Concept
In a manufacturing concern, two accounts financial and cost accounts both are used. They are two different accounting systems that are maintained separately. The profit and loss account is prepared under the financial account. Unlike that cost, the sheet is prepared under the cost account. The profit and loss account shows the net profit or net loss of the firm by summarizing actual incomes and expenses for a specified period. The cost sheet shows the net profit or net loss by deducting the cost of goods sold out of sales revenue. The two accounts show dissimilar profits since the financial account records actual incomes and expenses and the cost account records estimated cost figure also. Therefore, the preparation of a cost reconciliation statement is essential since two accounts show dissimilar profits.
NEEDS OF RECONCILIATION
o It ensures the reliability of cost data.
o It helps to check the arithmetic accuracy of both sets of accounts.
o It helps to decision making internal control.
o Management is enabling us to know the reason for the difference in the results of both cost and financial accounts.
REASONS FOR DIFFERENCE
The difference in the net profits of cost and financial accounts may arise because of the following reasons.
1. One-sided entry
i) Transactions are shown in the financial account
a) Transfer from profit
b) Financial charges
c) Financial incomes
ii) Transaction showed in the cost account
2. Indirect expenses recovered
3. Stock valuation
4. Different methods of charging depreciation.
5. Abnormal loss or gain
1. Transaction shown in one book: There is some financial transaction which is never recorded in cost accounting those are only recorded in financial accounting which leads to incomes and expenses are shown in only one account. A few examples of incomes and expenses shown in one book are as follows:
a) Transaction shown in financial account: Some financial transactions are recorded only in financial books. Those financial transactions are not recorded in the cost account. The financial transaction shown in the financial account are as follows:
Transfer from profit: The provision of bad and doubtful debt, provision for depreciation, transfer of profit to general reserve, dividend payable, the sinking fund for discharge of debentures and long term loans are made in the financial account.
Financial charge: The loss on the sale of assets, investment, writing off goodwill, preliminary expenses, discount and commission on the issue of shares and debentures, interest paid on the borrowed amount are financial charges item.
Financial incomes: The profit on the sale of assets, interest received on investments, transfer fees of shares, rent, income, increase in values of assets, dividend earned, bad debts recovered are financial accounts.
b) Transaction shown in cost account: Some transactions like rent of owner's assets, interest on owner's capital, depreciation of the plant with zero book value operated in the firm are shown only in the cost account.
2. Indirect expenses recovered: Financial account records entire actual expenses. But cost account shows entire indirect expenses on the basis of estimates.
3. Difference in inventory valuation: Financial accounting ascertains the value of inventory either at cost price or market price whichever is less. The inventory valuation in cost accounting is always made on the bases of cost price.
4. Difference in depreciation charged: The depreciation on fixed assets may be charged by using different methods. Thus, if two accounting systems use two different methods of depreciation then net profit remains dissimilar.
5. Abnormal loss or gain: Abnormal loss or gain affects the profit of the two sets of books. It is shown in the financial account. Those are not shown by the cost account. Therefore, abnormal loss or gain makes the net profits of the two accounts different.
PREPARATION OF COST RECONCILIATION STATEMENT
A cost reconciliation statement is prepared to reconcile the differences in net profits shown by cost and financial accounts. The reconciliation statement provides bases to verify the arithmetical accuracy of the incomes and expenses recorded in the two accounting systems. The statement also helps to know the items of income and expenses that made difference in the net profits of the two accounts.
METHODS OF PREPARING COST RECONCILIATION STATEMENT
1. On the basis of net
profit
o Net profit of cost
account
o Net profit of financial
account
2. On the basis of net
loss
o Net loss of cost
account
o Net loss of financial
account
The cost reconciliation statement shows either positive or negative net balance after adjustment made by the items of difference located in two accounts. The positive net balance means net profit of the next book.
STEPS FOR PREPARING COST RECONCILIATION STATEMENT
Reconciliation statement is a statement that reconciles the differences in net profits between cost and financial accounts. It is prepared with objectives of showing the reasons for differences.
The given below are
the steps taken for reconciliation of net profits between cost and financial
account:
o Start with the use of
a net profit or net loss shown by any one of account either cost or financial
account.
o Verify the net profit
or net loss and find out the reasons for differences and make a note for each
item of difference.
o Find out the decrease
or increase in the net profit due to the reasons of differences.
o Add the amount of
differences if the net profit is decreasing and deduct if the profit is
increasing due to the reason of the difference.
o Complete the
difference in a statement and find out the net profit shown by another account.
ITEMS ONLY INCLUDED IN FINANCIAL ACCOUNTING
There are many expenses and incomes recorded only in the financial account. Those items do not get a place in the cost account. The items are given below:
1. Profit or loss on the sale of fixed assets
3. Income tax paid
4. Interest paid on capital and loan
5. Interest received on investment
6. Dividend paid or received.
7. Underwriting commission
8. Discount on issues of shares and debentures
9. Amortization of goodwill and other fictitious assets
10. Transfer fees
11. Rent received
12. Transfer to a sinking fund or any creation of the reserve
13. Other capital gains or losses.
Reviewed by Bijay Munikar
on
March 15, 2021
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