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/tmp/unoconv_1289654859.doc 1CHAPTER XII
RECONCILIATION OF COST AND FINANCIAL ACCOUNTS
Learning Objectives:
After studying this chapter one will be able to
Understand the need and benefits of reconciliation of cost and financial accounts
State the reasons for the difference between the profits shown by cost books and
financial books
Reconcile the two figures of profits by preparing reconciliation statement or
memorandum reconciliation a/c
12.1 Introduction: It has been discussed in the preceding chapterthat two types of
systems are followed for cost book keeping i.e. integral and non-integral cost accounting
system.
Non-integral system emphasises that the difference in objectives of financial accounting
and cost accounting calls for a different approach of recording the transactions. Financial
accounting is concerned with the ascertainment of profit/loss for the whole operations of
the organisation, for a relatively long duration usually a year, without being too much
concerned with cost computations, whereas cost accounting aims at ascertaining the
profit/loss made by different manufacturing or product divisions for attaining the
efficiency in the organisation by cost comparision and for cost control.
In those organisations, where non-integral system exists, two accounting systems deal
with the same basic transactions (say, purchase of materials, consumption of materials,
payment of wages and other expenses etc) in different manner and transactions therein
are recorded with a different approach. The difference in purpose and approach give rise
to different figure of profit in cost accounts as compared to the profit figure disclosed by
the P&L A/c in financial set of books. Consequently, the need for reconciliation between
cost accounting's profits and financial accounting's profit amount arises.
Contrarily, in an organisation practicing integrated system of cost book-keeping, financial
accounting's transactions and cost accounting's transactions are presented and recorded in
the same set of books. There is one P&L A/c and one figure of profits. In such cases,
therefore, there is no need for reconciliation.
Need and usefulness of Reconciliation
It is important in case, non-integrated system is in existence that different figures of
profits (as per two sets of books) are periodically reconciled with each other lest they
should lose their credibility. The need for reconciliation between the profits as disclosed
by cost accounts and financial accounts if considered and catered to, results into the
following benefits for the organisation.
(1) To find out the reasons for the difference in profits/loss shown by cost
accounts and financial accounts
,/tmp/unoconv_1289654859.doc 2
(2) To ensure the mathematical accuracy and reliability of cost accounts (to
have appropriate cost ascertainment and cost-control) and to have check on the financial
accounts as well
(3) To facilitate coordination and promote better cooperation between the
activities of financial and cost sections of the accounting departments.
(4) To place the management in better position to acquaint itself with the
reasons for variation in profits and paving the way for more effective internal control and
for standardisation of policies regarding stock valuation and recovery of overheads etc.
12.1 Reasons for the difference
Various reasons leading to difference in profit figures disclosed by two sets of books can
be broadly classified into three categories i.e.
(i) Differing treatment of certain items in cost accounts and financial
accounts
(ii) Items appearing only in financial accounts
(iii) Items recorded only in cost accounts
These reasons are exhibited in the following diagram and elucidated in the following
paragraphs.
(i) Items treated differently in Cost Accounting and Financial Accounting
(a) Different methods of stock valuation
Stocks of Raw materials - In financial accounting, stock of raw materials are valued at
cost or market price whichever is less whereas raw material's stocks may be valued on the
basis of FIFO, LIFO or average method (as studied in chapter on materials) in cost
accounts. This leads to differencing figures of profits as per two sets of books.
Work-in progress stocks - Difference in profits may also be there in case in w-i-p stocks
are valued using different methods in two sets of books. For example, it may be valued at
prime cost or factory cost in case of cost accounting while in w-i-p stocks may be valued
after adding a part of administrative expenses also to factory cost in financial accounts.
Finished goods stocks - In financial accounting, such stocks are valued at cost or market
price, whichever is less. However, valuation of closing stock of finished goods is usually
made at total cost of current production in cost books.
(b) Under/over absorption of overheads
In financial books, overheads are recorded at the amount incurred actually on them. In
cost accounting, however, absorption of factory office and selling and distribution
overheads is based on an estimated or predetermined overhead rate e.g. - percentage of
prime cost
or - percentage of factory cost
or - percentage of total cost of production
or - rate per unit sold
or - percentage of sales or gross profit etc.,
which may be more or less than the actual amount incurred
, /tmp/unoconv_1289654859.doc 3
(c) Different methods of charging depreciation
The methods of providing depreciation under financial accounting is totally governed by
the Companies Act and Tax provisions. Accordingly, diminishing balance method or
straight line method of depreciation is usually followed. However, the most common
methods of charging depreciation in cost accounting are machine hour rate or production
hour or unit method.
(d) Abnormal losses or gains
Abnormal losses or gains, as a fundamental rule, are excluded from cost accounts. If they
are excluded and are transferred to costing profit and loss account, then profit figures
under two sets of books will not differ & no adjustment is required. In case, they are not
differ & no adjustment is required. In case, they are not transferred to P&L A/c, costing
profit/loss will differ from financial profit/loss. Example of such losses & gains are
abnormal wastage of material, cost of abnormal idle time or facilities, exceptional bad
debts or Abnormal gain while manufacturing through processes etc.
(ii) Items appearing only in financial accounts-
There are certain items of income and expenses, which are ignored completely while
preparing cost accounts and leading to difference in two profit figures. They include :
(a) Purely financial charges or expenses
- Loss on sale of fixed assets
- Loss on investments
- Discount on issue of shares or debentures
- Interest on bank loan, mortgaged, debentures etc.
- Damages payable under law
- Fines and penalties
- Loss due to scrapping of machinery etc.
- Loss due to theft, pilferage etc. adjusted in financial books or
- Company's expenses on transfer of office
- Goodwill written off, Preliminary Expenses written off
(b) Purely Financial Incomes
- Interest received on bank deposits
- Rent Receivable
- Transfer fee received
- Dividend and interest received on investments
- Profits on Sale of Capital assets
(c) Items of Profit and loss appropriation Account
- Transfer to Reserves
- Income tax paid
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