Understanding Cost Audit Applicability for MSMEs and Manufacturing Businesses
Updated: Sep 10
Every year, around September, a familiar conversation plays out in finance departments across India. The Company Secretary circulates a board agenda item on appointing a cost auditor. Someone asks whether the company actually needs one. Another person mentions that the turnover has changed since last year. A third person points out that most of the sales are exports, so surely the requirement falls away.
Three weeks later, the appointment is made in a hurry. Form CRA-2 is filed with additional fees, and nobody has actually gone back to the rule book to check whether the company should have been maintaining cost records for the last two years in the first place.
This article aims to clarify that conversation. It sets out how cost audit applicability is determined under Section 148 of the Companies Act, 2013, read with the Companies (Cost Records and Audit) Rules, 2014. We will discuss the tests, thresholds, exemptions, traps, deadlines, and the consequences of getting it wrong.
If you are a CFO, Finance Head, or Financial Controller of an Indian manufacturing or service company, this is a compliance area you own personally. You are an "officer in default" if it goes wrong.
Why This Matters Right Now
For companies with a March year-end, two clocks are running simultaneously in September:
The cost audit report for FY 2025-26 must reach your Board within 180 days of the close of the financial year — on or before 27 September 2026.
The cost auditor for FY 2026-27 must be appointed and intimated in Form CRA-2 within 180 days of the commencement of the financial year — also on or before 27 September 2026.
Miss the second one, and you cannot fix it retrospectively. There is no provision to appoint a cost auditor for a year that has already substantially elapsed without carrying the default. The appointment window is the one deadline in this entire framework that genuinely cannot be recovered.
The Single Most Important Distinction: Records Versus Audit
Almost every mistake I see in practice comes from collapsing two separate obligations into one. They are not the same thing; they have different thresholds and exemptions.
A company can be required to maintain cost records without being required to undergo a cost audit. This is the norm, not the exception. Roughly speaking, for every company under cost audit, there are several more that must maintain records but are below the audit thresholds. The reverse is never true. If cost audit applies, cost records necessarily apply.
Work through the tests in sequence. Step 1 first, always.
Step 1 — Do You Need to Maintain Cost Records?
Rule 3 covers a company (including a foreign company as defined under Section 2(42)) that is:
Engaged in the production of goods or provision of services listed in the Rule 3 Table, and
Has overall turnover from all its products and services of ₹35 crore or more in the immediately preceding financial year.
The Rule 3 Table is split into two items, and this split matters enormously later.
Item (A) — Regulated Sectors (6 entries)
# | Sector |
1 | Telecommunication services regulated by TRAI |
2 | Generation, transmission, distribution and supply of electricity |
3 | Petroleum products, including activities regulated by PNGRB |
4 | Drugs and pharmaceuticals |
5 | Fertilizers |
Item (B) — Non-Regulated Sectors (33 entries)
This is a long list, and it is far wider than most CFOs assume. It includes machinery and mechanical appliances for defense, space and atomic energy; turbo jets and turbo propellers; arms, ammunition, and explosives; radar and radio navigational apparatus; port services; aeronautical services; iron and steel; roads and infrastructure projects; rubber and allied products; coffee and tea; railway and tramway rolling stock; cement; ores and mineral products; mineral fuels and oils; base metals; inorganic and organic chemicals; jute products; edible oil; construction; health services (hospitals, diagnostic centers, laboratories); education services; milk powder; insecticides; plastics and polymers; tyres and tubes; paper, pulp and paper; textiles; glass; other machinery and mechanical appliances; electrical or electronic machinery; and a specified list of medical devices.
Look closely at entries 31 and 32 — "Other machinery and Mechanical Appliances" (CTA 8402 to 8487) and "Electricals or electronic machinery" (8501 to 8547). Between them, these two entries sweep in an enormous share of Indian engineering and capital goods manufacturing. If you make pumps, compressors, valves, machine tools, industrial equipment, motors, transformers, switchgear, panels, or cables, you are very likely inside Rule 3.
