Key Takeaways
- Cost records and cost audit are two separate requirements with two different thresholds.
- A cost auditor must be a cost accountant, and the statutory auditor cannot take the role.
- Form CRA 2 intimates the appointment, and the deadline runs from the board meeting or the start of the year.
- Cost records have to be kept through the year in the format the rules prescribe, not compiled at year end.
- Reconciliation between cost records and audited financial accounts is the part that takes longest the first time.
Table of Contents
- Executive Summary
- Client Overview
- Business Challenges
- Business Objectives
- Solution Strategy
- Records and Tools Used
- Implementation Process
- Business Results
- Lessons Learned
- Frequently Asked Questions
- Conclusion
Executive Summary
A cost audit obligation reached a Kerala engineering manufacturer in a year when nothing about its operations had changed. Turnover had grown steadily across three good years. That growth carried the company past the thresholds in the Companies Cost Records and Audit Rules 2014, and a requirement that had never applied to it suddenly did.
The directors knew the company well. They did not know that the Companies Act carries an audit requirement separate from the statutory audit they had filed for years.
JPKAD & Associates was engaged after a supplier mentioned its own cost auditor in conversation. The question reached the board, and nobody could answer it.
Work covered four things. Testing applicability against the rules, identifying which products carried the requirement, building cost records in the prescribed format, and supporting the appointment and the two filings that follow.
The company met its obligation for the year. Costing now runs as a monthly routine inside the plant rather than as an annual reconstruction from the financial ledger.
Has your turnover grown past a threshold nobody checked? Explore our advisory work.
Client Overview
The client manufactures engineered components at a plant in Kerala. It supplies industrial customers across South India and exports a modest volume to the Gulf. Ownership sits with a family, with two directors active in the business.
The product range runs to several dozen items across three broad groups. Most share the same machines and the same people, which matters more than it sounds.
Growth had been steady rather than sudden. Three consecutive good years moved overall turnover past the level at which the rules begin to apply.
The finance function is a controller, two accounts staff and a plant accountant. Statutory audit, income tax and goods and services tax work were handled competently and on time.
What did not exist was costing. Pricing decisions were made on a rule of thumb the promoters had used for years, and it had served the business reasonably well. Building a costing structure underneath the financial accounts is part of our management consultancy work.
Concept: Infographic showing the two separate tests under the Companies Cost Records and Audit Rules 2014, the cost records requirement and the cost audit requirement, with the sequence of appointment, report and filing that follows | File: cost-audit-applicability-infographic.webp
ALT: Infographic showing how cost audit applicability is tested under the 2014 rules
Caption: Two tests, not one. Many companies check only the first.
Text alternative: Sequence by which cost audit obligations arise for an Indian company. Section 148 of the Companies Act 2013 allows the Central Government to direct that particulars relating to cost be included in the books of account for prescribed classes of companies. The Companies Cost Records and Audit Rules 2014 set out two tables of covered activities. Table A lists regulated sectors including telecommunication, electricity, petroleum, drugs and pharmaceuticals, fertilisers and sugar. Table B lists sectors outside that regulated list, including machinery, steel, cement, rubber and a range of engineering activities. The first test is the cost records test under Rule 3. A company carrying on an activity in either table must maintain cost records where its overall turnover from all products and services in the immediately preceding financial year was rupees thirty five crore or more. The second test is the cost audit test under Rule 4, and it is separate. For Table A activities cost audit applies where overall turnover was rupees fifty crore or more and the aggregate turnover of the individual covered products or services was rupees twenty five crore or more. For Table B activities the corresponding figures are rupees one hundred crore or more and rupees thirty five crore or more. Rule 4 also sets out exemptions, including a company whose revenue from exports in foreign exchange exceeds seventy five percent of total revenue, a company operating from a special economic zone, and a company generating electricity for captive consumption. Where cost audit applies the board appoints a cost accountant under Section 148, intimates the appointment in Form CRA 2, receives the report in Form CRA 3, and files it with the Central Government in Form CRA 4.
Business Challenges
Nothing had gone wrong. A set of obligations had attached to a business that had grown, and none of the records the rules contemplate had ever been created.
Four problems had to be solved, and the financial year had already closed when the question was first asked.
Why did cost audit apply when the statutory audit was already done?
Because they are different requirements serving different purposes. The statutory audit reports on whether the financial statements give a true and fair view.
Cost audit examines whether cost records have been kept as prescribed, and whether the cost statements agree with those records.
