The document discusses whether company boards need to pay attention to cost audit reports. It notes that while some boards have started looking at cost audit reports, many do not pay them the attention they deserve. It argues that boards should ensure their companies have effective cost accounting systems in place and adopt best cost and management accounting practices, in order to optimize resource utilization and inform strategic decision-making. Financial statements alone do not provide the full picture of a company's cost management.

1. Asish K Bhattacharyya: Do company boards need cost audit?
Some boards have started looking into the cost audit report, but many do not pay the deserved attention to cost
audit report
Asish K Bhattacharyya / December 10, 2012, 0:09 IST
E-mail: asish.bhattacharyya@gmail.com
Affiliations: Professor and Head of the School of Corporate Governance and Public Policy at the Indian
Institute of Corporate Affairs; Advisor (Advanced Studies), the Institute of Cost Accountants of India;
Chairman, Riverside Management Academy Private Limited
In a recent debate in Forbes magazine in the context of the bankruptcy filing by the Monitor
Group, which was formed by Michel Porter, many viewed ‘sustainable competitive advantage’
as a mirage in the current business environment. If a company can build sustainable competitive
advantage, it continues to earn above average profit. According to Porter’s thesis, a company
should choose either of the two generic strategies: cost leadership or differentiation. A company
that is cost leader earns a higher margin because of its cost advantage over competitors. A
company that pursues the differentiation strategy earns a premium for its products and thus earns
above average profit. A company that gets stuck in the middle cannot earn above average profit
and may find growth or even survival difficult. However, Porter does not suggest that a company
that peruses differentiation strategy should not pay attention to cost management.
The view that the ‘sustainable competitive advantage’ is a mirage is true for most companies. In
past companies that could build competitive advantage could maintain that for a long period. But
in the fast changing business environment, it is difficult to maintain the same for long. There are
companies that continue to earn their return higher than the average return primarily because
they manage their intangible assets (not in accounting sense) and product and process innovation
well. Although experts may differ, but Apple-Samsung rivalry shows that even a very strong
company can face competition from a once unknown competitor. In the backdrop of this rivalry
between Apple and Samsung, the survival and growth of other players depend largely on their
ability to manage cost and innovation. Indian automobile industry presents another example how
a leader can lose competitive advantage to other players.
In the above context it is imperative that every company should have an effective and efficient
cost accounting system, which provides reliable information on operating costs and product cost
and also provides support in strategic decision-making. Sophistication of the costing system
depends on the complexity of the product, process and the business model.
Therefore, the board of directors should pay attention to the efficiency and effectiveness of the
cost accounting system.

2. The government has ordered mandatory maintenance of cost accounting records by almost all
companies that cross the threshold of specified turnover or net worth.
Most companies whose turnover exceeds Rs 100 crores or whose securities are listed in a stock
exchange are required to get cost record audited by a practicing cost accountant.
For long the boards paid attention to accounting ratios and did not enquire into the adequacy and
effectiveness of the cost accounting system. However, after the government initiative, some
boards have started looking into the cost audit report. But many do not pay the deserved attention
to cost audit report and view it as compliance of another unnecessary law framed by the
government. It is true that financial statements capture the overall performance of a company.
Therefore, if a company is able to manage cost effectively, the financial statements and
accounting ratios will capture it. But financial statements do not tell the whole story of cost
management.
For example, the financial statements and related audit report fails to mention whether the
company has optimised the resource utilisation. Similarly the financial audit report does not give
the assurance that the product and customer profitability presented before the board is correct.
This is so because determination of product cost for inventory valuation under financial
accounting rules is guided by the principle of accounting prudence as understood by financial
accountants.
The principles applied to determine the product cost might deviate from cost accounting
principles. Moreover, audit of the market/customer profitability estimated by the cost accounting
system is outside the scope of financial audit. Therefore, financial audit is not a substitute for the
cost audit.
When I interact with cost auditors, I get a gloomy picture of the adequacy of the cost accounting
systems prevailing in different companies. This is not surprising because the average maturity
level in the use of cost and management accounting principles, methods and tools in India is low.
It is the responsibility of the board to ensure that the company adopts best cost and management
accounting practices. This will be a move towards optimal utilisation of resources. It will also
help the company to get appropriate cost and revenue information necessary to formulate and
implement strategies.
The government has taken the right initiatives and now it is the responsibility of the boards of
companies to take it forward.