Usefulness of Cost Audit Annexures – Vidhrta CFO Services

There are eight main annexures to cost audit report with their respective explanations.

The annexures are: 1. General 2. Cost Accounting System 3. Process of Manufacture 4. Quantitative Details 5. Break- Up of Cost of Input Materials Imported during the Year 6. Power, Fuel and Utilities 7. Salaries and Wages 8. Repairs and Maintenance.

Annexure # 1. General:

The name and address of registered office of the company, and that of the Cost Auditor; Reference No. and date of the Government’s Cost Audit Order; Reference No. and date of Government’s letter approving the appointment of the Cost Auditor; Company’s financial year under audit; Location of factory/factories; Location where accounts are maintained; Date of first commencement of commercial production (particulars of all factories, if more than one); the number of Audit Committee meetings held and the number attended by the cost auditor; Note on the nature of other activities besides the manufacture of the product under reference (if any); Copy of the Annual Report along with the audited Profit and Loss Account and Balance Sheet and Auditor’s Report for the company’s financial year under audit to be enclosed.

This Annexure also requires furnishing the following information:

Date of Board of Directors’ meeting wherein the Annexure and Proforma to the cost audit report were approved.
Name, qualification, and designation of the officer heading the cost accounting section or department.
In case of loan license / job work assignment by the company, the name of the third party and location of the factory, where the product has been produced / manufactured; and
If there is any foreign technical collaboration, the particulars of – name and address of the foreign collaborators, the main terms of agreement, amount of royalty / lump-sum payment / technical aid fee payable and the basis of calculation, and the technical collaborators’ contribution (if any) to the share capital and the amount of paid-up share capital so held by each of them.

In this Annexure, the expression ‘other activities’ means any activity other than the manufacture and sales of the product under reference.

Examples of ‘other activities’ are:

Manufacture of products not covered by the Cost Accounting Records Rules,
Job work or process work undertaken on the materials owned and supplied by other companies for eventual return to the latter,
Packaging of bulk quantities of ‘product under reference’ belonging to the other companies, etc.

Usefulness of this annexure is to understand.

This annexure gives an overview of various critical summary about the company, product, its adherence to Cost accounting records and general compliance perspective laws and will be like a dashboard to senior management.

Annexure # 2. Cost Accounting System:

Description and the adequacy or otherwise of the system (in a ‘Comment’ form) to correctly determine the cost of production of the product, including the procedures for accounting of materials, labour depreciation, overheads, treatment of by-products/joint-products/scrap, etc. and inventory valuation.

While reporting under this Para, a Cost Auditor of a company should bear in mind that mere description of the system and its sub-systems will not be sufficient, although such description needs mention.

To confirm whether the Cost System is adequate or not for the correct ascertainment/determination of the cost of the product, it is expected of him that he would critically examine the system, appraise, and evaluate its adequacy, and then offer his comments.

System:

The Cost Auditor broadly follow the requirements of the Cost Accounting Records Rules for the Products (s) under reference.

The type of costing adopted, i.e., Process Costing, Unit or Job or Batch Costing or a combination thereof.
Raw Materials.
Process Materials.
Consumable stores, tools, machinery spares, etc.
Salaries and wages, including basis of differentiation of Direct and Indirect Labour.
Depreciation.
Overheads including classification procedure.
Departmentalisation — Production and Service department expenses; system of apportionment, reapportionment of services’ expenses to production.
Method of recovery of costs to the products.
Valuation of work-in-progress inventories.
Valuation of items captivity consumed.
System of preparation of different Cost Statements as required under the relevant Cost Accounting Record Rules.
System followed for the reconciliation of Cost Accounts Records with the Financial Books of Account.
The determination of value of joint-products, by- products, own manufactured components.
System of Standard costing, if any, in operation and a reference as to whether the cost accounting is done on a historical basis.

