Reconciliation of Cost and Financial Accounts
Need For Reconciliation
The two systems of accounting viz. financial and cost accounts co-exist in the same organisation and they deal with same basic transactions say, purchases, consumption of materials, wages and other expenses. But the difference of purpose calls for a difference in approach in collection, analysis and presentation of data to meet the objective of 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 provided for ascertaining the profit or loss made by manufacturing or product divisions/products for cost comparison and preparation and use of variety of cost statements. The difference in purpose and approach more often than not results in a different profit from what is disclosed by the financial accounts and this establishes the need for a reconciliation of profit between cost accounts and financial accounts.
Thus, reconciliation between the results of the two sets of books is necessary due to the following reasons:
Causes of Differences
The vital differences between the two branches of accounting are manifested in the variation of the profit figure of one from the other through the cumulative impact of the following factors:
I. Items Shown Only In Financial Accounts
There are certain items which are included in financial accounts but find no place in cost accounts. These may be items of expenditure or appropriation of profit or items of income. The items may be classified as under:
(a) Purely Financial Charges:
(b) Purely Financial Income:
(c) Appropriation of Profits:
II. Items Included In Cost Accounts Only
There are certain items which are excluded from financial accounts but are included in cost accounts:
III. Over or Under Absorption of Overheads
In cost accounts, recovery of overheads is based on an estimate or pre-determined ratio e.g. percentage on prime cost, percentage on sales etc. which may be more or less than the actual amount incurred. In financial accounting the actual expenses of overheads are recorded. If overheads are not fully absorbed i.e. the amount in cost accounts is less than the actual amount, the short fall is called under absorption. On the other hand, if overhead expenses in cost accounts are more than the actual, it is called over-absorption. Thus under or over absorption of overheads leads to difference in two accounts. The under recovery or over recovery of overheads may be carried forward to the next period or may be charged by a supplementary rate (positive or negative) or transferred to costing profit and loss account. In case, the under recovery or over recovery of overheads has been carried forward to the next period, the profit as shown by the cost accounts will be different from the profits as shown by the financial books and adjustments will have to be made on this account. Some cases, selling and distribution expenses are ignored in cost accounts and as such costing profit will be higher and thus requiring reconciliation.
IV. Adoption of Different Basis of Valuation of Stock
Thus the method of valuation of stock gives rise to different results in the sets of books.
V. Different Methods of Charging Depreciation
The methods of charging depreciation may be different in cost books as well as in financial books. The method of providing depreciation under financial accounting is totally governed by Companies Act or tax provisions so that diminishing balance method or fixed instalment method is generally followed. However in cost accounts machine hour rate or production hour or unit method may have been followed.
VI. Abnormal Gains and Losses
Abnormal gains or losses may completely be excluded from cost accounts or may be taken to costing profit and loss account. If it is excluded, costing profit/loss will differ from financial profit/loss and adjustment will be required. In case, if these are transferred to costing profit and loss account, the profit or loss shown by cost accounts will agree with the profit or loss of financial accounts. In such a case no adjustment will be required. Examples of such abnormal gains and losses are, abnormal wastage of materials, e.g. by theft, fire etc., cost of abnormal idle time, cost of abnormal idle facilities, exceptional bad debts, abnormal gain in manufacturing through processes etc.
Preparation of Reconciliation Statement or Memorandum Reconciliation Account
A Reconciliation Statement or a Memorandum Reconciliation Account should be drawn up for reconciling profits shown by two set of books. Results shown by any set of books may be taken as the base and necessary adjustments 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 as under:
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:
I. Ascertain the various reasons of disagreement (as discussed above) between the profits disclosed by two sets of books of accounts.
II. If profit as per cost accounts (or loss as per financial accounts) is taken as the base.
III. 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 above shall be deducted and items to be deducted shall be added i.e. the procedure discussed above shall be reversed.
Memorandum Reconciliation Account
Reconciliation can also be done by preparing a Memorandum Reconciliation Account. This account is a memorandum account only and does not form part of the double entry. A specimen form of Memorandum Reconciliation Account is given below:
Memorandum Reconciliation Account
To Financial Expenses:
Fine and penalties
Goodwill written off
To Under-charge of depreciation
To Under-absorption of overheads
To Under-valuation of opening stock
in cost accounts
To Over-valuation of closing stock in
To Profit as per Financial Accounts
By Profit as per Cost Accounts
By Financial income
Profit on sales of assets
By Items charged in cost accounts:
Interest on own capital
Rent on own building
By Over-charge of depreciation
in cost accounts
By Over-absorption of overheads
By Over-valuation of opening stock
in cost accounts
By Under-valuation of closing stock
in cost accounts
Reconciliation of Cost and Financial Accounts Question Answer :
1. Why cost and Financial Accounts are Reconciled?
Answer: Cost and financial accounts are reconciled to verify the accuracy of both the accounts.
