The Audit Report, Internal Audit and Cost Audit
Chapter Fifty-Five
Syllabus topic 2.5, labels: "Audit and Auditor's Report", "Internal Audit", "Cost Audit"
Pages 372 to 378 of 830
In one line
There are three audits in this Act, and they answer different questions: the statutory audit says whether the accounts are true and fair, the internal audit checks the company's own systems from inside, and the cost audit checks what things actually cost to make.
In exam wording: the statutory audit report is governed by section 143(2) to (4); section 138 requires prescribed classes of companies to appoint an internal auditor, who shall be a chartered accountant or a cost accountant or such other professional as the Board may decide; and section 148 empowers the Central Government to direct the maintenance of cost records and the conduct of a cost audit by a cost accountant appointed by the Board.
Why the law has this at all
The statutory audit is an annual, external, backward-looking examination of one thing: whether the financial statements give a true and fair view. It is done once a year by somebody outside the company, and by the time it is finished the year is over.
That leaves two gaps.
The first gap is time and process. A yearly check cannot catch a control that has been failing since April. The internal audit runs continuously, inside the company, and reports to the Board. It is about whether the systems work, not about whether the final numbers add up.
The second gap is cost. Financial accounts show what a company earned and spent in total. They do not show what it costs to make one tonne of cement, and in industries where prices are regulated or where the public interest is engaged, that number matters a great deal. The cost audit examines it, and the report goes to the Central Government.
And note who each reports to, because that is the cleanest way to keep them apart: the statutory auditor reports to the members, the internal auditor to the Board, and the cost auditor to the Board and then to the Central Government.
Some words this chapter uses
Cost records are the particulars of material, labour and other items of cost. Cost auditing standards are those issued by the Institute of Cost Accountants of India with the Central Government's approval. A reservation is a qualification in a report. Net worth is defined in section 2(57). Remuneration in section 142 includes expenses and facilities but not fees for other services.
The statutory audit report, in outline
The full treatment is in [Rights, Duties and Liabilities of Auditors]. In short: the auditor reports to the members under section 143(2) on whether the accounts give a true and fair view of the state of affairs, the profit or loss and the cash flow; the report must also state the ten matters in section 143(3); and where any of them is answered in the negative or with a qualification, the reasons must be given under section 143(4). The report is attached to every financial statement under section 134(2), and its qualifications are read out at the general meeting under section 145.
The Audit Report, Internal Audit and Cost Audit
Remuneration of the auditor: section 142
Section 142(1). The remuneration of the auditor shall be fixed in its general meeting or in such manner as may be determined therein.
The proviso: the Board may fix the remuneration of the first auditor appointed by it.
The point of the sub-section is independence. The people who appoint the auditor also fix his pay, and those people are the members, not the management he audits. Only the first auditor, who is appointed by the Board under section 139(6), is paid on the Board's decision.
Section 142(2): what is included. The remuneration shall, in addition to the fee payable to the auditor, include the expenses incurred by him in connection with the audit and any facility extended to him, but does not include any remuneration paid to him for any other service rendered at the request of the company.
So the audit fee and the non-audit fee are kept separate, which is what makes section 144 workable and what lets section 147(2) compute a penalty by reference to "the remuneration of the auditor".
Internal audit: section 138
Section 138(1). Such class or classes of companies as may be prescribed shall be required to appoint an internal auditor, who shall be:
- a chartered accountant, or
- a cost accountant, or
- such other professional as may be decided by the Board,
to conduct internal audit of the functions and activities of the company.
Three points that are regularly examined. The obligation applies only to prescribed classes, not to every company. The internal auditor need not be a chartered accountant: a cost accountant, or any other professional the Board decides on, will do. And the subject is the functions and activities of the company, which is wider than its accounts.
Section 138(2). The Central Government may prescribe the manner and the intervals in which the internal audit shall be conducted and reported to the Board.
Note the reporting line: to the Board. That is what distinguishes internal audit from the statutory audit, which reports to the members.
And note the connection to section 144(b). The statutory auditor may not conduct the internal audit, directly or indirectly, of the company or its holding or subsidiary company. The two functions must be in different hands.
The Audit Report, Internal Audit and Cost Audit
Cost audit: section 148
Section 148(1): cost records. Notwithstanding anything contained in this Chapter, the Central Government may, by order, in respect of such class of companies engaged in the production of such goods or providing such services as may be prescribed, direct that particulars relating to the utilisation of material or labour or to other items of cost as may be prescribed shall also be included in the books of account kept by that class of companies.
The proviso: before issuing such an order in respect of a class of companies regulated under a special Act, the Central Government shall consult the regulatory body constituted or established under that Act.
Section 148(2): the cost audit. If the Central Government is of the opinion that it is necessary, it may by order direct that the audit of cost records of a class of companies covered under sub-section (1) which have a net worth or a turnover of such amount as may be prescribed shall be conducted in the manner specified in the order.
