Reconciliation of Cost and Financial Accounts

reconciliation of cost and financial accounts

In this Article, we will discuss the Reconciliation of Cost and Financial Accounts which includes-

(i) Meaning of Reconciliation, (ii) Need of Reconciliation, (iii) Reasons for the Difference in Reconciliation, (iv) Procedure of Reconciliation, (v) Format of Memorandum Reconciliation Account, (vi) Practical Problems and Solutions of Reconciliation of Cost and Financial Accounts.


Meaning of Reconciliation of Cost and Financial Accounts


The Term Reconciliation has taken from the word “Reconcile” which means to tally, check, equate. The Reconciliation is done to reconcile the Profits/Loss as per the Financial Accounts with the Cost Accounts.

When Cost and Financial Accounts are prepared separately in different set of books, results or profits/losses in both the accounts don’t match with each other.

In this Case, both the accounts results are necessary to reconcile. It is prepared by showing the reasons for the difference in the results of accounts. It is done to make the arithmetical accuracy.

Reconciliation Statement is a Memorandum Reconciliation Account to know the items required to make the profits of Cost Accounts with the Financial Accounts.


Reasons for the Reconciliation of Cost and Financial Accounts


There are so many reasons which gives rise to the reconciliation of Cost and Financial Accounts. So, the Following Reasons or Causes of the Reconciliation of  Cost and Financial Accounts are as follows-

(i) Different Treatment of Item


There are so many items which has different treatment in the Cost and Financial Accounts. The Items in the Cost Accounts are computed on the estimate basis. Cost Accounts works as a Control Device so that to achieve the standard or estimates.

Estimates or Standards can be nearer to the Actuals but it can’t be equal to the Actuals all the time. This leads to the difference in the results of the Cost and Financial Accounts.

The Difference in the Treatment of Firm can be on the following basis-

1. Direct Material- The Standard or Estimated Cost of the Direct material used in the production process is different from the Actual Costs. The Difference in both the accounts can be due to the increase or decrease in the Prices of material.

2. Direct Labour- The Difference in the Estimated or Standard Costs of Direct Labour with the actuals can be due to the change in the Wage payment system or work hours. So Many Times Workers are paid more because of the increased Dearness Allowance, Bonus etc.

3. Overheads- In Cost Accounts, the Recovery of Overheads is based on the Estimates. But in Financial Accounts, the actual expenses are recorded. This results in under or over recovery of overheads. The Under or Over Recovery can be carried forward to the next period.

4. Depreciation- Depreciation is also an other reasons for the Reconciliation of Cost and Financial Accounts. In both Cost and Financial Accounts, different methods of Depreciation is used.

In Cost Accounts, Depreciation is charged according to the Machine Hour Rate. But in Financial Accounts, it is charged according to the Fixed Installment or the Diminishing Balance Method.


(ii) Valuation of Stocks


The Difference in the Valuation of Stocks in both the accounts are as follows-

1.Raw Materials- In Cost Accounts, the raw materials are valued on LIFO (Last-In First-Out) or FIFO (First-In First-Out) Basis. But in Financial Accounts, the Raw Materials are valued at Market or Cost Price whichever is less.

2. Work-in-Progress- There is also a difference in the valuation of Work-in-progress in both the Accounts. In Cost Accounts, the Work-in-Progress is valued at the Factory Cost. But in the Financial Accounts, it is valued at the Production Cost.

3. Finished Goods- In Financial Accounts, the Cost of Finished Goods is valued at Market Price or Cost Price whichever is lower. But in Cost Accounts, the Cost of Finished Goods is valued at the Production Cost.

So, the Valuation of Stocks gives rise to the difference in both the Cost and Financial Accounts. More Valuation of Opening Stocks in Cost Accounts refers to the less profit in Cost Accounts or vice-versa. More Valuation in Financial Accounts refers to the more profit in Cost Accounts and vice-versa.


(iii) Items appearing only in Financial Accounts only-


There are certain items which is only included in Financial Accounting which rise the needs to do the Reconciliation of Cost and Financial Accounts. The Items are Purely Financial Charges, Purely Financial Incomes and Appropriation of Profits.

The Purely Financial Charges are-

1.Loss on Sale of Investments

2. Interest on Bank Loan

3. Penalties payable for the late completion of Tax

4. Damages payable by law

5 Expense of the Company Transfer Office

6. Discount on the Issue of Shares

7. Loss due to the Scrapping of Machinery.

The Purely Financial Incomes are-

1.Interest received on Bank a/c and Fixed Deposit.