The MSME Exemption — Read the Proviso Carefully
Rule 3 carries a proviso: nothing in the rule applies to a company classified as a micro enterprise or a small enterprise, including as per the turnover criteria under Section 7(9) of the MSMED Act, 2006.
Two things CFOs consistently get wrong here:
Medium enterprises are not exempt. The exemption stops at "small." A medium enterprise is fully covered.
Classification under the MSMED Act is composite — both investment in plant and machinery and turnover must be within the limits. A company can breach the small-enterprise turnover limit while its investment is modest, and it is then no longer small.
Also note where the real decision now sits. Since 1 April 2025, a small enterprise is one with investment in plant and machinery up to ₹25 crore and turnover up to ₹100 crore. Because the Rule 3 threshold is ₹35 crore, there is now a wide band — roughly ₹35 crore to ₹100 crore of turnover — in which cost records applicability turns entirely on the investment limb of the composite test. Two companies with identical ₹70 crore turnover can fall on opposite sides of Rule 3 depending on how capital-intensive they are. One further point: exports are excluded when computing turnover for MSME classification, so an export-heavy company may remain "small" on the MSMED computation even at high total revenue.
A separate carve-out: for serial number 33 (medical devices), the rules do not apply to foreign companies having only liaison offices in India.
Step 2 — Do You Need a Cost Audit?
If Rule 3 applies, move to Rule 4. Two conditions must be satisfied cumulatively — both, not either.
Regulated Sectors (Item A) | Non-Regulated Sectors (Item B) | |
Overall annual turnover of the company from all products and services | ₹50 crore or more | ₹100 crore or more |
Aggregate turnover of the individual product(s) or service(s) covered under Rule 3 | ₹25 crore or more | ₹35 crore or more |
Both conditions must be met | Yes | Yes |
Both tests are applied on the immediately preceding financial year's figures. So the cost auditor you appoint in September 2026 for FY 2026-27 is appointed based on your FY 2025-26 numbers.
Three Nuances in Rule 4 That Are Routinely Missed
1. The second threshold is an *aggregate*, not a per-product test. The rule says "the aggregate turnover of the individual product or products or service or services for which cost records are required to be maintained." You add up the turnover of all covered products and compare that total to ₹25 crore or ₹35 crore. You do not test each SKU individually. A company with eight covered products of ₹6 crore each has ₹48 crore of covered turnover, not eight products that each fall below the line.
2. "Overall turnover" means everything — including uncovered and traded goods. The first threshold is turnover "from all its products and services." Trading revenue, service income, revenue from products outside the Rule 3 Table — all of it counts towards the ₹50 crore / ₹100 crore test. Only the second threshold is restricted to covered products.
3. A company with both regulated and non-regulated products applies both tests separately. The same company-wide overall turnover figure is compared against ₹50 crore for the Item (A) test and ₹100 crore for the Item (B) test, while each covered-product aggregate is tested against its own limit. It is entirely possible for cost audit to apply to your pharmaceutical division and not to your engineering division, or the other way round.
What Counts as "Turnover"?
Section 2(91) defines turnover as the gross amount of revenue recognized in the profit and loss account from the sale, supply, or distribution of goods, or on account of services rendered, or both, during a financial year. In practice this means:
Take revenue from operations, net of GST.
Include export sales, sales to SEZ units, deemed exports, traded goods, scrap sales that are part of operating revenue, job work income, and other operating revenue.
Exclude other income — interest, dividend, forex gains, profit on sale of assets.
Use the standalone company figures. This is a company-level test, not a group or consolidated test. Each subsidiary is assessed independently.
Where the classification of a revenue line is genuinely arguable, document the basis of your determination in a note approved by the Audit Committee. If the position is later questioned, contemporaneous reasoning is worth a great deal.