Adequacy or Otherwise of the System:

The Cost Auditor should critically analyse and evaluate the following to draw conclusions for offering his comments:

Type of costing adopted by the company is appropriate to the industry.
Standards — physical and monetary — fixed by company are reasonable.
distinction made between direct and indirect labour is reasonable to meet the requirements of the costing system.
allocation of salaries and wages is appropriately made. What could be the possible limitations in the system?
Whether the classification and codification of materials facilitate easy identification. Are these adequate?
Whether the system is flexible for collection of significant data on wastages, spoilages, defectives, rejections, etc. Whether it provides for generation of data on non- moving, slow-moving, and obsolete items. How are the fast-moving items and sundry materials treated?
How is the system of overheads classification? Is the classification procedure understood and applied consistently? Is there any Standard Chart of Accounts? Is it rational under the present set-up? Is the system of Standing Order Numbers adequate and appropriate?
How are the different overhead rates (i.e., Machine hour rate, Labour hour rate, Prime cost percentage rate, Direct wages rate, etc.) determined?
Is the basis of apportionment of overheads to the various production and service departments properly determined with reference to technical factors and followed consistently?
In the system of Reconciliation of the books of Cost Accounts with the Financial books adequate? Does it need any improvement?

Usefulness of this annexure is to understand.

Adequacy or otherwise of the system to correctly determine the cost of production/ sales, sales realisation, and margin of the product.
Inventory valuation policies and systems for raw materials, work-in-progress, and finished products by

highlighting the distinguishing features and consistency in practices; and

Changes that might have been made in the systems of costing, overheads allocation/ apportionment/ absorption during the year under audit compared to the previous year as also their quantification in terms of value and effects on cost.

Annexure # 3. Process of Manufacture:

Obtain a write-up on the manufacturing process and a production-process flow chart from a competent technical person.
Visit the plant, discuss with key technical people, understand the material flow from the input (or throughput) to the various manufacturing stages to the output and quality control unit reaching the stockyard or warehouse; and
Ascertain the flow of operations, input-output relationship, product-wise norms, key plants and their efficiency, critical factors involved in loading and off- loading and the interaction or inter linkages between the ‘Product’ producing plants and plants meant for other activities.

The note on the manufacturing process should be drafted in a simple language and without the use of unfamiliar technical terms.

Usefulness of this annexure is to understand.

The nature of industry — Engineering, chemical or mining; and the types —job orders or process industries.
The methods of production and processing, and their sub-systems.
The state of automation and mechanisation of the processes or operations.
Whether the industry is labour- intensive or machine- intensive, and if both, which of the production and service departments fall under these categories.
The systems of production planning and controls, viz., process layout, product layout, production plans and scheduling and important stages of production where the raw materials are converted to semi-finished or finished products, or where the components and parts are sub- assembled and/or assembled to the products.
The reports of Industrial Engineering Department relating to rated capacity, time, and motion study, etc., to ascertain
- Scope of optimising facilities of men, materials, and machines,
- Imbalances in capacities, and
- Bottlenecks in workflow, if any; and the licensed and installed capacities of the various plants in the process
The systems of recovery of process materials/chemicals, defectives, rejection, and spoilages in the production and assembly departments, and of reckoning these arising at the important stages during manufacture.
The ‘production process flow chart’ showing the input of materials, process materials stocks at the beginning and at the end, output of materials at various stages of operation.
The existence of process-related service departments, viz., Quality control, Effluent treatment, Water treatment, Steam, Power, Compressed Air, Heat treatment, etc., and their relationship with the identifiable processes of manufacture

Cost Annexure # 4. Quantitative Details:

Installed capacity, to consider following points for this:
- Rated capacity available from the manufacturers’ catalogue.
- Technical certification as well as age of the plant.
- Additions or renovation made to increase the original capacity.
- Number of shifts working — single, double, or triple; and
- Technical estimate of hourly production, particularly when diverse types or sizes are manufactured in different plants [Hourly production should be multiplied by normal working hours based on total days available less weekly off days, statutory holidays and normal shut-down for repairs and maintenance.]

In case of continuous plant, annual capacity should be computed for 365 days less normal shut-down period for plant overhauling.

In case of different plants having different capacities for different operations or processes, the lowest capacity of the series becomes the capacity of the plant.

In case of multi-product industrial unit, the installed capacity should be computed in terms of standard hours, machine hours, equipment, or vessel occupancy hours, crushing hours, spindle/loom shifts, etc.

In case of certain products requiring different operation time (i.e., speed), the capacity should relate to that speed.