So there are two separate orders: one requiring cost records to be kept, and a second requiring them to be audited, and the second applies only to companies within the first that also meet a net worth or turnover threshold.
Section 148(3): who conducts it. The audit shall be conducted by a cost accountant, who shall be appointed by the Board on such remuneration as may be determined by the members in the prescribed manner.
Note the split: appointed by the Board, paid as the members determine.
The first proviso is the independence rule: no person appointed under section 139 as an auditor of the company shall be appointed for conducting the audit of cost records. The statutory auditor cannot be the cost auditor.
The second proviso: the auditor conducting the cost audit shall comply with the cost auditing standards.
The Explanation defines cost auditing standards as those issued by the Institute of Cost Accountants of India, constituted under the Cost and Works Accountants Act 1959, with the approval of the Central Government.
Section 148(4). An audit under this section shall be in addition to the audit conducted under section 143. The cost audit does not replace the statutory audit.
Section 148(5): the cost auditor's position. The qualifications, disqualifications, rights, duties and obligations applicable to auditors under this Chapter shall, so far as may be applicable, apply to a cost auditor, and it shall be the duty of the company to give all assistance and facilities to him.
The proviso: the report on the audit of cost records shall be submitted by the cost accountant to the Board of Directors.
The Audit Report, Internal Audit and Cost Audit
Section 148(6): to the Central Government. The company shall, within thirty days from the date of receipt of a copy of the cost audit report, furnish the Central Government with the report along with full information and explanation on every reservation or qualification contained in it.
Section 148(7). If, after considering the report and the company's explanation, the Central Government is of the opinion that any further information or explanation is necessary, it may call for it, and the company shall furnish it within the time specified.
Section 148(8): default.
- (a) the company and every officer in default shall be punishable in the manner provided in section 147(1), that is, the company twenty-five thousand to five lakh rupees and every officer in default ten thousand to one lakh rupees; and
- (b) the cost auditor in default shall be punishable in the manner provided in section 147(2) to (4), that is, twenty-five thousand to five lakh rupees or four times his remuneration, whichever is less, with imprisonment up to one year and a heavier fine where the contravention was knowing or wilful with intent to deceive, and, on conviction, refund of remuneration and damages.
Section 143(14) completes the picture: the fraud reporting duty in section 143(12) applies to a cost accountant in practice conducting a cost audit and to a company secretary in practice conducting a secretarial audit, exactly as it applies to the statutory auditor.
A worked example
Chandrapur Cement Limited manufactures cement, which is a prescribed class of goods.
Cost records. By an order under section 148(1) the Central Government has directed that particulars relating to the utilisation of material and labour and other prescribed items of cost shall be included in the books of account of cement companies. Because cement is not regulated under a special Act, no consultation with a regulatory body was needed; had it been, for example, an electricity company, the proviso would have required the Central Government to consult the regulator first.
Cost audit. The company's turnover exceeds the prescribed amount, so a second order under section 148(2) requires its cost records to be audited.
Who does it. The Board appoints a cost accountant, and his remuneration is determined by the members in the prescribed manner. The company's statutory auditor cannot be appointed, by the first proviso to section 148(3). The cost auditor must comply with the cost auditing standards issued by the Institute of Cost Accountants of India with the Central Government's approval.
It is additional. The cost audit is in addition to the statutory audit under section 143: section 148(4). The company has both.
The Audit Report, Internal Audit and Cost Audit
His position. The qualifications, disqualifications, rights, duties and obligations of auditors under Chapter X apply to him so far as applicable, and the company must give him all assistance and facilities: section 148(5).
The report. He submits it to the Board. The company must then, within thirty days of receiving it, furnish it to the Central Government with full information and explanation on every reservation or qualification: section 148(6). The Government asks for further explanation on one qualification, and the company must supply it within the time specified: section 148(7).
A default. The company files the report forty days late. The company and every officer in default are punishable as under section 147(1), and if the cost auditor were in default he would be punishable as under section 147(2) to (4).
And a fraud. During the cost audit the cost accountant has reason to believe that stock has been systematically misstated by employees. By section 143(14) the fraud reporting duty in section 143(12) applies to him, so he reports to the Central Government above the prescribed amount, or to the audit committee or the Board below it.
Internal audit. The company also falls within the prescribed class under section 138, so it must appoint an internal auditor. It appoints a cost accountant, which section 138(1) permits; it could equally have appointed a chartered accountant or any other professional the Board decided on. The internal audit covers the functions and activities of the company, and is conducted and reported to the Board in the manner and at the intervals prescribed.
A conflict avoided. The company asks its statutory auditor to take on the internal audit as well. Section 144(b) forbids it, directly or indirectly, and for the holding and subsidiary companies too.
Remuneration. The statutory auditor's remuneration is fixed in general meeting under section 142(1), except that the first auditor's was fixed by the Board. It includes his expenses and any facility extended to him, but not the fee for a permitted non-audit service: section 142(2).
