RECONCILIATION OF COST AND FINANCIAL ACCOUNTS NEED FOR RECONCILIATION OF COST AND FINANCIAL ACCOUNTS
Under non-integrated accounting system, separate set of books is maintained for financial accounting and cost accounting. Financial accounts and cost accounts are kept independent of each other and different approaches are adopted in their preparation. Because of this, profit disclosed under one set of accounts may differ from the profit shown under other set of accounts. The difference in profit figures shown in two sets of accounts necessitates the need to reconcile them. Financial accounts being the audited financial records, the reconciliation of the two sets of accounts will also establish the accuracy of cost accounts.
CAUSES OF DIFFERENCE
The reasons for difference in profit shown by cost and financial accounts can be broadly summarised in the following five categories:
1. Items included in financial accounts only : There are certain items of cost, revenue and appropriation of profits which are included in financial accounts only. In other words, these items do not appear in cost accounts. Because of inclusion in one set of accounts, the profit figure will differ in other set of accounts. These items can be classified as under :
(a) Purely financial charges or losses :
• Expenses (and or discount) on issue of shares, debentures, etc.
• Loss on sale of fixed assets/investments • Fines and penalties
• Interest on debentures, bank loans and mortgages • Cash discount allowed
(b) Purely financial incomes or gains :
• Profit on sale of fixed assets/investment
• Interest/dividends received on bank deposits/investments • Transfer fees received
• Rent received or receivable • Cash discount received
(c) Writing off intangible and fictitious assets:
• Goodwill
• Preliminary expenses • Patents & Copyrights • Advertisement
(d) Appropriations of profit:
• Dividend paid
• Income tax
• Transfer to reserves
• Donations and Charities
2. Items included in cost accounts only : There are certain cost which are not incurred in financial accounts but are allowed in cost accounts for the purpose of cost ascertainment. These are known as notional or imputed costs. The examples of such costs are :–
(i) Inetrest on capital allowed in cost accounts but not actually incurred.
(ii) Salary of owner-cum manager allowed in cost accounts but not actually paid.
(iii) Notional rent of own building.
(iv) Notional depreciation on the fully depreciated assets .
3. Under or over absorption of overheads, if transferred to next year’s accounts: In financial accounts all costs including overhead costs are charged on incurred basis whereas in cost accounts overheads may be charged on pre-determined overhead rates basis. This may result under or over absorption of overheads. Under or over absorption of overheads if adjusted in the same year either through the use of supplementary overhead rate or transferring to profit and loss account will not cause difference in profit between cost and financial accounts. However, if under or over absorption of overheads is carried forward through overhead adjustment account to next year then it will certainly result in a difference in profit between two sets of accounts.
4. Adoption of different basis of stock valuation : In financial accounts, stock (i.e., raw material, WIP, finished goods) is valued on the basis of the “cost or market value, whichever is lower”
principle whereas cost accounts either of the different methods like FIFO, LIFO, Weighted Average, etc. may be adopted. Work-in-progress may be valued at prime cost or at prime cost plus factory overheads. Sometimes in cost accounts stocks are valued at product cost which includes only variable cost of manufacturing. Hence, different methods of stock valuation may result in different values of opening and closing stocks of raw materials, WIP and finished goods in two sets of accounts. Profit in two sets will differ on this account.
5. Adoption of different methods of charging depreciation : In financial accounts, depreciation is charged on the basis of straight line method, written down value method, etc., whereas in cost accounts, depreciation may be charged on the basis of machine hours or production units. Hence, adoption of different methods of charging depreciation in two sets of accounts will also cause a difference in profit figures.
PREPARTION OF RECONCILIATION STATEMENT
After studying different reasons which causes difference in the amount of profits disclosed in two sets of accounts, there is a need to reconcile them. For the purpose, a statement known as reconciliation statement is prepared. This statement helps in judging the accuracy of both sets of accounts by reconciling their profit figures. At the outset it should be mentioned that reconciliation statement is a memorandum statement and is not a part of double entry system. Following simple procedure can be adopted for preparing this statement:–
1. Profit disclosed as per cost accounts can be taken as the starting point and the profit as per financial accounts can be arrived at by adding some items which has caused difference in profit and deducting the other items.
2. If we start with the profit figure as per cost accounts then assume it as base book profit. For loss write the figure in minus. Assume profit to be arrived as per financial accounts as profit disclosed in other set of books.
3. To find out which item is to be added or deducted, analyse each and every item or information given in the question and find its impact on the profit figure to be disclosed as per other set of book i.e., financial accounts here.
4. If the item given has resulted an increase in profit to be disclosed as per the other set of book (financial accounts) then increase the base book (cost accounts) profit by adding it’s amount.
5. On the other hand, if the item has caused a decrease in profit to be disclosed as per other set of books then decrease the base book profit as well by deducting the amount of the item.
6. The above process can be repeated for each and every item or information which has caused the difference in profits. At the end, we will arrive at the profit disclosed by financial accounts.
The procedure can again be explained as follows:
Reconciliation Statement
` `
Profit as per cost accounts (Base book) ...
Add : ...
Amount of those items which have resulted an ...
increase in profit disclosed by financial accounts ...
(other set of books here) ... ...
Less : ...
Amount of those items which have resulted a ...
decrease in profit disclosed by financial accounts ...
(other set of books here) ... ...
Profit as per financial account (other set of books here) ...
Note: In the above procedure, students need not to remember the long list of individual items to be added or deducted. The same statement can also be prepared by taking financial profit as base book profit and finding cost accounts profit as profit in other set of books.
MEMORANDUM RECONCILIATION ACCOUNT
Reconciliation of profit shown in the cost and financial accounts can also be done in the form of a ledger account called “Memorandum Reconciliation Account”. The procedure is simple and same as discussed under the head “Preparation of Reconciliation Statement”. Start writing the profit disclosed in cost accounts on the credit side of the account (write on debit side if it is a loss). The amounts of items which are to be added to the cost accounts profit will be credited while the amounts of items to be deducted are debited to this account. The balancing figure will disclose the profit as per financial account.
Similarly, memorandum reconciliation account can also be prepared by taking profit as per financial books as starting point and finding profit as per cost accounts as finishing point. This can be described as follow:
Dr Memorandum Reconciliation Account Cr
To Write the amounts of those items — By Net profit as per cost — individually which are to be — accounts (Base book profit)
deducted from cost accounts profit —
— By Write the amounts of those —
— items individually which are — to be added to cost accounts —
To Profit as per financial accounts — profit —
(balancing figure)
— —
Note : If cost accounts are disclosing a loss then write the amount on the debit side of this account. Rest of the procedure is same.
