FAQs on Maintenance of Cost Records and Audit thereof

Under the Companies Act, 2013, the government can make rules regarding the maintenance of cost records by companies engaged in the production of goods or the provision of services in certain industries and for the audit of those records. The government may appoint a cost auditor for the company at a time of its own choosing. According to the Company (Cost Records and Audit) Rules, 2014, cost records are defined as “books of account relating to the use of materials, labour, and other items of cost which relate to the production of goods or the provision of services.” This article focuses on FAQs on Maintenance of Cost Records and Audits.

FAQs on Maintenance of Cost Records and Audit thereof

The following are the FAQs on Maintenance of Cost Records and Audit 

Question 1: What are the objectives of Cost Records and Audits?

Below are some of the objectives for which a cost audit is conducted:

• To determine the accuracy of billing data. This is done by verifying the arithmetical correctness of cost accounting entries in the ledgers.
• Ensure that cost accounting principles are guided by management objectives and that they are strictly adhered to in the preparation of cost accounts.
• Ensure expense account accuracy and detect errors, fraud, and malpractices in the existing system.
• Review the general functioning of the organization’s cost department and make suggestions for improvement.
• To help the management make the right decisions on certain important matters.
• To determine actual production costs when goods are ready.
• An effective internal cost audit system is in place to reduce the number of detailed checks by the external auditor. 

Question 2: What is the applicability of Maintenance of Cost Records and Audits?

The Companies (Cost Records and Audit) Rules 2014 apply to every company registered under the Companies Act, 2013 which is engaged in the manufacture of goods or the provision of services listed in Schedule A or Schedule B of Rule 3. 

Rule 3 classifies sectors/industries into regulated and unregulated sectors. 6 sectors/industries covered by Item A of the Rules are ‘Regulated Sector’ and 33 sectors/industries covered by Item B are ‘Unregulated Sector’. For clarity, the headings of the Central Excise Tariff Act (CFTA) are listed under the relevant sectors. No distinction is made between companies falling under item A and B for keeping records of costs.

Question 3: What is the significance of cost audit?

• Through a cost audit, a company can take a closer look at its production costs and find effective ways to reduce its labour, material, and overhead costs.
• It is a great tool for organizations to examine their earnings and efficiency and optimize the use of resources that may be underutilized – for better productivity. Malpractices and unethical practices can be easily detected by cost audit.
• Meanwhile, cost audit findings enable management to make timely decision that will help the company financially.

Question 4: What types of educational services do companies apply under Companies (Cost Records and Audit) Rules 2014?

The Companies (Cost Records and Audit) Rules 2014 cover “Educational Services, Other than such similar services falling under philanthropy or as part of social expenditure which they are not part of any business”. Any company that provides training or education through any means is covered under Educational services. However, ancillary services are provided by the company as a separate entity independent entity, to educational institutions, e.g. 

• Student Transport, Faculty and Staff
•  Food Services including any midday meal program; 
•  Security or janitorial or janitorial services in such educational institution
•  Services relating to admission to such institution or taking an examination are not included in the Education Services section.

In case the educational institution covered by the Rules provides the above ancillary services as part of their overall operations, then the institution will they must also keep records of these ancillary services.

Question 5: Who should keep records of costs?

Keeping records of costs applies to the company in the following cases:

• If the company is engaged in the production of goods or the provision of services as provided by law; or
• If the company’s total turnover from all its products and/or services is INR 350 million (US$ 4.9 million) or more during the immediately preceding financial year.

Question 6: What types of health services do companies cover under Companies (Cost Records and Audit) Rules 2014?

The Companies (Cost Records and Audit) Rules 2014 cover “Health services namely operating or operating hospitals, diagnostic centres, clinical centres or test Labs”. Any company engaged in the provision of health services through operation or operation hospitals, diagnostic centres, clinical centres, testing laboratories, physiotherapy centres and post-op/treatment centres are covered within the companies (Cost Records and Audit) Rules 2014. Furthermore, companies operating exclusively hospitals for own employees are excluded from the scope of these rules, if however if these hospitals provide health services to outsiders in addition to their own employees on salaried basis then such hospitals are covered under these Rules. It is clarified that companies engaged in the operation of beauty salons / cosmetics these Rules do not apply to them. 

Question 7: The Company is engaged in its own production of products and their purchase same products from other companies. Outsourced products are treated as business activity on financial accounts. It also produces the same products supplies of materials to converters. What would be the treatment of such products for cost accounting and cost audit record keeping purposes?

Products manufactured by the company, as well as the conversion of activities through third parties the Companies (Cost Records and Audit) Rules 2014 will apply to the parties and the company would have to keep cost accounting records and acquire costs audit performed within limits. Finished products purchased from external parties (considered business activity on financial accounts) as “Cost of Purchased Finished Goods” in the Summary Cost Statement. 

Question 8: A robotics and artificial intelligence company that develops drone-based solutions that provide actionable intelligence from aerial data. It also manufactures deeply customized aerial remote sensing instruments. Will Rule 3 (B) of the Companies (Cost Records and Audit) Rules, 2014 apply to the company? 

If a company is engaged in a composite activity i.e. software development along with equipment/tools like robotics, drones etc. or any part thereof covered by CTA Chapter Code 85 then the said rules will apply if it meets the prescribed threshold turnover. The Companies (Cost Recording and Auditing) Rules 2014 do not apply if the company is engaged only in the development of software tools.

Question 9: There is a company engaged only in the construction and sale of residential apartments and had income only from the sale of residential apartments. Now the turnover of the company in the current year is around INR 200 million which is beyond the threshold limit under the provisions of Section 148 of the Companies Act 2013, read further with the rules for maintaining cost records and for conducting cost audit. 

Since the company is only engaged in the construction and sale of residential apartments and as per the definition of construction as given in Schedule VI (5) of the Companies Act, 2013, only industrial, commercial and social development and maintenance is prescribed.

Question 10: The Companies (Cost Records and Audit) Rules 2014 provide exemption from costs an audit of a company subject to rule 3 whose export earnings, in foreign currency exceeds seventy-five percent of its total income. How to determine the percentage of total income in the following cases:

• In a company that manufactures pharmaceutical products, income from export of pharmaceutical products earned in foreign currency divided by total sales including other income etc. are 58%.
•  Foreign currency earnings earned from pharmaceutical exports products plus foreign currency revenue earned from conducting research and development service divided by total income including other income is 82%.

Cost audit applies to specific products/services. Rule 4(3) states “the cost audit requirement under these rules does not apply to a company which is included in Rule 3 and (i) whose income from professionals in foreign currency exceeds seventy-five percent of its total income”. Incorporation or coverage of the company under Rule 3 applies to the products/services listed in Table-A and Table-B an as a result, 75% must be calculated for the particular products/services covered by rule 3 and not in relation to all products/services companies.

Total income and turnover from research and development activities not covered by rule 3 cannot be taken into account for the calculation of 75%.In this context, it is also clarified that the “total income” of the company is to be treated as total income as defined in Schedule III to the Companies Act 2013. Total income, as defined in Schedule III, is total operating income plus others Revenues.

Question 11: Is there a penalty for non-compliance?

Cost audits must be in accordance with the auditing standards laid down by the Institute of Cost and Works Accountant of India and the audit must be carried out by a practicing cost accountant. The cost auditor must submit an audit report to the company’s board of directors within 180 days of the close of the financial year. Then this audit report has to be submitted to the central government within 30 days of receiving the report.

Where a company is found to be non-compliant with the cost audit provisions under the Companies Act 2013 and the Companies (Cost Records and Audit) Rules 2014 – the following penalty may be imposed:

• Fines ranging from INR 25,000 ($351) to INR 500,000 ($7,017), depending on the degree of non-compliance;

• For each office in default, imprisonment for a term which may extend to one year or a fine of INR 10,000 ($140) to INR 100,000 ($1,403) or both.

Takeaway

A cost audit has not lost its relevance, even for companies operating in a competitive environment. The benefits of a cost audit outweigh its costs. If the company already keeps cost records, the incremental cost is the audit fee. The costs of regular staff that support the audit are fixed in nature. Therefore, even if the costs are insignificant, the benefits in terms of better corporate governance are huge. They may not be from a management perspective.