Meaning of Reconciliation of Cost and Financial Accounts
When cost accounts and financial accounts are
maintained in two different sets of books, there will be prepared two profit
and loss accounts - one for costing books and the other for financial books.
The profit or loss shown by costing books may not agree with that shown by
financial books. Such a system is termed as, ‘Non-Integral System’ whereas
under the integral system of accounting, there are no separate cost and
financial accounts. Consequently, the problem of reconciliation does not arise
under the integral system.
However, where two sets of accounting systems,
namely, financial accounting and cost accounting are being maintained, the
profit shown by the two sets of accounts may not agree with each other.
Although both deal with the same basic transactions like purchases consumption
of materials, wages and other expenses, the difference of purpose leads to a
difference in approach in a collection, analysis and presentation of data to
meet the objective of the individual system.
Financial accounts are concerned with the ascertainment of profit or loss for the whole operation of the organisation for a relatively long period, usually a year, without being too much concerned with cost computation, whereas cost accounts are concerned with the ascertainment of profit or loss made by manufacturing divisions or products for cost comparison and preparation and use of a variety of cost statements. The difference in purpose and approach generally results in a different profit figure from what is disclosed by the financial accounts and thus arises the need for the reconciliation of profit figures given by the cost accounts and financial accounts.
The
reconciliation of the profit figures of the two sets of books is necessary due
to the following reasons
a)
It
helps to identity the reasons for the difference in the profit or loss shown by
cost and financial accounts.
b)
It
ensures the arithmetical accuracy and reliability of cost accounts.
c)
It
contributes to the standardization of policies regarding stock valuation,
depreciation and overheads.
d)
Reconciliation
helps the management in exercising a more effective internal control.
Reasons for disagreement between Profits as per financial accounting and Profits as per cost accounting:
The
difference in the profitability of cost and financial records may be due to the
following reasons.
1)
Items included in the financial accounts but not in cost accounts.
Ø Purely financial income- such as
interest received on bank deposits, interest and dividend on investments, rent
receivables, transfer fee received, profit on the sale of assets etc.
Ø Purely financial charges – such as
losses due to scraping of machinery, losses on the sale of investments and
assets, interest paid on the bank loans, mortgages, debentures etc., expenses
of company’s transfer office, damages payable at law etc.
Ø Appropriation of profit – the
appropriation of profit is again a matter which concerns only financial
accounts. Items like payment of income tax and dividends transfer to reserve,
heavy donations, writing off of preliminary expenses, goodwill and patents
appear only in profit and loss appropriation account and the costing profit and
loss a/c is not affected.
2)
Items included in cost accounts only: There are certain items
which are included in cost accounts but not in financial accounts. They are:
Charges in lieu of rent where premises are owned, interest on capital employed
in production but upon which no interest is actually paid.
3)
Under/Over absorption of overhead expenses: In cost accounts,
overheads are absorbed at predetermined rates which are based on past data. In
the financial accounts the actual amount incurred is taken into account. There arises
a difference between the actual expenses and the predetermined overheads
charged to product or job.
If
overheads are not fully recovered, which means that the amount of overheads
absorbed in cost accounts is less than the actual amount, the shortfall is
called as under recovery or under absorption. If overhead expenses recovered in
cost accounts are more than that of the actually incurred, it is called over
absorption. Thus, both the over and under recovery may cause the difference in
the profits of both the records.
4) Different basis of stock valuation: In
cost accounts, the stock of finished goods is valued at cost by FIFO, LIFO,
average rate, etc. But, in financial accounts stocks are valued either at cost
or market price, whichever is less.
The
valuation of work-in-progress may also lead to variation. In financial books
only prime cost may be taken into account for this purpose whereas in cost
accounts, it may be valued at prime cost plus factory overhead.
5) Different basis of depreciation
adopted: The rates and methods of charging depreciation may be different in two
sets of accounts.