Section 148 of the Companies Act 2013 is the source, and the Companies Cost Records and Audit Rules 2014 carry the detail on who is covered.
The directors had assumed one audit covered everything. That assumption is common in owner managed manufacturing, and the rules do not work that way.
Which products actually fell within the cost records requirement?
That question took longer than expected. The rules attach to activities listed in the tables, not to the company as a whole.
Two of the three product groups fell squarely inside a listed activity. The third was a trading line the company bought in and resold without processing.
Turnover had been reported to the board as a single figure for years, so nobody had a split that matched the way the rules are written.
Getting that split right mattered twice over, because the individual product threshold in Rule 4 is tested separately from the overall turnover threshold.
Why were the existing accounts not enough?
Because the financial ledger records what was spent, not what each product consumed. Those are different questions.
Power, stores, repairs and supervision were held in plant level accounts with no allocation to products at all.
Form CRA 1 sets out the items of cost the records must capture, including material, employee cost, utilities, repairs, depreciation and overheads, each treated in a prescribed way.
None of that structure existed. The company had accurate financial accounts and no costing system underneath them.
What was at stake if the position was left unaddressed?
Default under Section 148 draws the penalty provisions in Section 147, which reach the company and its officers separately.
There is also a practical consequence that concerned the directors more. A first year default tends to invite questions about earlier years.
The board wanted the position regularised cleanly rather than argued, and it wanted the first report filed without a modified opinion attached to it.
Doing that required real records for the year, not a document assembled after the fact to satisfy a filing.
Not sure whether the cost rules reach your products? Read more about our audit and assurance services.
Business Objectives
The instruction from the board was to establish the position on the facts, meet the obligation for the year, and leave the plant able to produce costing data every month without outside help.
What did the company need to settle first?
A written answer on whether the rules applied at all, and to which products. The directors asked for that before any other work was commissioned.
A turnover split that matched the activity descriptions in the tables rather than the internal reporting groups the business used.
Cost records for the year in the prescribed form, capable of supporting a report rather than merely existing.
And clarity on the appointment, because the board had to act and the deadline for intimation was already running against it.
Why was the appointment treated as a board matter?
Because Section 148 requires the board to appoint the cost auditor, and the remuneration is fixed by the board and then ratified by the shareholders.
It is not an administrative step that the finance function can complete on its own, and treating it that way creates a defect in the appointment itself.
The statutory auditor cannot hold the role, so the company could not simply extend its existing engagement.
The board also wanted the appointment minuted properly, since the intimation in Form CRA 2 refers back to the board resolution.
What defined success for this engagement?
Cost records maintained in the prescribed form for the full financial year, reconciled to the audited financial statements.
A cost auditor appointed within time, intimated in Form CRA 2, with the report received in Form CRA 3 and filed in Form CRA 4.
A monthly costing routine the plant accountant could run, so the second year would be a review rather than a rebuild.
And a product level view of cost the directors could actually use when they priced work, which none of them had ever had. The appointment and intimation steps sit inside our company law matters and compliances work.
Want the first year handled so later years follow a pattern? Explore our approach.
Solution Strategy
Work followed the order the rules do. Establish applicability, split turnover by covered activity, build the cost record structure, then appoint and support the cost auditor. Reconciliation ran alongside rather than at the end.
Nothing was taken from the internal product grouping. Each line was tested against the activity descriptions in the tables rather than assumed to fit.
How was applicability tested against the rules?
By reading the two tables against what the plant actually makes, using process descriptions and customer specifications rather than catalogue names.
Rule 3 was applied first to settle whether cost records were required at all, which turns on overall turnover in the immediately preceding year.
Rule 4 was then applied separately, because the cost audit threshold is higher and it tests the covered products on their own as well.
The exemptions in Rule 4 were checked rather than assumed away. Export revenue was well below the level that would have released the company.
How were products mapped to the covered activities?
Through a line by line exercise against the sales ledger, with the plant manager present, because the description that matters is the process rather than the label.
Each item was assigned to a listed activity or excluded with a written reason. The bought in trading line was excluded and the reasoning recorded.
The turnover split was then rebuilt on that basis and reconciled back to the audited revenue figure so the two agreed.
That reconciliation is the document the cost auditor asked for first, and having it ready saved a week of correspondence later.
How was the cost accounting structure built?
By following the items of cost set out in Form CRA 1 and creating a cost centre structure underneath the existing chart of accounts.
Material cost came through directly from consumption records. Employee cost was split between production, maintenance and administration on attendance data.
Utilities were the difficult one. A single electricity connection served the whole plant, so machine ratings and running hours were used to allocate power.
Repairs, stores, depreciation and supervision were assigned on bases that were documented once and applied consistently, which is what the rules expect.
How was the cost auditor appointed?
The company had to appoint a cost accountant in practice, because Section 148 reserves the role to that profession and the statutory auditor is barred from it.
Two firms were approached, and the board considered independence and availability before it resolved on one of them.
The appointment was made by board resolution with remuneration fixed, and shareholder ratification was placed on the agenda for the general meeting.
Form CRA 2 was then filed to intimate the Central Government, within the period the rules allow for that intimation.
How was reconciliation with the financial accounts handled?
By building the reconciliation as the cost records were built, rather than attempting to tie two finished sets of numbers together afterwards.
Every allocation base was recorded with the reason for choosing it, so a difference could be explained rather than merely identified.
Items that sit in the financial accounts but not in product cost, such as finance cost and certain provisions, were listed and reconciled as such.
The cost auditor tests exactly this agreement, and a reconciliation prepared late is where most first year engagements lose time.
[IMAGE PLACEHOLDER]
Concept: Diagram of the cost record structure showing material, employee cost, utilities, repairs, depreciation and overheads flowing through cost centres to product cost, with the reconciliation line back to audited financial accounts | File: cost-records-structure-cra-1.webp
ALT: Cost record structure built to Form CRA 1 for a cost audit
Caption: The reconciliation back to audited accounts is built alongside, never afterwards.
Do your accounts show what was spent but not what each product consumed? Read more about our accounting and financial reporting.
Records and Tools Used
This was a records exercise before it was an analytical one. Most of what the cost file needed already existed somewhere in the plant, in a form nobody had brought together.
Which records had to exist before the audit?
Production records showing quantity produced by item, which the plant kept for its own scheduling and had never shared with finance.
Material consumption records tied to production, reconciled to purchases and closing stock so the quantities agreed in both directions.
Attendance and payroll data split by function, which allowed employee cost to be allocated rather than treated as a single overhead.
Machine logs with running hours, which became the basis for allocating power and depreciation across products sharing the same equipment.
How was the costing data produced each month?
Through a monthly routine rather than an annual exercise, because the rules contemplate records kept on a regular basis.
The plant accountant closes production and consumption quantities in the first week, and the controller applies the agreed allocation bases.
Output is a product level cost statement that ties to the trial balance for the same month, with differences listed rather than absorbed quietly.
The accounting software already held the data. What it lacked was a cost centre structure, and adding that took configuration rather than new systems.
How is the cost records file organised?
In the order of the items of cost in Form CRA 1, so each prescribed element has a place rather than sitting inside a general folder.
Product mapping and the turnover split come first, with the written reasoning for inclusion and exclusion attached.
Allocation bases and the reason for each follow, then the monthly cost statements, then the annual reconciliation to audited accounts.
Supporting production and machine records sit behind an index, so any figure can be traced without reassembling the file.
Implementation Process
The engagement ran across roughly twelve weeks, and it was compressed because the question arrived after the financial year had closed. The same work done during the year would have been considerably lighter.
The first fortnight settled applicability, which the board had asked to resolve before committing to anything further.
How was the applicability question settled?
By testing the activity descriptions and both turnover thresholds on documented figures, then recording the conclusion in writing with reasons.
The answer was not obvious at the outset, because the trading line inflated overall turnover while contributing nothing to the covered product test.
Once that line was separated, the position was clear and the board could see why it had changed in this year and not earlier.
That written conclusion went to the directors before further work was commissioned, so the decision to proceed was theirs on the facts.
How was the first costing period closed?
By rebuilding one representative month first, end to end, rather than attempting the whole year at once.
That trial month exposed two problems early. Consumption records did not tie to production for one product group, and the power allocation ignored a compressor running continuously.
Both were corrected before the remaining months were processed, which is why the later months took days rather than weeks.
Rebuilding a year backwards is possible where the underlying quantity records are sound. Where they are not, it becomes guesswork and a cost auditor will say so.
How was the cost auditor supported during fieldwork?
With a single reconciliation pack handed over at the start, covering the product mapping, the turnover split and the tie back to audited accounts.