The Rule 4(3) Exemptions — And the Trap Inside Them
Cost audit is not required for a company otherwise covered by Rule 3 if:
Its revenue from exports, in foreign exchange, exceeds 75% of its total revenue; or
It is operating from a Special Economic Zone; or
It is engaged in generation of electricity for captive consumption through a Captive Generating Plant (as defined in Rule 3 of the Electricity Rules, 2005).
Now the trap, and it is the single most expensive misunderstanding in this entire area:
These exemptions apply to cost *audit* only. They do not exempt the company from maintaining cost records under Rule 5.
An export-oriented unit with 90% export revenue is still required to maintain cost records in Form CRA-1. It simply does not need them audited. Your statutory auditor is required to report on this under CARO 2020, and "we are exempt" is not a defense, because the exemption you are relying on was never an exemption from record-keeping.
Two further points on the export test:
The requirement is exports in foreign exchange. Supplies to SEZ units billed in Indian rupees and deemed exports do not count towards the 75%, even though they may be zero-rated under GST. This trips up a lot of companies whose "export" percentage looks comfortably above 75% until the forex filter is applied.
The test is on total revenue, and it must exceed 75% — exactly 75.0% does not qualify.
Worked Examples
Company A — Engineering, Pune, Maharashtra. Manufactures industrial pumps (CTA 8413, covered under Item B entry 31). FY 2025-26 revenue from operations: ₹62 crore, entirely from pumps. Investment in plant and machinery ₹40 crore, so it exceeds the ₹25 crore small-enterprise limit and is a medium enterprise — not exempt under the Rule 3 proviso. Rule 3: Overall turnover ₹62 crore > ₹35 crore, covered product → cost records required. Rule 4: Overall turnover ₹62 crore < ₹100 crore → cost audit not required. Outcome: Maintain CRA-1 records. No cost auditor. Statutory auditor will report under CARO 2020 clause (vi).
Company B — Pharmaceutical formulations, Sanand, Gujarat. FY 2025-26 revenue: ₹140 crore, of which ₹95 crore is drugs and pharmaceuticals (Item A entry 4) and ₹45 crore is trading of packaging materials. Rule 3: ₹140 crore > ₹35 crore → records required for the pharma products. Rule 4(1): Overall turnover ₹140 crore > ₹50 crore ✓ and covered product aggregate ₹95 crore > ₹25 crore ✓ → cost audit required. Outcome: Appoint a cost auditor. Note that the trading turnover pushed the overall figure higher but does not itself enter the ₹25 crore test.
Company C — Chemicals, Ankleshwar, Gujarat. FY 2025-26 revenue: ₹180 crore of organic chemicals (Item B entry 18). Exports in foreign exchange: ₹150 crore (83.3% of total revenue). Rule 3: → records required. Rule 4: Both thresholds crossed, but exports in forex exceed 75% → cost audit exempt under Rule 4(3)(i). Outcome: Full CRA-1 cost records must still be maintained. No cost audit. If export share drops to 70% next year, cost audit applies for the following financial year — and the company had better have the records to audit.
The Compliance Calendar and the Four CRA Forms
Form | Purpose | Timeline |
CRA-1 | Format in which cost records must be maintained | Continuous, on a regular basis — monthly, quarterly, half-yearly or annually |
CRA-2 | Intimation of appointment of cost auditor to the Central Government | Within 30 days of the Board meeting making the appointment, or within 180 days of commencement of the financial year, whichever is earlier |
CRA-3 | Cost audit report by the cost auditor to the Board | Within 180 days from the closure of the financial year |
CRA-4 | Filing of the cost audit report with the Central Government, in XBRL | Within 30 days of receipt of the cost audit report |
For a March year-end company, that means: CRA-2 by 27 September of the audit year; CRA-3 by 27 September following the year-end; CRA-4 by roughly 27 October.