PREPARATION ON RECONCILIATION STATEMENT AND MEMORANDUM RECONCILIATION
ACCOUNT
A memorandum reconciliation
account is a type of account that is used to reconcile or adjust the profit or
loss as shown by cost accounting and financial accounting. It is used when
there are differences between the profit or loss as calculated using cost
accounting principles and the profit or loss as reported in the financial
statements.
To prepare a memorandum
reconciliation account, the company would first calculate the profit or loss
using cost accounting principles. This would involve identifying the cost of
goods sold, the gross profit, and the operating expenses. The company would
then compare this amount to the profit or loss as reported in the financial
statements.
If there are differences
between the two amounts, the company would use a memorandum reconciliation
account to reconcile the differences. For example, if the profit as calculated
using cost accounting principles is greater than the profit reported in the
financial statements, the company would debit the memorandum reconciliation
account and credit the profit and loss account for the difference. This would
adjust the profit and loss account to reflect the correct profit or loss as
calculated using cost accounting principles.
The memorandum
reconciliation account is typically a temporary account that is used to make
adjustments to the profit and loss account and is closed at the end of the
accounting period. It can be used to reconcile a variety of differences between
cost accounting and financial accounting, including differences in the
treatment of expenses, differences in the valuation of inventory, and
differences in the calculation of depreciation.
Preparation of Reconciliation statement
When there is a difference between the profits
disclosed by cost accounts and financial accounts, the following steps shall be
taken to prepare a Reconciliation Statement
1 Ascertain the various reasons of
disagreement (as discussed above) between the profits disclosed by two sets of
books of accounts.
2. If profit as per cost accounts (or loss as
per financial accounts) are taken as the base:
ADD:
(i) Items of income included in financial
accounts but not in cost accounts.
(ii) Items of expenditures (as interest on
capital, rent on owned premises, etc.) included in cost accounts but not in
financial accounts.
(iii) Amounts by which items of expenditure
have been shown in excess in cost accounts as compared to the corresponding
entries in financial accounts.
(iv) Amounts by which items of income have
been shown in excess in financial accounts as compared to the corresponding
entries in cost accounts
(v) Over-absorption of overheads in cost
accounts.
(vi) The amount by which closing stock of
inventory is under-valued in cost accounts.
(vii) The amount by which the opening stock of
inventory is over-valued in cost accounts.
DEDUCT:
(i) Items of income included in cost accounts
but not in financial accounts
(ii) Items of expenditure included in
financial accounts but not in cost accounts.
(iii) Amounts by which item of income have
been shown in excess in cost accounts over the corresponding entries in
financial accounts.
(iv) Amounts by which items of expenditure
have been shown in excess in financial accounts over the corresponding entries
in’ cost accounts.
(v) Under absorption of overheads in cost
accounts.
(vi) The amount by which closing stock of
inventory is over-valued in cost accounts.
(vii) The amount by which the opening stock of
inventory is under -valued in cost accounts.
3. After making all the above additions and
deductions, the resulting figure will be profit as per financial accounts.
Note: If, profit as per
financial accounts (or loss as per cost accounts) is taken as the base, then
items added shall be deducted and items to be deducted shall be added, i.e.,
the procedure shall be reversed.
Also Read: Important Questions for Upcoming Exams
Unit – 4: job, Contract and Process Costing
(These Questions are subject to modification, if necesary. Download DTS Application for complete notes)
Q. Explain the features, advantages and disadvantages of job costing.
Q. What is process costing? What are the fundamental principles of Process Costing? Point out the advantages and limitations of Process costing. 2019
- Preparation of process accounts together with normal, abnormal loss and abnormal gain account, preparation of profit and loss account and costing profit and loss account, treatment of process finished stock and stock of raw material in process accounts. Follow examples of BASU AND DAS COST ACCOUNTING BOOK. 2013, 2016, 2018
- Preparation of contract account (Question bank given in Mobile application)