Reconciliation of Cost and Financial Accounting
Branches of Accounting
There are three branches of accounting but out of three financial and cost accounting is more popular than management accounting. Financial accounting is a necessity for medium and large trading organisation and cost accounting system is essential for manufacturing entities. First of all, we have to understand the meaning of these three accounting systems:
a)
Financial
Accounting: It is the original form of accounting. It is mainly concerned with
the preparation of financial statements for the use of outsiders like
creditors, debenture holders, investors and financial institutions. Its main
aim is to find the operating efficiency and financial position of a firm at the
end of the accounting year. It starts with the recording of transactions and ends with the preparation and presentation of financial statements.
b)
Cost Accounting: It is that
branch of accounting which is concerned with the accumulation and assignment of
historical costs to units of product and department, primarily for the purpose
of valuation of stock and measurement of profits. It is the method of
accounting for cost. I.C.M.A. has defined cost accounting as follows: “The
process of accounting for cost from the point at which expenditure is incurred
or committed to the establishment of its ultimate relationship with cost
centers and cost units. In its widest usage, it embraces the preparation of
statistical data, the application of cost control methods, and the ascertainment
of the profitability of activities carried out or planned”.
c)
Management Accounting:
It
is accounting for the management i.e., accounting which provides necessary
information to the management for discharging its functions.
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Table of Contents of This Article |
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1. Branches of
Accounting 2. Follow up of
both cost and financial accounting system 3. Relationship
between cost and financial accounting system 4. Profits
of Cost accounting is different from profit as shown by financial accounting 5. Expenses
excluded from cost accounting 6. Expenses
recorded in Cost accounting but not recorded in financial accounting 7.
Reconciliation of Cost and Financial Accounts – Meaning 8. Reasons for
Reconciliation of Cost and Financial Accounts 9. Preparation
of Reconciliation statement or Memorandum Reconciliation Account 10.
Comprehensive Video on Reconciliation Statement |
Follow up of Both Cost and Financial accounting system
It is a common practice in every manufacturing entity to maintain both cost and financial accounting. Cost accounting is needed to ascertain the cost of production and also helps in the fixation of the selling price. Financial accounting is needed for a manufacturing firm to determine the operating efficiency and financial position. But the main problem of maintaining two accounting systems is that both accounting systems show differences in profits or loss. So there is a need for reconciliation of cost and financial accounting system. First of all, understand the relationship between these two accounting systems.
Relationship between Cost and Financial Accounting
Cost accounting is very closely related to financial accounting. Some
authorities on the subject consider cost accounting to be the branch of
financial accounting. But it may be said that cost accounts are complementary to
financial accounts, i.e., a subject which is necessary to make financial
accounts whole or complete. Financial accounts and cost accounts are both
similar in certain respects. But in some other respects, they differ from one
another. These points of similarities and enumerated below:
1) The fundamental principles of double-entry are applicable in both the systems of accounts.
2) The invoices and vouchers constitute the common basis for recording transactions under both the systems of accounts.
3) The results of the business are revealed by both the systems of accounts.
4) The causes for losses and wastages of a business are provided by both these systems of accounts.
5) The determination of future business policy is guided by both these systems of accounts.
6) A the basis for comparison of expenses is being provided by both the accounting systems.
7) Accuracy of accounts is maintained under both the systems by means of exercising check over errors and commissions which might creep in either of the accounts.
Profits of Cost accounting is different from profit as shown by financial accounting
Though both the accounting system are closely
related and followed by various manufacturing entities, but profits shown by
both the accounting system are different. The main reason for this is that
there are certain items which are shown in financial accounting but not taken
into consideration in cost accounting. Also there are certain items which are
recorded in cost accounting but recorded in financial accounting. These items
are listed below:
Expenses excluded from cost accounting:
Items which recorded in Financial Accounting but excluded from Cost sheet are listed below:
·
Donation,
·
Income tax,
·
Profit or loss on
the sale of assets,
·
Provision for
income tax and bad debts, etc.,
·
Transfer to
reserves,
·
Goodwill and
intangible assets written off,
·
Preliminary
expenses,
·
Discount of issue
of shares and debentures,
·
Dividend,
·
Cash discount,
·
Advance income
tax,
·
Debenture
interest, interest on loan and overdrafts,
·
Any income
received,
·
Over
depreciation,
·
Abnormal bad
debt,
·
Interest on
capital,
·
Capital losses,
·
Fines and
penalties,
·
Discount allowed
and received,
·
Brokerage and
underwriting commission,
·
Guesthouse
expenses and incomes,
· Sales Tax.
Expenses recorded in Cost accounting but not recorded in financial accounting
There are a few
items which are shown in cost accounts only. All expenses incurred, whether for
cash or on credit, appear in financial accounts. But there are some notional
items which are shown in cost accounts only:
a) Interest on own capital: Such interest is
never actually incurred, but is considered for the purpose of ascertaining
cost. If the capital would have been
employed in outside investment, some interest could have been earned. This interest
is often regarded as an item of cost. This is termed as opportunity cost.
b) Rent of own building: Often rent of own
building is considered as an item of cost in order to facilitate the comparison
of the cost of production of a factory having own building with that of a
factory occupying building on rent.
Reconciliation of Cost and Financial Accounts
In a non-integral
accounting system, cost accounts and financial accounts are maintained in two
different sets of books and profits shown by both the system may not agree due
to difference in both the accounting system. So, there is a need to reconcile
the profit of both the sets of account. But under the integral system of accounting,
where there are no separate cost and financial accounts, the problem of
reconciliation does not arise.
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 find out the reasons for the difference in the profit
or loss shown by both the accounting system.
b)
It checks the arithmetical accuracy and reliability of cost
accounts and financial accounts.
c)
It contributes to the standardization of policies regarding stock
valuation, depreciation and overheads.
d)
More effective internal control can be exercised with the help of
reconciliation statement.
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 as mentioned above.
2)
Items included in cost accounts only as
mentioned above.
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 arise 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, simple average etc. But, in financial accounts stocks are valued either
at cost or market price, whichever is lower. The valuation of WIP may also lead
to variation. In financial books WIP is valued at prime cost whereas in cost
accounts, it may be valued at prime cost plus factory overhead.
5)
Different basis of charging depreciation: The
rates and methods of charging depreciation may be different in two sets of
accounts.
PREPARATION ON RECONCILIATION STATEMENT OR MEMORANDUM RECONCILIATION ACCOUNT
A Reconciliation
Statement or a Memorandum Reconciliation Account should be drawn up for
reconciling profits shown by the two sets of books. Results shown by any sets
of books may be taken as the base and necessary adjustment should be made to
arrive at the results shown by the other set of books. The technique of
preparing a Reconciliation Statement as well as a Memorandum Reconciliation
account is discussed below:
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
b 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 5:
Part A: Non-integrated and Integrated Accounts System
Part B (Reconciliation Statement – Theory or Practical)
(These Questions are subject to modification, if necesary. Download DTS Application for complete notes)
Q. Practical Problems: Preparation of reconciliation statement together with profit and loss account and cost sheet. Follow examples of BASU AND DAS COST ACCOUNTING BOOK. 2012, 2015, 2017, 2019, 2022