Distinctions that carry marks
| Statutory audit | Internal audit | Cost audit | |
|---|---|---|---|
| Section | 143 | 138 | 148 |
| Compulsory for | Every company | Prescribed classes | Prescribed classes meeting a net worth or turnover threshold |
| Who conducts it | A chartered accountant or firm, section 141 | A chartered accountant, cost accountant or other professional the Board decides | A cost accountant |
| Appointed by | The members, section 139 | The company, under section 138 | The Board, section 148(3) |
| Remuneration fixed by | The members, section 142 | Not specified | Members, in the prescribed manner |
| Reports to | The members | The Board | The Board, then the Central Government within thirty days |
| Subject | Whether the accounts show a true and fair view | The functions and activities and the systems | Cost records: material, labour and other items of cost |
| May the statutory auditor do it | Not applicable | No, section 144(b) | No, first proviso to section 148(3) |
The Audit Report, Internal Audit and Cost Audit
| Default under section 148(8) | Punishable as |
|---|---|
| The company and every officer in default | Section 147(1): company twenty-five thousand to five lakh rupees; officer ten thousand to one lakh rupees |
| The cost auditor in default | Section 147(2) to (4): fine, imprisonment for a knowing contravention, refund of remuneration and damages |
What this does NOT mean
It does not mean every company must have an internal audit. Only such classes as may be prescribed under section 138(1).
It does not mean the internal auditor must be a chartered accountant. He may be a cost accountant or such other professional as the Board may decide.
It does not mean a cost audit replaces the statutory audit. Section 148(4) makes it in addition to the section 143 audit.
It does not mean the cost audit report goes straight to the Government. It is submitted to the Board, and the company then furnishes it to the Central Government within thirty days, with explanations on every reservation or qualification.
Quick revision
- 142(1): the auditor's remuneration is fixed in general meeting, or as determined there; the Board may fix the first auditor's. (2) it includes expenses and facilities, but not fees for other services.
- 138(1): prescribed classes must appoint an internal auditor, being a chartered accountant, a cost accountant, or such other professional as the Board may decide, to audit the functions and activities of the company. (2) the manner and intervals are prescribed, and the report goes to the Board. Section 144(b) bars the statutory auditor from doing it.
- 148(1): the Central Government may order prescribed classes producing prescribed goods or services to include cost particulars in their books; consult the regulator first where a special Act governs the class.
- 148(2): a further order may require the cost records to be audited, for companies within (1) meeting a prescribed net worth or turnover.
- 148(3): conducted by a cost accountant, appointed by the Board, remuneration determined by the members. The statutory auditor may not be appointed. Cost auditing standards of the Institute of Cost Accountants of India, approved by the Central Government, apply.
- 148(4) and (5): in addition to the section 143 audit; the Chapter's qualifications, disqualifications, rights, duties and obligations apply so far as applicable; the company must give all assistance and facilities; the report goes to the Board.
- 148(6) and (7): the company furnishes the report to the Central Government within thirty days of receipt, with full information and explanation on every reservation or qualification, and supplies further explanation if called for.
- 148(8): company and officers punishable under section 147(1); the cost auditor under section 147(2) to (4).
- 143(14): the fraud reporting duty in section 143(12) applies to a cost accountant conducting a cost audit and to a company secretary in practice conducting a secretarial audit.
The Audit Report, Internal Audit and Cost Audit
Test yourself
1. Who may be appointed as an internal auditor? A chartered accountant, a cost accountant, or such other professional as may be decided by the Board, to conduct internal audit of the functions and activities of the company: section 138(1). The obligation applies only to such classes of companies as may be prescribed.
2. To whom does the internal auditor report? To the Board, in the manner and at the intervals prescribed by the Central Government: section 138(2).
3. Who conducts a cost audit, who appoints him and who fixes his pay? A cost accountant, appointed by the Board, on such remuneration as is determined by the members in the prescribed manner: section 148(3). No person appointed as the company's auditor under section 139 may be appointed to conduct the cost audit.
4. What must a company do with the cost audit report? Within thirty days of receipt of a copy, furnish the Central Government with the report together with full information and explanation on every reservation or qualification contained in it: section 148(6). The Central Government may call for further information, which the company must furnish within the time specified.
5. Is a cost audit a substitute for the statutory audit? No. Section 148(4) provides that an audit conducted under section 148 shall be in addition to the audit conducted under section 143.
6. How is the auditor's remuneration fixed, and what does it include? It is fixed in general meeting, or in such manner as may be determined there, except that the Board may fix the first auditor's remuneration: section 142(1). It includes the fee, the expenses incurred in connection with the audit and any facility extended to the auditor, but excludes remuneration for any other service rendered at the company's request: section 142(2).
The rest of this subject
These notes are cut from the University's printed syllabus. Open the syllabus itself, or the past papers, for the same subject.