2. What is the object of Reconciling cost and Financial accounts?
Answer:To know the reasons for the difference. know the situation of under absorption and over absorption of overhead. To check the mathematical mistake.
3. What is memorandum Reconciliation Accounts?
Answer: Memorandum reconciliation account is basically a presentation of reconciliation statement in T account form balance of this account is termed as profit as per the financial book and shown on the debit side of this account.
4. Why the cost accounts and financial accounts show a different profit?
Answer: The difference between costing profit & financial profit is on account of their difference in the object of preparing account.
5. Explain two reasons for the difference in profit as per cost books and financial books?
Answer: It may be due to under/ over-absorption of overhead. It may be due to the difference in the valuation of opening/ closing stock in both books.
6. State any four items of expenses which are included in financial accounts but not in cost account?
Answer: The items which are included only in financial accounts are:
7. State any two items which are included in cost accounts but not in financial accounts?
Answer: Two items in cost books only are national rent of self-occupied house and national interest on own capital.
8. Give the causes of difference between costing profit and financial profits?
Answer: Reasons for difference in profit are:
9. How is stock of finished goods valued in financial accounts and ost accounts?
Answer: In cost book, only prime cost and factory overhead are considered for valuation of stock while in financial accounts it is valued at total cost of production I.e in addition to work costs office overhead are also included hence it is necessary to adjust it while preparing reconciliation statement.
10. Explain the valuation of stock in financial and cost accounts?
Answer: In financial accounts stock are valued at cost price or market price whichever is less while is cost accounting it is shown only at its cost price.
(When profits as per financial and cost accounts are given). The profit shown in the financial accounts was Rs. 1,12,870 and for the same period the cost accounts showed a profit of Rs. 27,040.
ILLUSTRATION 2. (When profit as per financial accounts is given). A company maintained separate cost and financial accounts, and the costing profit for the year 2012 differed to that revealed in financial accounts, which was shown as Rs 50,000.
(ii) Dividends of 7 1,000 were received by the company.
(iii) A machine with net book value of 2 10,000 was sold during the year for 1' 8,000.
(iv) The company charged 10% interest on its opening capital employed of 1' 80,000 to its process costs. You are required to determine the profit figure which was shown in the cost accounts.
ILLUSTRATION 3. (When profits as per financial and cost accounts are given). Red Ltd. made a profit of rs 20,000 during the year 2011 as per their costing system, whereas their Final Accounts disclose a profit of rs 15,000. From the following Profit and Loss Account for the year ended 31st December, 2011 as per the financial books, you are required to prepare a Reconciliation Statement showing the causes for this difference :
ILLUSTRATION 4. (When profits as per financial & cost accounts are given). From the following summary of Trading and Profit and Loss Account which appears in the financial accounts of X. Ltd., and the additional information given, you are required to prepare detailed statement reconciling the profit of rs 60,570 as disclosed by the Financial Accounts with the figure of profit i.e. rs 54,65p as disclosed in Cost Accounts.
Note. (a) In the Cost Accounts
(i) works expenses are charged at a rate of 5 paise per product produced,
(ii) selling expenses are charged at a rate of 12 per cent. on sales,
(iii) administration expenses are charged at a fixed sum of t 25,000 per annum, which include financial expenses 13,000.
(b) Items of non-revenue value are not included in the Coat Accounts.
(c) In the Cost Accounts, stock is valued at direct cost (Materials and Labour) but in financial accounts, it. includes an allowance for overheads.
ILLUSTRATION 5. (Where profit as per cost accounts is given). From the following data prepare a reconciliation statement :
ILLUSTRATION 6. (When profits as per financial and cost accounts are given). The net profit of A. Co. Ltd. appeared at rs 60,652 as per financial records for the year ending 31st March, 2012. The Cost Books, however, showed a net profit of rs 86,200 for the same period. A scrutiny of the figures from both the sets of accounts revealed the following facts :
ILLUSTRATION 7. (When both profits are not given). A firm of Sports Equipments commenced business on 1-4-2011 for manufacturing 2 varieties of bats, Senior' and 'Sub-Junior'. Following information has been extracted from the accounts records for the half-year period ended 30.9.2011:
You are required to prepare a statement showing :
(1) the profit-tr each brand-piece of bat; charge labour and material at actual average cost, works am-rinses at 100% on labour cost and office cost at 25% of works cost.
(2) financial profit for the half-year ending 30-9-2011.
(3) reconciliation between profit as shown by cost accounts and financial accounts.