In case of non-availability of technical data regarding installed capacity, maximum production achieved on any one day in a particular year may be considered for calculating the installed capacity.

Capacity and various states:

Capacity is the rate of output at which there is no incentive to alter the size of the plant if that rate of output is expected to be permanent.

The need to optimize between the existing facilities and market demand of products gives rise to various states of capacity production.

These are as follows:

Practical capacity:

Practical capacity represents the installed or rated capacity less normal capacity losses due to repairs, maintenance, breakdowns, etc. It is also called operating capacity.

Normal capacity:

“The normal capacity basis is the total possible time (that means, any kind of work, machine or otherwise) less reasonable allowances for breakdowns, repairs, inefficiency, reasonable lack of operators and all other regular normal delays outside lack of orders to run on.”

Idle capacity is a part of the productive capacity of a plant lost because of repairing, oiling, overhauling, maintenance, job-setting, absenteeism, bottlenecks, or unavoidable machine idleness.

Average capacity refers to the average of the capacities achieved and utilised in the past over a period. It, therefore, concerns itself to realised conditions.

Limiting capacity (or Critical capacity) under which the ‘key factor’ limiting the flow of production is considered. This ‘key factor’ relates to the least capacity in the production process flowline. For example, if a production flowline requires two plants A and B, and the capacity of A is not adequate to cope with B, it will be necessary to take the least capacity as the controlling Critical capacity.

The overall net capacity of a unit is thus determined by considering the corresponding matching capacities of other plants.

Production capacity enhanced by leasing and all details of added capacities and other utilizations. The cost auditor must report all details of production capacity; that is, capacity owned, capacity increased by leasing of plants, capacity increased by adding new plants or altered by replacement, etc.
The information under this Para may be given either product group-wise or in totality, e.g., tablets, capsules, liquids, etc.

SI. no. 2. Capacity enhanced…. If some plants have been taken on lease, its capacity should be shown here. Similarly, where some of the plants have been given on lease, their capacities should be reduced from installed capacity to arrive at available capacity.

SI. no. 4(b). Third party on job work: It means the company has manufactured goods for others.

SI. No. 4(c). The term ‘Loan license Basis’ means that the company gets manufactured goods from outside parties.

In the case of plants operating at varying speeds (time factor) producing different thicknesses/gauges of products, installed capacity in terms of M.T. etc. may not be comparable with actual production in M.T. for arriving at capacity utilisation. Therefore, it would be better to calculate capacity utilisation in terms of machine hours, etc. as per Note (2) of this Para. In such cases, installed capacity and actual production should also be expressed in terms of machine hours etc.

Sl. No. 10. Quantity captively consumed:

This should include quantity transferred for subsequent product/process and/or for samples.

Here, the term ‘production capacity’ must be distinguished from ‘productive capacity’ this is defined as the industrial unit’s ability to produce within its present facilities saleable goods and to accumulate saleable inventories.

The production capacities of various utilities like water, steam, power etc. should also be stated. The additions to capacity that have not contributed to the production of products or utilities should also be considered for the computation of production capacity.

Where the products are of varied sizes, grades, gauges, etc. having different production capacities then all items should be converted to a particular size, etc. to determine the equivalent production capacity.

The above data can be collected from the statistical records maintained by a company.

(d) Actual Production:

‘Production Records’ should be shown under: (a) Self- manufactured, (b) Job work and (c) Loan license.

In case of widely varying opening/closing WIP stocks, equivalent production should be computed to obtain the actual production.

In case of products of many sizes/shapes/dimensions, etc. itemized actual production should be converted to equivalent production in a standard unit to make it comparable with that of installed capacity as required under sub-Para (5) below.

The cost auditor should cross-check the actual production figures with those of excise records and returns to DGTD, Directorate of Industries, National sample Survey, etc. SI. no. 6 of this Annexure requires indication of ‘Production as per Excise Records’.

Production awaiting testing, quality control and final inspection should not be considered. The production quantities shown in the Annual Accounts (financial) may not serve the purpose adequately.

(e) Percentage of Production to Installed Capacity:

The cost auditor must indicate the percentage only, but he must ensure that both production and installed capacity are expressed in the same unit. For this the figure under SI. no. 3 should be compared with the figures under SI. no. 4(a) plus 4(b) only.

