommendation of the regulatory authority supervising the business of relevant sector or any entity of the sector. There is also an element of ambiguity in the company law as the word “regulatory authority” is not defined as to who is the regulatory authority of the particular economic sector and when, why and for what terms of reference (ToR) will it recommend the SECP for cost audit.

After the commencement of Companies Act, 2017, the ongoing cost audit assignments of the existing companies have come to a halt and terminated. The cost audit is now the first casualty of the Companies Act, 2017.

In view of the declining exports, adverse current account position and rising cost of doing business and more particularly the economic effects of the CPEC, the importance of cost audit cannot be denied. The cost audit should be made fully applicable to each and every industry so that invisible losses, unusual wastages and industrial losses are adequately avoided.

In case of India, cost audit has been made mandatory for forty-three (43) different types of industries and the scope to cover other industries is vast as these industries generally cater to essential commodities which are required by the public at large and play an important role in the economic development of that country.

We may now examine the role of cost audit as a means of cost control/cost reduction and its usefulness to everyone and harm to none which is the core objective of the Companies Act, 2017.

Cost Audit – meaning, objectives and advantages 

In an environment of increasing foreign trade competition, the Cost Audit Reports have assumed greater importance and significance being the important source of reliable and authentic feedback to the government and its various departments and agencies. The Cost Audit Reports do not only contain merely the cost details, but are full of information related to all aspects of business organization which, if harnessed properly can provide a comprehensive analysis about the company, the industry and the economy as a whole. A Cost Audit Report serves as an effective tool of information in the hands of directors on the Board ensuring good corporate governance.

Cost Audit in fact is the cost and benefit analysis or more appropriately Cost Performance Review of the companies engaged in manufacturing, processing and mining. Cost audit helps the management of the company 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 from where financial audit ends:

In financial terms:


In contrast to the above said financial equation, cost audit means that it should be either 5,4 or 3.


In case of 5, benefit of 1 is the reward of input cost and efforts made by the entrepreneur.


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 analyze the reasons and probe the areas of cost performance in either case.

The financial auditor will be satisfied if 2 + 2 equate 4 (i.e., debits and credits are equal)~ but cost auditor will not be satisfied unless the equation ends up at 5; and even if it is 5 he will try to 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. Examples of such losses are as follows:

i) Loss arising from non utilization of full plant capacity.

ii) Loss arising from over capitalization with borrowed funds resulting in high markup cost.

iii) 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.

iv) Loss arising from lack of budgetary controls and absence of costing procedures of products or services and variance analysis thereof.

v) Loss arising from unfavourable input/output ratios.

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 switch over to alternate process/tech no logy.

xi) Loss arising from inefficient use of human resources.

Cost accounting techniques when applied in audit, the invisible/hidden losses are identified and reported to the management for remedial action.

Cost audit is a process for verifying the cost of manufacture or production of any product or services 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 account and records and checking of adherence to the objectives of the cost accounting. It is clear that cost audit is a systematic examination of cost accounts to verify correctness of cost accounting records.

Objectives of Cost Audit 

The following are some of the objectives for which cost audit is undertaken:

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

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

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

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

— 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.

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

Advantages of Cost Audit to the Management 

Cost audit provides reliable cost data for managerial decisions.

— Cost audit helps management to regulate production.

— Cost audit acts as an effective managerial tool for the detection of errors, frauds and irregularities so that reliable and smooth functioning of the system is continued.

— Cost audit reduces the cost of production through plugging loopholes relating to wastage of material, labor and overheads.

— Cost audit can fix the responsibility of an individual wherever irregularities or wastage are found.

— Cost audit improves efficiency of the organization as a whole and costing system in particular by constant review, revision and checking or routine procedures and methods.

— Cost audit helps in comparing actual results with budgeted results and points out the areas where management action is more needed.

— Cost audit also enables comparison among different units of the factory in order to find out the profitability of the different units.

— Cost audit exercises moral influence on employees which keeps them efficient and alert.

— Cost audit ensures that the cost accounts have been maintained in accordance with the principles of costing employed in the industry concerned.

Advantages of Cost Audit to the government 

— Cost audit assists the ‘Tariff Board’ in deciding whether tariff protection should be I extended to a particular industry or not.

— Cost audit helps ascertain whether any particular industry should be given any subsidy in order to develop that industry.

— Cost audit provides reliable data to the government for fixing up the setting prices of the various commodities.

— Cost audit helps the government take necessary measures to improve the efficiency of sick industrial units.

— Cost audit can reveal the fraudulent intentions of the management.

— Cost statements may be helpful to authorities in imposing tax or duty at the cost of finished products.

— Cost audit facilitates settlement of trade disputes of companies.

Advantages of Cost Audit to society

— Cost audit tells the true cost of production. From this the consumer may know whether the market price of the article is fair or not. The consumer is protected against the exploitation.

— Cost audit improves the efficiency of industrial units and thereby assists in economic progress of the nation.

— Since price increase by the industry is not allowed without justification as to increase in cost of production, consumers can maintain their standard of living.

Advantages of Cost Audit to the Shareholders 

— Cost audit ensures that proper records are maintained as to purchases, utilization of materials and expenses incurred on various items i.e wages and overheads etc. It also makes sure that the industrial unit has been working efficiently and economically.

— The cost audit enables shareholders to determine whether or not they are getting a fair return on their investments. It reflects managerial efficiency or inefficiency.

— Cost audit ensures a true picture of company’s state of affairs. It reveals whether the resources like plant and machinery are being properly utilized or not.


Avoidance of cost audit as a regular feature in the industry is against the spirit and core objectives of the Companies Act, 2017. Accounting fraternity all over Pakistan wonders as to how the cost control will be exercised in the absence of cost audit in the industry. In view of the usefulness and effective role played by it in cost control, it is hoped that SECP may like to review the text of controversial legal provision of sub section 2 of section 250 of Companies Act, 2017 and make necessary amendments by deleting it from the company law so as to make cost audit compulsory in each and every industry without involving the so called ‘regulatory authority’ if any.

Wasful Hassan Aiddiqi, "Cost audit under the Companies Act, 2017," Business Recorder. 2017-10-01.

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