ILLUSTRATION 8. (When both profits are not given). Following figures were available in respect of Ashok Engineering Company for the year ended 31st March, 2012:
ILLUSTRATION 9. (When both profits are not given). Ashoka Engineering Co. manufactures two sizes of'a machine component, Size A and Size B. Following data refer to the year ended 31st March, 2012:
All expenses other than wages and materials are analysed under 'works overheads' which during the year amounted to rs 9,000 and 'office overheads' which amounted to rs 10,000. In fixing the selling price it was.estimated that works overheads should be taken at 50% on wages and office overhead expenses at 335% on works cost. You are required to compute the following :
(a) The total coat of each unit on the basis of the above overhead percentages ;
(b) The net profit for the year shown by the financial accounts, valuing unsold stocks at actual material and wages cost plus works overheads at 50% on wages ; and
(c) The reconciliation of net profit in (b) above with estimated total net profit based on cost figures.
ILLUSTRATION 10. (When profits as per finanical accounts is given). Following is a summary of the Trading and Profit and Loss Account of Messrs Alpha Manufacturing Co. Ltd. for the year ended 31st March, 2012 :
The company manufactures a standard unit. In the Cost Accounts :
(i) Factory expenses have been recovered from production at 20 per cent on Prime Cost ;
(ii) Administration expenses at 3 per unit on units produced ;
(iii) Selling and distribution expenses at 4 per unit on units sold.
You are required to prepare a statement of cost and profit in cost books of the company and to reconcile the profit disclosed with that shown in the Financial Accounts.
ILLUSTRATION 11. (When both profits are not given) The financial records by Modern Manufacturers Ltd. reveal the following data. for the year ended March 31, 2012 :
In the costing records, factory overhead is charged at 100% of wages, administration overhead at 10% of works cost and selling and distribution overhead at Rs. 16 per unit sold.
Prepare a statement reconciling the profit as per cost records with the profit as per financial records of the company. All workings should from part of your answer.
Sometimes both normal output and actual output are given in the question and fixed expenses are charged on the basis of normal output in the profit and loss account. But while preparing statement of cost and profit these are charged on the basis of actual output i.e. by reducing or increasing the fixed expenses in that proportion which actual output bears to that of normal output.
ILLUSTRATION 12. (When actual and normal output are given). Following information is available from the financial books of a company having a normal production capacity of 60,000 units for the year ended 31st March, 2012 :
(i) Sales rs 10,00,000 (50,000 units).
(ii) There was no opening and closing stock of finished units.
(iii) Direct material and direct wages cost were rs 5,00,000 and rs 2,50,000 respectively. (iv) Actual factory expenses were rs 1,50,000 of which 60% are fixed.
(v) Actual administrative expenses were rs 45,000 which are completely fixed.
(vi) Actual selling and distribution expenses were rs 30,000 of which 40% are fixed.
(vii) Interest and dividends received rs 15,000.
You are required to :
(a) Find out profit as per financial books for the year ended 31st March, 2012 ;
(b) Prepare a statement of cost and profit to ascertain the profit as per cost accounts for the year ended 31st March, 2012 assuming that the indirect expenses are absorbed on the basis of normal production capacity ; and
(c) Prepare a statement reconciling profits shown by financial and cost books.
ILLUSTRATION 13. In a factory, works overheads are absorbed at 60% of Labour Cost and office overheads at 20% of Works Cost. Prepare (i) Cost Sheet, (ii) Profit & Loss Account and (iii) Reconciliation Statement if Total Expenditure consists of Material rs 2,00,000: Wages rs 1,50,000; Factory Expenses rs 1,00,000 and Office Expenses rs 85,000.
10% of the Output is Stock at the end and Sales are rs 5,20,000.
ILLUSTRATION 14. The Profit and Loss Account of Oil India (Pvt.) Ltd. for the year ended 31st March, 2012 is as follows :
As per the cost records the direct expenses have been estimated at a cost of 30 per kg. and administration expenses at rs 15 per kg. During the year production was 6,000 kgs. and sales were 4,800 kgs.
Prepare a statement of costing profit and loss account and reconcile the costing profit with financial profit.
ILLUSTRATION 15. (When cost ledger accounts are to be prepared before reconciliation). Following figures have been extracted from the Cost Records of a manufacturing unit :
Finished products : Entire output is sold at a profit of 10% on actual cost from Work-in-Progress.
Direct wages incurred rs 270,000 ; Overheads incurred rs 2,50,000.
Items not included in Cost Records : Income from investments rs 10,000 ; Loss on sale of capital assets rs 20,000.
Draw up Stores Control Account, Work-in-Progress Control Account, Costing Profit and Loss Account, Profit and Loss Account and Reconciliation Statement.