If there is shortfall in production of the product as compared to the installed capacity, the cost auditor should give brief comments as to the reasons for such shortfall clearly stating the extent to which they are controllable both in short term as well as long term.

(f) SI. no. 11: Quantity sold:

This needs to be shown under the following break¬ups.

Domestic at controlled price,
Domestic at market price,
Export under advance licence,
Export under other obligation, and
Export at market price.
(f). Major input materials/Components consumed.
(g). Standard/Actual consumption of input materials per unit.

Usefulness of this annexture is to understand the reasons for shortfall in production may be on account of:

(a) Internal factors such as faulty production planning/ programming/scheduling, imbalance in production facilities causing bottlenecks in production flow line, lack of harmony in the production units, lack of technical knowledge on the part of the operation personnel, poor quality or deficiencies in the raw materials, deficiencies in the plant design and layout, frequent plant break-downs, excessive absenteeism of operatives, absence or ineffectiveness of production incentive plans, improper maintenance of productive plants, failure to keep the plant staff contended, etc.; and

(a) External factors such as absence of market, fall in the market demand, restrictions as to the availability of raw materials, sudden scarcity of raw material inputs, acute power shortage, seasonality of the products, lock out, poor order book position, non-availability of imported materials when needed, high rate of skilled labour turnover owing to attractive terms offered by the competitors, product substitutes appearing in the market, product life cycle approaching the stage of obsolescence, change in fashion and technology forcing cuts in production, etc.

Annexure # 5. Break-Up of Cost of Input Materials Imported during the Year:

Information must be given for three years — current year and two preceding years.

Important points in the requirements are:

Details should be furnished in respect of major input materials each constituting at least 2% of total raw material cost.
For imported raw materials — FOB value, ocean freight, insurance, customs duty, and inland freight, clearing charges should be separately indicated.
The consumption figures of raw materials separately for Indigenous and imported categories should be shown so that percentage mix of consumption both in quantity and value may be ascertained to report under Para 5 of the main certificates if deemed necessary.
Quantity of consumption per unit of production and against standard requirement/ theoretical norm together with the reasons for variations should be ascertained to give observation/suggestion under Para 5 of the main certificate if deemed necessary.
Value of raw materials, components, finished and semi- finished parts not moving for more than 12 months should be identified and its proportion to the value of stock at the end of the year should be ascertained for reporting under Proforma 18(A): Non-Moving Stock.

The cost auditor must ensure that the item-wise raw materials consumption both in quantity and value shown in his Statements tally with relevant details of the relevant Cost Proforma and with the information contained in the Annexure to Schedule VI of the profit and loss account.

The consumption of process materials, process chemicals and dyes or agents which are incidental or extra to the

Semi-finished components purchased from outside require further processing before use in the sub-assembly/final assembly of an engineering product and the cost of processing should be considered in the computation of ‘value.’ In case of raw materials imported against the export commitment of the ‘product under reference’, import duty not paid and export profits earned should also be ascertained.

Usefulness of this annexure is to

Understand the mix of Imported and indigenously sourced and used RM, its impact on cost which trigger them guidance to management from a control perspective.
Help in understanding the make or buy decisions for the sourced semifinished /bought out components.
tracing out slow-moving items, contributes towards better inventory control, and reduces the cost of inventory carrying.

Annexure # 6. Power, Fuel and Utilities:

To report and offer comments in respect of (a) details of quantity, rate per unit and total cost of each major form of power (e.g., solar power, atomic power, electricity, etc.) and fuel (e.g., coal, furnace oil, diesel oil, etc.) used in the production of product and other utilities like water, steam, etc., separately for purchased, self-generated and imported categories; and (b) differences noticed by having comparison between the actual consumption and standard consumption per unit of production of the product and with the preceding two years.

The cost auditor should also consider the following:

Statements of ‘power’ and other ‘utilities’ as per the Proforma ‘A’ of the cost accounting records rules give the desired information.
Basis adopted for inter-unit transfer charge in case of power supplied from another unit or transferred to another unit.
Special features as to the costs common to utility centres like power, steam, water, etc. and their allocation bases.
Characteristics of input materials like ash content in coal, efficiency of fuel gas and furnace oil, etc.

Usefulness of this annexure is to understand.

The impact on the unit product cost on account of measures taken for the conservation of energy. This is to advocate ‘Energy Audit’.by energy specialist with emphasis on:

Identifying the quantity and cost of various forms of energy,
Identifying energy consumption at various levels, and
Highlighting wastages by relating energy input and production output. This aspect would assist him to give his observation under Para 5 of the main certificate, if deemed necessary.

The diagnostic audit profile may concentrate on:

Technical analysis of processes,
Quantum of energy spent, and
Evaluation of managerial and technical devices for energy conservation programme.

This Annexure useful for:

Monitoring energy consumption factors,
Identifying possibilities of savings,
Recommending policies for bringing about savings in energy consumption; and
Possibility of avoiding losses thereby — conserving energy.

Annexure # 7. Salaries and Wages:

All information is factual and can be collected from the concerned records and account heads. Other fringe benefits like contribution to PF, FPF, ESI, LTC and group insurance should be included but not the amounts of annual bonus and gratuity paid-under B: Cost detail.

Direct labour cost on production refers to the labour costs of all production centres including packing departments.

Other employee cost refers to the salaries and wages paid for departments other than those indicated in (1) to (4) (e.g., payments to contract labour).

Indirect employee cost on production refers to the salaries and wages of all service and utility centres arrived at after apportionment.

Attendance records for both regular and causal workers give clues to this information. There should be a proper reconciliation of person-days available and worked with consideration of person-days lost due to absenteeism, idle time, lay-off, leave, raw materials shortage, power shortage/ failures, etc.

Idle person-days:

In the normal working situation, a factory may not have idle work force, since in case of any unexpected temporary idleness the same worker is provided with alternate work or used for maintenance work.

There may be two approaches to determine the average number of direct or indirect workers employed:

Dividing the total person-days of direct or indirect workers available by the number of days worked during the year, and
- Aggregating the strength of direct or indirect workers at each month-end for the year and dividing the same by 12.

Direct labour cost per unit of output which is referred as SI. no. 4: Direct wages and salaries as per Proforma showing the ‘cost of production’ should be computed. In case of several processes involved, such labour costs are to be grouped together making adjustment for the quantities processed in different centres to obtain one unit product.

If standard costing system is adopted the cost variances are required to be adjusted to obtain actual costs.

Year to year variations in the direct labour costs (i.e., SI. no. 4: Direct wages and salaries) per unit should be properly ascertained with causes. Reasons for variations may be rise or fall in the working-class cost of living index, wage revisions by union-management agreement or wage board, rationalisation of labour, mechanisation, productivity changes, etc.

Usefulness of this annexure is to

give management as to how direct resources are used with a focus on productivity.
understand and guide the impact of Indirect resource.
Make management aware that how efficiencies in this area can bring improvement to product cost with a focus on yield.
Bring a coherence between direct and indirect labour force in terms of their contribution is value adding to the product produced and identify areas of improvement.

Annexure # 8. Repairs and Maintenance:

(1) cost auditor should refer to the proforma of ‘Cost of Production’ wherein this figure is available, and the records under this head maintained by the company as per the cost accounting record rules.

The proforma shows the total of ‘repairs and maintenance’ and the records provide for the expenses for each item, namely, stores and spares, labour charges, and outside contract repair charges, and so there should be a reconciliation between them.

The job cards and outside contract cards for maintenance and major repairs for the production centres (excluding the works of capital nature) should be sorted out and a summary sheet obtained for data collection as follows.

Repairs and maintenance expenses on staff-quarters and colony are included in administrative overheads and will therefore appear as an item in the break-up for administrative overheads also. Amount capitalized will not be forming part of the expenditure.

Usefulness of this annexure is to

Understand to what extent that the machines of production centres are healthy to support the productivity and efficiencies and trigger time to replace the asset when Repairs and maintenance cost are showing a progressive upward trend.
Help in more monitoring the machine health through Job cards/outside contract cards to understand the cause and costs attributable to each of event/activity of such repair and guide in readily support management for quick addressal of the problems supported by history of logged data inputs.

Overall, usefulness of the Cost audit with its annexures is aimed sustainable value creation, value enhancement and value sustenance of the organisation by timely triggering the management for timely decisions.