Note the CRA-2 wording — "whichever is earlier." If your Board appoints the cost auditor in its May meeting, the 30-day clock runs from May, and you cannot wait until September. A large share of CRA-2 defaults arises from reading "180 days" and ignoring the 30-day limb.
Relief Where the AGM is Extended. Where a company has obtained an extension of its AGM under Section 96(1), it may file CRA-4 within the resultant extended period available for filing financial statements under Section 137.
The 2025 Form Changes. MCA notified the Companies (Cost Records and Audit) Amendment Rules, 2025 (G.S.R. 361(E) dated 30 May 2025), substituting Forms CRA-2 and CRA-4 with effect from 14 July 2025. The revised CRA-2 requires the nature of the appointment (fresh appointment, re-appointment, or other) and an explicit confirmation that the cost auditor's consent has been obtained. The revised CRA-4 captures lead auditor status where multiple cost auditors are appointed, AGM extension details including the GNL-1 SRN and revised AGM date, whether there has been a change in the financial year, and disclosures split between regulated and non-regulated sectors.
Update your internal checklists and board resolution templates accordingly. Several of these are fields your Company Secretary will need from finance well before the filing date.
Note that the amendment substituted the forms only. The turnover thresholds in Rules 3 and 4 were not changed and remain as set out above. There has been some inaccurate commentary online suggesting the thresholds were revised upward in 2025 — they were not. Rely on the gazette notification, not on secondary summaries.
Governance: Who Appoints, Who Fixes the Fee, Who Cannot Be Appointed
Appointment. The Board of Directors appoints the cost auditor. Only a Cost Accountant in practice — an individual holding a valid Certificate of Practice, or a firm or LLP of cost accountants — is eligible.
Before Appointment, the company must obtain from the proposed cost auditor:
Written consent to the appointment; and
A certificate confirming eligibility and absence of disqualification under the Act and the Cost and Works Accountants Act, 1959; that the criteria in Section 141 are satisfied so far as applicable; that the appointment is within the prescribed ceiling limits; and that the list of pending professional conduct proceedings disclosed is true and correct.
Remuneration. Under Rule 14 of the Companies (Audit and Auditors) Rules, 2014, where the company is required to constitute an Audit Committee, the Committee recommends the remuneration, the Board considers and approves it, and it is subsequently ratified by the shareholders. Where no Audit Committee is required, the Board determines the remuneration and shareholders ratify it. Build the ratification item into your AGM agenda — it is a commonly missed step.
Who Cannot Be Appointed. The statutory (financial) auditor appointed under Section 139 cannot be appointed as the cost auditor. The disqualifications in Section 141 apply, as do the restrictions on prohibited services in Section 144.
Removal and Casual Vacancy. A cost auditor may be removed before the expiry of the term through a Board resolution, after giving a reasonable opportunity of being heard and recording reasons in writing; the CRA-2 filed for the replacement must enclose the relevant Board resolution. Any casual vacancy — resignation, death, or removal — must be filled by the Board within 30 days, with CRA-2 filed within 30 days of the new appointment.
Board Approval of Cost Statements. The cost statements and other annexures to the cost audit report must be approved by the Board before being signed on behalf of the Board by an authorized director and submitted to the cost auditor for reporting. This is a real Board agenda item, not a formality to be handled at the last minute.
Fraud Reporting. Section 143(12) applies mutatis mutandis to the cost auditor. Your cost auditor carries the same fraud reporting obligation as your statutory auditor.
What Non-Compliance Actually Costs
Section 148(8) routes the penalty through Section 147:
The company: fine of not less than ₹25,000, extending up to ₹5,00,000.
Every officer of the company who is in default: fine of not less than ₹10,000, extending up to ₹1,00,000. (Imprisonment under this limb was removed by the Companies (Amendment) Act, 2020.)
The cost auditor, for contravention of Sections 148(5), (6), or (7), is separately liable under Sections 147(2) to (4).
