Do company boards need cost audit?

Last Updated: Mon, Dec 10, 2012 03:50 hrs

pIn 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 &lsquosustainable competitive advantage&rsquo 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&rsquos 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 managementppThe view that the &lsquosustainable competitive advantage&rsquo 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 playersppIn 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 modelppTherefore the board of directors should pay attention to the efficiency and effectiveness of the cost accounting systemppThe government has ordered mandatory maintenance of cost accounting records by almost all companies that cross the threshold of specified turnover or net worthppMost 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 accountantppFor 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 managementppFor 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 accountantsppThe principles applied to determine the product cost might deviate from cost accounting principles Moreover audit of the marketcustomer profitability estimated by the cost accounting system is outside the scope of financial audit Therefore financial audit is not a substitute for the cost auditppWhen 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 strategiesppThe government has taken the right initiatives and now it is the responsibility of the boards of companies to take it forwardppThe author is professor and head School of Corporate Governance and Public Policy Indian Institute of Corporate Affairs Maneshar and advisor Advanced Studies Institute of Cost Accountants of Indiahr pp alignrightEmail a hrefmailtoasishbhattacharyyagmailcomasishbhattacharyyagmailcoma  p

More from Sify: