Concept & Preparation of Cost Reconciliation Statement

Concept of Cost Reconciliation Statement

Financial accounting is concerned with recording of the financial transactions and reporting the financial position of the business, whereas cost accounting is prepared by cost accounting department and its objective is to record, classify, analyze and control the cost. Thus, cost accounting and financial accounting are two different accounting systems.

The differences between these two topics occur not only because of the error in the system but also due to the different procedures and principles carried by these accounts. Moreover, the amounts of profit and loss obtained from both accounts are often found to be different. Hence, there comes necessity to reconcile the profit between these two accounts and statements. So, a statement which is prepared for reconciling the profit shown by cost and financial account is known as reconciliation statement.

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Needs for reconciliation

The problem of reconciliation does not arise if there are no separate cost and financial accounts. When cost and financial accounts are maintained independently, the accounts are reconciled. Although, both of the topics are concerned with the same basic transactions in terms of disclosing figure of profit or loss, they do not agree with each other. Therefore, reconciliation between the consequences of these two distinct topics is necessary because of these given sources:

• It helps to find out the reasons for the differences in the profit or loss in cost and financial accounts.

• It helps to ensure the mathematical accuracy and reliability of cost account and in order to have a check on the financial account.

• It helps to contribute to the standardization of policies recording stock valuation, depreciation and overheads.

• It helps to place management in a better position to acquaint itself with the reasons for the valuation in profit paving the way to more effective internal control.

Reasons for disagreement in profit & loss

1. Items available only in financial account

It includes those items which are included in the financial account but may not be shown by cost account. Because of these items, profit or loss available in a set of account may not agree with the profit or loss available in another set of account.

The following incomes and expenditures are included in financial account but excluded by cost account:

Purely financial charges:

• Loss arising from sale of fixed assets
• Loss on sale of investment
• Interest on bank loan, debentures, mortgages loan
• Penalties and fines donation and charity
• Damage payable

Intangible and fictitious assets:

• Goodwill
• Patents
• Copyrights
• Trade mark
• Preliminary expenses
• Underwriting commission
• Deferred advertisement expenses
• Research and development expenses

Appropriation of expenditures/ losses:

• Dividend paid
• Taxes and incomes
• Donation and charities
• Transfers to general reserves and depreciation funds
• Additional provision for bad debts
• Capital expenditure specially charged to revenue expenditure

Purely financial incomes/ gains:

• Gain on sale of fixed assets
• Gain on sale of investments
• Dividend received
• Rent received/ transfer fees received
• Interest on deposits/ investment

2. Items available only in cost accounts

The items included in cost accounts and not in financial accounts are:

• Interest on own capital employed.
• Depreciation charged on fixed assets when the book value is reduced to a negligible figure.
• Salary of proprietor when he works but does not charge salary to profit and loss account.
• Rent charged when premises are owned and no rent is payable.

3. Over and Under absorption of Overheads

Overhead is absorbed on the basis of predetermined rates in cost account and overhead in financial account is absorbed in actual cost. Due to this, the profit shown by one and the other is likely to be either higher or lower. If overheads are not fully absorbed i.e. the amount in cost account 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.

4. Different basis of stock valuation

The disagreement of profit between financial account and cost account also depends on the difference in the valuation of opening and closing stock. Stocks are valued on the principle of “Cost or market value whichever is lower” in the financial account. But the stocks are valued at factory cost or prime cost basis in cost account. Sometimes, stocks are valued according to the method adopted in stores accounts. E.g. FIFO, LIFO, weighted average, etc. With such a different approach in the two sets of books, it is likely that the profit figures are different.

5. Different methods of charging depreciation

The method of charging depreciation may differ in financial accounts and cost accounts and may cause disagreement in a profit of the two books of accounts. The rate and method of depreciation may be different in cost and financial accounts. Overcharge of depreciation shows less profit and undercharge of depreciation shoes more profit.

Preparation of Cost Reconciliation Statement

When there is a difference between the profits or loss disclosed by cost accounts and financial accounts, the following steps shall be taken to prepare it.

Step 1: Ascertain the various reasons of disagreement between profit disclosed by cost account and financial account.

Step2: If profit as per cost accounts is taken as the base, then the following specimen should be taken into the mind while preparing reconciliation statement.

Step3: If profit as per financial accounts is taken as the base, then the following format consideration should be taken into mind while preparing reconciliation statement.

References:

Koirala, Madhav et.al., Principles of Accounting -XII, Buddha Prakashan, Kathmandu

Shrestha, Dasharatha et.al., Accountancy -XII, M.K. Prakashan, Kathmandu

Bajracharya, Puskar, Principle of Accounting-XII, Asia Publication Pvt. Ltd., Kathmandu