UNIT 2

RECONCILIATION OF COST AND FINANCIAL ACCOUNTS

2.1 Introduction

It is normally assumed that the profit of a business for a given period is given by the Profit & Loss account made out for that period.

Imagine your surprise, when Profit and Loss Account  prepared by the financial accountant of X Ltd. Shows a profit of Rs.4,56,000 for the year ended 31.03.2009. While the cost accountant has prepared a cost sheet for the same period and arrived at a profit of Rs. 5,12,000. You feel that one of the figures reported should be wrong, otherwise how could there be a difference.

However, there is a logical explanation for the difference in the profit figures and both may be right. This is because the fundamental assumptions made by the two accountants for preparing the profit and loss account vary. For example, Interest on loan will be debited in financial Profit & Loss Account but the cost accountant will ignore this item as he does not consider this interest expense as an item of cost. Naturally, in this case, the cost accountant will report a higher profit than the financial account.

In the following sections we shall see the types of differences and the items which give rise to these differences.

2.2 Need for Reconciliation

The need for reconciliation arises due to the following reasons:

1. To ensure that no income or expenditure item has been omitted and that there is no under or over recovery of overheads.
2. To check the arithmetical accuracy, as well as for the determination of reason for disagreement between the two results.
3. To know the reason for variation of profit or loss as internal control.
4. To take administrative decisions such as depreciation, stock valuation and direct expenses.
5. To test the reliability of cost accounts.

2.3 Reasons for disagreement between Cost & Financial Records

It is very essential to know the causes, which generally give rise to disagreement between Cost and Financial Accounts. These are briefly summarized below:-

Expenses that are not taken into account. The under mentioned expenses are usually not included in overheads or, for that matter in cost.

1. Expenses or income of purely financial nature like dividends received, rent received, cash discount allowed, etc.
2. Expenses or profits of capital nature like profit or loss on sale of investments, plant and equipment, etc.
3. Items not representing actual costs but dependent on arbitrary decisions of management e.g. An unreasonably high salary to the managing director, providing for depreciation at a rate exceeding the economic rate.
4. Appropriation of profits for dividends, payment of income tax and transfer to reserves.

1. Items recorded in financial books only and not in cost books:

1. Interest received/ paid on Debentures,
2. Interest received and paid on Investment and Bank loan or overdraft respectively.
3. Interest charged/ paid to debtors /creditors
4. Discount allowed/ received.
5. Provision for discount on debtors/ creditors
6. Bad Debts written off/ bad debts recovered.
7. Discount on issue of shares and debentures.
8. Income tax paid /refund
9. Penalty and fines paid / received
10. Rent received/ paid
11. Loss by fire, natural calamities or theft /damage recovered.
12. Loss/ profit on sale of fixed assets, investment
13. Cost of share transfer/share transfer fees received.
14. Donation given/received
15. Deferred revenue expenses written off. Such as write off of :

-          Preliminary Expenses

-          Discount  on Shares/ Debentures

II.                   Items recorded in cost book only and not in financial books:

1. Notional rent charges of owned premises
2. Salary of proprietor
3. Interest on proprietors fund

III.                   Items recorded in both books with different amounts:

In Cost book and Financial book some item of expenses and incomes which are treated differently such as:

1. Method of charging depreciation:

In Financial Books depreciation may have been provided, on Straight Line Method or Written down Value Method whereas in Costing Book depreciation may have been charged on the basis of Machine Hour Rate Method. Amounts of depreciation charge in  both books are bound to be different.

b.           Under and Over recovered expenses:

The expenses in costing books are recorded on the basis of pre-determined rates but in financial books they are recorded on actual basis hence the amount recorded in these two set of books differ.

c.                  Method of Valuing Stocks:

It is well known that in Cost Book Stocks are only valued at cost. But in Financial Books stock are valued either at cost or market price, whichever is lower.

2.4 Procedure for Reconciliation

When there is a difference between the profit/loss shown by cost accounts and financial accounts the procedure for reconciliation is similar to that of Bank Reconciliation Statement. For reconciliation following steps should be considered.

1. Prepare a cost sheet for a particular period and find out costing profit or loss if it is not given.
2. If financial profit or loss is not given then find out the same by preparing Trading and Profit and loss account for a period which corresponds to the cost sheet.
3. Ascertain items which are shown in financial account and not in cost account.
4. Ascertain items which are shown in cost account only.
5. Calculate difference between expenses recorded in financial books and the amount of expenses recorded in cost accounts.
6. Reconciliation Statement is to be prepared as on a particular date. Hence one can start with the figure of profit / loss as per cost account and arrive at the figure of profit/ loss as per financial accounts or vice –versa.

[Entries which are at variance with each other will appear in Reconciliation Statement and also entries appearing in only one set of book (non - common items).

2.5 Proforma Statement of Reconciliation
 

Starting with financial profit- Statement of Reconciliation between Financial Profit and Cost Profit for the Year ended

Starting with financial profit- Statement of Reconciliation between Financial Profit and Cost Profit for the Year ended

2.6 Solved Examples

Q.1. From the following particulars reconciliation statement

Solution:

Q.2. Following is the Trading and Profit and loss account of a factory producing a particular unit of a product of which the actual output is 1,00,000 units.

Trading & Profit and Loss A/c for the year ended 31/12/09

The normal output of the factory is 1,50,000 units. Works expenses are fixed to the extent of Rs. 36,000. Office expenses for all practical purposes are constant, Selling and distribution expenses are variable to the extent of Rs.6000/- Prepare a cost sheet and reconciliation statement.

Solution:

Cost Sheet

Actual output 1,00,000 units Normal output 1,50,000 units

Reconciliation statement

Q.3. The Trading & Profit & Loss account of “A’ Ltd. Is as follows:-

The profit as per cost accounts was only Rs.19,770. Reconcile the financial and costing profits using the following information:

a)        Cost accounts valued closing stock at Rs. 4280

b)       The work expenses in the cost accounts  were taken at  100% of direct wages.

c)        Selling & administration expenses were charged in the cost accounts at 10% of sales and 0.10 per unit respectively.

d)       Depreciation in the cost accounts was Rs.800.

Solution:

Q.4. From the following Profit & loss account draw up a Reconciliation statement showing the Profit as per Cost Accounts:-

The cost accountant has ascertained a Profit of Rs. 19636 as  per his books.

Solution:

Q.5.

M/s ESVEE Ltd. Has furnished you the following information from the financial books for the year ended 31st December, 2009.

The cost sheet shows the following:

Cost of materials Rs. 26 per unit.

Labour cost Rs. 15 per unit

Factory overheads 60% of Labour cost

Administration overheads 20% of Factory cost

Selling expenses Rs. 6 per unit

Opening Stock Rs. 45 per unit

You are required to prepare:

1. Financial Profit & Loss Account
2. Costing Profit & Loss Account
3. Statement of Reconciliation

Solution:

Financial Profit & Loss A/c

Cost Sheet for the year ended 31.12.2009

(Production 10,000 units)

Statement of Reconciliation