Beyond the statutory penalty, the practical costs are usually larger:
MCA additional fees on delayed CRA-2 and CRA-4 filings, which escalate with the period of delay.
CARO 2020 reporting. Clause 3(vi) requires your statutory auditor to state whether maintenance of cost records has been specified by the Central Government under Section 148(1) and whether such accounts and records have been made and maintained. A negative remark sits permanently in your audited financial statements, where lenders, investors, rating agencies, and acquirers will read it.
Due diligence exposure. In transaction due diligence, an unremedied cost records default becomes a disclosed contingency and a negotiating point.
Continuing default. Each financial year of non-compliance is a fresh default. A company that has not maintained cost records for four years is not carrying one default; it is carrying four.
A Readiness Checklist for the CFO
Run this annually, ideally in April or May — not in September.
Confirm the applicability determination in writing. Map your revenue lines to CTA headings, test against Rule 3 and Rule 4, and place a signed note on file. Refresh it every year; applicability is dynamic.
Check MSME status separately. Confirm current Udyam classification and whether the small-enterprise limits are still met on a composite basis.
Verify the export percentage on a forex basis, not a zero-rated-supply basis, if you are relying on Rule 4(3)(i).
Assess whether your ERP can actually produce CRA-1 records. Product-wise and unit-wise cost of production, capacity utilization, normal capacity, cost center-wise allocation, utility costing, related party transaction pricing at normal price, and reconciliation of cost and financial accounts. Most standard ERP implementations require configuration work — and in SAP terms, that means a Controlling module that has actually been set up for product costing, not just cost center accounting.
Reconcile cost records to financial accounts every quarter, not once at year-end. The year-end reconciliation is where unpleasant surprises surface.
Diarise the September dates in the board calendar in April.
Obtain consent and the eligibility certificate early — before the Board meeting, not after it.
Add cost auditor remuneration ratification to the AGM agenda.
Brief the Audit Committee on the applicability position and any qualifications in the prior year's cost audit report.
The Part Most CFOs Eventually Come Round To
I will not pretend that cost audit is a value-creating exercise for every company. For some, it is a compliance cost, and it should be run efficiently as such.
But for a manufacturing business under real margin pressure, the CRA-1 discipline forces something that most finance functions never quite get around to: product-level and unit-level cost visibility that reconciles to the audited financials.
The Annexure to the cost audit report requires an abridged cost statement per product, capacity utilization against normal capacity, a value addition statement, product-wise profitability, related party transactions benchmarked against normal price, and a full reconciliation between cost and financial profit. If you are producing that anyway, you have most of the raw material for a serious margin management exercise — the ability to answer, with audited numbers, which products actually make money, where unabsorbed fixed cost is sitting, whether your inter-unit transfer prices are defensible, and what your true cost of idle capacity is.
Companies that treat cost records as a filing exercise get a filing. Companies that treat them as a management information system get a costing capability, and they usually discover something about their product mix that they did not expect.
Where to Get Help
Cost audit applicability is one of those areas where the analysis is genuinely straightforward once done properly, and genuinely expensive when assumed. If you are unsure whether Rule 3 or Rule 4 applies to your company, the determination takes a few hours of work against your HSN-wise sales register and your audited financials.
D P Jadhav & Co., Cost & Management Accountant advises manufacturing companies across Maharashtra and Gujarat on cost records applicability, CRA-1 system design, statutory cost audit under Section 148, and the ERP and process work needed to make cost records genuinely useful rather than merely compliant.
For an applicability assessment for your company, write to contact@dpjadhav.com or visit www.dpjadhav.com.
This article reflects the position under the Companies Act, 2013 and the Companies (Cost Records and Audit) Rules, 2014 as amended, including the Companies (Cost Records and Audit) Amendment Rules, 2025 effective 14 July 2025. It is intended as general guidance and does not constitute professional advice. Applicability should be determined on the specific facts of each company. Readers should refer to the relevant MCA notifications and seek professional advice before acting.
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