Queries were routed through the controller and logged, so the same question was not answered twice in different ways by different people.
Plant staff were made available for the walkthrough, because allocation bases are tested against what actually happens on the floor.
The cost auditor formed an independent view and the company did not attempt to direct it. That separation is the point of the appointment.
How were the filings completed?
Form CRA 2 had already been filed at the appointment stage, intimating the Central Government of who had been appointed and for which year.
The report in Form CRA 3 was submitted by the cost auditor to the board within the period the rules allow after the year closed.
The company then filed the report with the Central Government in Form CRA 4, within thirty days of receiving it, and kept the acknowledgement.
Shareholder ratification of the remuneration was completed at the general meeting, closing the appointment chain the rules set out.
[IMAGE PLACEHOLDER]
Concept: Twelve week engagement sequence showing applicability assessment, product mapping, cost structure build, trial month, full year rebuild, appointment, fieldwork and the CRA filings | File: cost-audit-engagement-sequence.webp
ALT: Engagement sequence for a first year cost audit at a Kerala manufacturer
Caption: Twelve weeks after year end. During the year it is a monthly routine.
Facing a first cost audit year with the filing date approaching? Explore how we can help.
Business Results
Results are described here as direction of change rather than in figures. Compliance outcomes depend on the records, on the facts and on the view the authorities take, and figures would suggest a precision that is not there.
What follows is what the company reported once the first cycle had closed.
What changed about the compliance position?
Cost records now exist for the full year in the prescribed form, reconciled to the audited financial statements and indexed so that any figure can be traced back to its source.
The appointment chain is complete and documented, from board resolution through intimation to shareholder ratification.
The report was received and filed within the periods the rules allow, and the acknowledgements are on file with the records they relate to.
Exposure under the penalty provisions was addressed by meeting the requirement rather than by arguing that it did not apply. Our case study on internal financial controls in a first reporting year follows a similar first year obligation at a Kerala manufacturer.
What changed about how the plant reports cost?
Production, consumption and machine hours now reach finance every month instead of staying inside the plant’s own scheduling records.
Allocation bases are written down and applied consistently, so a change in product cost can be explained by something that actually happened.
The compressor that had been missed from the power allocation turned out to matter for one product group in particular.
Costing is now produced alongside the monthly financial close rather than being treated as a separate annual project.
What changed inside the finance function?
The plant accountant runs the monthly costing routine, with the controller reviewing the allocations rather than preparing them.
Year end work has become review and support for the cost auditor, instead of reconstruction of records that should already exist.
The reconciliation between cost and financial accounts is prepared monthly, so differences surface while anyone still remembers the cause.
A short checklist covers what to do if turnover or the product mix moves, which is the event that created this exercise.
What changed for the board?
The directors can see cost at product level for the first time, which changed two pricing conversations almost immediately.
One product group was carrying more overhead than the promoters had assumed when they set its price years earlier.
Threshold tests are now part of the annual planning discussion rather than something discovered through a supplier’s passing remark.
The board treats cost audit as a standing compliance item with a named owner and a review date, which it had not been before.
Want product level cost you can price against? Speak to us about a threshold review.
Lessons Learned
Nothing here needed an unusual reading of the law. It needed somebody to test a growing business against a rule that had been sitting there all along.
What surprised the company most?
That cost records and cost audit are two separate tests with two different thresholds, and that a company can fall inside one without the other.
That the trading line inflated overall turnover while contributing nothing to the covered product test, which changed the answer entirely.
Nobody had realised the statutory auditor could not take the cost audit role. The directors had assumed the existing engagement could simply be widened.
The plant also turned out to hold most of the data required, which meant the gap was in structure rather than in information.
What worked better than expected?
Rebuilding one representative month before attempting the year. It exposed two errors early, when correcting them was still cheap.
Settling applicability in writing before any other work started. It gave the board a decision point and framed the whole engagement.
Recording the reason for every allocation base. That file answered most of the cost auditor’s queries before they were asked.
Involving the plant manager in product mapping. Finance would have mapped several items to the wrong activity on catalogue descriptions alone.
What would be done earlier next time?
The threshold test would run at the start of each year, as part of planning, rather than after the year has closed.
The turnover split by covered activity would be maintained continuously, since it drives both tests and takes very little effort monthly.
Machine logs and consumption records would be reconciled from the first month, because that is where a backward rebuild breaks down.
The cost auditor would be approached earlier, so the appointment and intimation are not squeezed against a deadline.
