7.

1
CHAPTER - VII
RECONCILIATION OF COST AND
FINANCIAL ACCOUNTS
1, Why reconciliation of cost and
necessary? State the possible financial accounts is
reasons for differences
profit shown by both the accounts. between
Where cost accounts and financial
accounts are maintained seperately,
the profit/loss shown by the two sets of
accounts differ. The difference
arises due to ditferences in the valuation of
stock, over or
under-absorption
of overheads and non-inclusion of some
items of expenses (and/or incomes)
in cost and financial accounts. Such
differences must be reconciled. In
order to reconcile the differences and ensure arithmetical accuracy, a
reconciliation statement is prepared.
Reasons for difference in profit:
The reasons for differences in
profit/loss shown'by cost accounts
and financial accounts are
explained below.
1. Items included in financial accounts only
There are certain items of income and expenditure which are recorded
in financial accounts only. That is, thhey are not recorded in cost accounts.
These items are as follows:
a) Purely financial incomes :
Rent received
Transfer fees received
Interest on bank deposits and other investments
Dividend income
Profit on sale of assets (e.g. buildings, machinery etc.)
b Purely financial charges
nterest on bank loans, mortgages, debentures etc.,
Discount on debentures
Damages payable by law (e.g. compensation to a worker)
Expenses on transfer of company's office
O8S on sale of asscts, investments elc
Penalties and fines.
C)ApPpropriationor|
of profit is nts aonly. It
concerned with financial accounts
Appropriation
includes:
Income tax
Dividend paid
Transfer to reserve
Amounts written off (Goodwili, preliminary expenses
debenture discount etc.)
Donation and Charities.

2. Items included in cost accounts only

Certain notional charges are included in cost accounts only. That is,
they are not considered in financial accounts. These items are

a) Notional rent: When the premises are owned, no rent is payable.

However, the rental value called notional rent may be included in cost
accounts for cost ascertainment.

b) Notional interest: Interest on capital employed (though not actually

paid) may be included in cost accounts for cost ascertainment.

3. Under or over-absorption
ofoverheads
In cost accounts, overheads are absorbed on the
basis of pre-determined
rates. (1.e, as a percentage on direct
wáges, works cost etc.) In financ1a
accounts, actual amount of expenditure is taken into account. As a resull
there is difference in the absorption of overheads. It
a
may be either under
absorption or over-absorption.
If overheads absorbed in cost accounts is less than
the actual amoun
(recorded in financial accounts) it is known as
It
under-absorption.
overheads absorbed in cost
accounts is higher than the actual unt,
(recorded financial accounts) it is known
in amou
4. Different methods of
as
over-absorption.
depreciation
Adoption of different
methods of and
financial accounts may lead
to
depreciation in cost accou
straight line method in financialdiffernce in profit/loss. For examp
accounts will result accounts and machine hour
in difference in metno
profit/loss.
 7.3
5. Different bases of stock valuation
In financial accounts, stocks are valued at
whichever is less. In cost cost price or market price
accounts, stocks are
FIFO, LIFO. Simple average valued at cost by
price etc. The adoption of adopting
stock valuation leads to differences in different bases of
profit / loss.
2. Explain the
procedure to reconcile cost and
accounts at the end of an financial
accounting period.
The profitloss shown by cost
shown by financial accounting differs from the profit/loss
accounting. The reconciliation statement is
reconcile the difference between these two sets
prepared to
of accounts.
Profit as per financial accounts or
cost accounts is taken as the
point, reconciliation. Items included in one set of accounts
for start1ng
other set, are added or deducted, and not in the
to be found. For
depending upon
their effect on the profit
example, rent received is
an item of income. It is
included in
financial accounts only. As a result,
If the reconciliation statement starts
profit as per financial accounts is high.
with costing profit, rent received is
added to arrive at profit as per financial accounts.

Ifthe given profit is less, then the profit to be found will be more. Hence
the difference
(i.e., the amount of difference between the figure in cost
accounts and the figures in financial
accounts) is added. If the given profit
IS more, then the profit to be found will be less. Hence, the
difference is
deducted.
The steps in the
preparation of reconciliation statement are given below.
I. Ascertain the reasons for difference between the profits shown
the two sets of by
accounts.
I. If
profit as per cost accounts (or loss as per finanCial accounts)
taken as the is
starting point:
Add the following:
1. Items of income included in financial
accounts only.
2 Items of expenditure included in cost
3. accounts only.
Amounts by which incomes are over
stated in financial accounts.
4 Amount by which expenses are
over-stated in cost accounts.
 7.4
stock is Over-stated in cost
opening
Amount by which
5
accoutS.

stock is over-staicd in financial accounts

b. Amount by which closing
overheads in cost accounts
Over-absorption of
7
Deduct the following:

1. Items of income included in cost

accounts only.

Items of expenditure included in

financial accounts only.
2.

over-stated in cost accounts.

3. Amount by which incomes are

over-stated in financial accounts.

which expenses are
4. Amount by
in financial
5 Amount by which opening stock is over-stated

accounts.

which closing stock is over-stated in cost

Amount by
accounts.

cost accounts.
1. Under-absorption of overheads in

obtained after additions and deductions wil! be profit

as per
L The figure
financial accounts.

Is
per financial accounts (or
loss as per cost accounts)
If the profit as
itens
the procedure shall be reversed. That is,
taken the starting point,
as
items deducted shall be added.
added shall be deducted and

Memorandum Reconciliation Account

ring
financial accounts can be done by prepale
Reconciliation of cost and ot
uble

a Memorandum Reconciliation
Account. It does not form part d
entry dum

cost records is credited to the

amount of profit as per
nmemora
The a n d the items
account and the
account. The items to be added are credited to this a sp e r

are debited. The balancing figure represents

profit/loss
he deducted under
financial accounts. This account may be prepared as
 7.5
Memorandumn Reconciliation Account

Rs.
To Financial
By Profit as
Rs.
expensCS Not per cost
included in cost accounts
accounts
By Financial incomes not
shown in cost accounts
To Under-absorption
of overheads
By Over-absorption of
Overheads
To Under-valuation
By Items charged in
of opening stock
accounts only
cost
in cost accounts

By Over-valuation of
opening stock in cost
accounts
To Profit as
per
financial
accounts By Under-valuation of
closing stock in cost
balancing figure) accounts