Internal Audit and Cost Audit

In one line

Two audits sit beside the statutory audit and are often confused with it: internal audit, which reports to the Board on how the company runs itself, and cost audit, which examines the company's cost records for the classes of company the Central Government specifies.

In exam wording: under section 138(1) such class or classes of companies as may be prescribed shall 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; and under section 148(1) the Central Government may, by order, in respect of prescribed classes of companies engaged in the production of prescribed goods or the provision of prescribed services, direct that particulars relating to the utilisation of material or labour or to other prescribed items of cost shall also be included in the books of account.

Why the law has this at all

The statutory audit under Chapter X answers one question: do the financial statements give a true and fair view? It does not answer two others that matter to different people.

How well does the company run itself? Internal audit examines processes, controls and compliance from inside, continuously, and reports to the Board, not to the members. It is the practical means by which the directors discharge the assertions they must make in the Directors' Responsibility Statement under s.134(5), particularly on adequate accounting records and, for listed companies, on internal financial controls. Its audience is management and the audit committee, which is why the Act keeps it separate from the statutory audit.

What does the output actually cost? Cost records answer that, and they matter where price is regulated or where the public interest turns on the relationship between cost and price, in utilities, pharmaceuticals, and industries under administered pricing. A financial audit tells you the company's total costs; a cost audit tells you the cost of a unit of output. Section 148 therefore lets the Government require both the keeping of cost records and, for larger companies within those classes, an audit of them.

Section 138: internal audit

138(1): such class or classes of companies as may be prescribed shall 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.

138(2): the Central Government may, by rules, prescribe the manner and the intervals in which the internal audit shall be conducted and reported to the Board.

Three points, all examinable and all easy to state wrongly.