What should other Kerala manufacturers check?
Check whether any product line sits inside the activity tables, reading the process description rather than the name used internally.
Test overall turnover for the immediately preceding year against the cost records requirement, and then the covered products separately against the audit requirement.
Look at whether traded goods are inflating the overall figure while contributing nothing to the product level test.
Check who would sign, because the role is reserved to a cost accountant and the company’s existing auditor cannot fill it. The wider compliance picture is set out in our note on building a strong compliance framework.
Frequently Asked Questions
What is cost audit and how is it different from statutory audit?
Cost audit examines whether a company has kept cost records as prescribed, and whether its cost statements agree with those records. Statutory audit reports on whether the financial statements show a true and fair view. They are separate requirements under the Companies Act, they are conducted by different professions, and meeting one does nothing to satisfy the other.
Which companies have to maintain cost records?
Companies carrying on activities listed in the two tables of the Companies Cost Records and Audit Rules 2014, where overall turnover from all products and services in the immediately preceding financial year reached the level the rules set. Table A covers regulated sectors and Table B covers a wide range of manufacturing and engineering activities outside that list.
Is cost audit required for every company that keeps cost records?
No, and this is the point most companies miss. Cost records and cost audit are tested separately. The cost audit thresholds in Rule 4 are higher, and they test the covered products or services on their own as well as overall turnover. A company can be required to keep records without being required to have them audited.
Who can be appointed as a cost auditor?
A cost accountant in practice, appointed by the board under Section 148. The role is reserved to that profession, so a chartered accountant cannot sign a cost audit report. The company’s statutory auditor is barred from the role as well, which means an existing audit engagement cannot simply be extended to cover it.
What is Form CRA 2 and when is it filed?
It is the intimation to the Central Government of the cost auditor’s appointment, filed by the company after the board resolves on it. The rules set the period within which it must be filed, running from the board meeting or from the start of the financial year. It refers back to the board resolution, so the appointment must be minuted properly first.
What are Form CRA 3 and Form CRA 4?
Form CRA 3 is the cost audit report itself, submitted by the cost auditor to the board of directors after the financial year closes. Form CRA 4 is the company’s filing of that report with the Central Government, made within thirty days of receiving it. The two are separate steps and the second is the company’s responsibility, not the auditor’s.
Can cost records be prepared at the end of the year?
The rules contemplate records kept on a regular basis through the year, in the format Form CRA 1 sets out. A backward rebuild is possible where production, consumption and machine records are sound, because the quantities can be reconstructed. Where those underlying records are weak it becomes estimation, and a cost auditor will report that position rather than accept it.
Are any companies exempt from cost audit?
Rule 4 sets out exemptions, including a company whose revenue from exports in foreign exchange exceeds the prescribed share of total revenue, a company operating from a special economic zone, and a company generating electricity for captive consumption. These should be tested on documented figures rather than assumed, since a near miss on the export share leaves the requirement fully in place.
What happens if a company does not comply?
Default under Section 148 attracts the penalty provisions in Section 147, which reach the company and its officers separately. There is a practical consequence too. A first year default tends to draw questions about earlier years, so a company that regularises the position cleanly is usually in a better place than one that argues applicability after the event.
How long does a first year cost audit exercise take?
This one ran about twelve weeks, and it was compressed because the question arrived after the financial year had closed. Applicability testing and product mapping take days. Building the cost structure, rebuilding the year and reconciling to audited accounts take most of the time. Run as a monthly routine during the year, the same work is far lighter.
Conclusion
Cost audit reached this Kerala manufacturer because it grew, not because it changed what it does. Three steady years moved turnover past a threshold in rules that had been sitting in the Companies Act the whole time, and nobody inside the business had been testing against them. The two part structure is what caught the company out. Cost records and cost audit are separate requirements with separate thresholds, and a trading line that contributed nothing to the covered products was quietly inflating the figure everyone looked at. Once that line was separated the position became clear. The work took about twelve weeks because it began after the year had closed. Run during the year, alongside the monthly close, it is a routine the plant accountant handles and the controller reviews. The company also got something it had never had, which is a view of what each product actually consumes. If your turnover has grown materially in the last two years, the question worth answering this month is whether any of your products sit inside those activity tables, and what your turnover looks like once traded goods are stripped out. JPKAD & Associates advises manufacturers on audit, assurance and compliance, and you can read more through the contact page.