2. Rent Receivable.

3. Dividend received on Investments.

4. Profit on Sale of Fixed Assets.

Appropriation of Profits are-

1 Taxation

2. Transfer to Debenture Redemption Fund/Sinking Funds to pay the liabilities.

3. Transfer to General Reserve or any other Reserve.

4. Preliminary Expenses.

5. Underwriting Commission.

6. Charitable Donations.

7. Amount written off as Goodwill.


(iv) Items appearing only in the Cost Accounting-


There are certain items which are only included in the Cost Accounts and not in the Financial Accounts. That items are as follows-

1.Notional Interest to charge on its own capital.

2. Notional Rent where to charge on its own premises.

3. Depreciation on Assets.

These items reduce the profits in the Cost Accounts.


(v) Abnormal Gains and Losses


Abnormal Gains and Losses are not completely included in the Cost Accounts. In Financial Accounts, the abnormal gains and losses are taken to the Profit and Loss Account.

In the Former case, the results of Cost Accounts will differ with the Financial Accounts. But in the Latter Case, there will not be any difference in the results of the Cost and Financial Accounts.

That’s why No Adjustment is done for the absorption of gains and losses. Some of the Items of Absorption of Gains and Losses are Abnormal Wastage of Materials, loss by Theft, Fire, Abnormal Gain in Manufacturing etc.

So, these are the reasons or the Difference in the results of Cost and Financial Accounts. The Need for Reconciliation doesn’t arise in those firms where is one set of books is used for both types of accounts.

But it is used in those firms where are separate sets of books used for both Cost and Financial Accounts.


Need for Reconciliation of Cost and Financial Accounts


The Need for Reconciliation of Cost and Financial Accounts are as follows-

  • It is done to make the arithmetical accuracy between the two accounts.
  • Reconciliation of Cost and Financial Accounts ensures that No Expense or Income has been left to record.
  • It helps in Proper Decision Making because of the accurate results prepared in reconciliation.
  • It shows the reasons for difference in the Results of Cost and Financial Accounts.
  • Reconciliation also makes the coordination between the Cost and Finance Accounts.

Procedure of Reconciliation of Cost and Financial Accounts


The Procedure for Reconciliation Statement of Cost and Financial Accounts is done by the Reconciliation Statement or Memorandum Reconciliation Account.

Reconciliation Statement is a Memorandum Reconciliation Account to reconcile the profits of Cost and Financial Accounts.

(i) Reconciliation Statement-  If the Profit as per the Cost Accounting is taken as the Starting Point. Then to find out the Profit as per the Financial Accounts, the following items are added or deducted.

It is better explained by the Format of Reconciliation of Cost and Financial Accounts.

format of reconciliation statement of cost and financial accounts

(ii) Memorandum Reconciliation Account-

In Memorandum Reconciliation Account, the Profit of the Cost Accounts is shown on the Credit Side. The Items which are added to the Profit of Cost Accounts are shown on the Credit side.

The Items which are deducted from the Costing Profit are shown on the Debit Side.

reconciliation of cost and financial accounts questions

Reconciliation of Cost and Financial Accounts Practical Questions


The Practical Questions for the Reconciliation of Cost and Financial Accounts are as follows-

The Financial Books of the Company has a Net Profit of ₹1,27,560. The Cost Account has a Net Profit of ₹1,33,520. The Net Profit of both the accounts are for the 31 Dec, 2003.

ParticularsAmount (₹)
Under Recovery of Factory Overheads in Cost Accounts11,400
Over Recovery of Administration Overheads in Cost Accounts8,500
Depreciation Charged in Financial Accounts7,320
Interest received but not included in the Cost Accounts900
Income Tax Debited in the Financial Accounts1200
Bank Interest credited in the Financial Accounts460
Stores Adjustment credited in the Financial Accounts840
Rent charged in the Financial Accounts1,720
Dividend paid in the Financial Accounts2,400
Loss of Obsolescence in the Financial Accounts520
Depreciation recovered in the Cost Accounts7,900

Solution:

                 Reconciliation Statement

ParticularsAmount (₹)Amount (₹)
Profit as per Cost Accounts1,33,520
Add:
Over Recovery of Administration Overheads in Cost Accounts8,500
Over Recovery of Depreciation in Cost Accounts580
Interest Received but not included in Cost Accounts900
Bank Interest credited in the Financial Accounts460
Stores Adjustment credited in the Financial Accounts84011,280
1,44,800
Less:
Under Recovery of Factory Overheads in Cost Accounting11,400
Income Tax received but not included in Cost Accounts1,200
Rent charged in the Financial Accounts1,720
Dividend Paid in the Financial Accounts2,400
Loss of Obsolescence in the Financial Accounts52017,240
Profit as per Financial Accounts1,27,560

So, this was all about the Reconciliation of Cost and Financial Accounts. If you have any query, write that in the comment section.

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