RECONCILIATION OF COST AND FINANCIAL ACCOUNTS
- Marghhoob Enam
- Feb 17
- 2 min read
There are two primary systems of cost book-keeping:
Integral Cost Accounting
Non-Integral Cost Accounting
Each system serves a distinct purpose based on the organization's financial reporting and cost management needs.
Non-Integral Cost Accounting System
Financial accounting and cost accounting operate separately.
Financial accounting determines the overall profit or loss over a long period (usually a year) without focusing deeply on cost computations.
Cost accounting aims to determine the profitability of different manufacturing units or product divisions, ensuring efficiency through cost comparison and control.
Since both systems handle the same fundamental transactions—such as material purchases, wage payments, and other expenses—but record them differently, variations may arise in the profit figures reported in financial and cost accounts.
This discrepancy necessitates reconciliation to align the profit figures from both systems.
Integral Cost Accounting System
Financial and cost accounting are merged into a single framework.
All financial and cost-related transactions are recorded within the same set of books.
Ensures uniformity in profit computation.
Eliminates the need for reconciliation, as there is only one Profit & Loss Account (P&L A/c) and a single profit figure.
Key Differences Between Financial and Cost Accounting
(a) Different Methods of Stock Valuation
Raw Materials: In financial accounting, valued at cost or market price (whichever is lower). In cost accounts, may be valued using FIFO, LIFO, or the average method.
Work-in-Progress: Financial accounts may include administrative expenses in valuation, whereas cost accounting typically values it at prime cost or factory cost.
Finished Goods: Financial accounting values at cost or market price (whichever is lower), while cost accounts value at the total cost of current production.
(b) Under/Over Absorption of Overheads
Financial books record overheads at the actual amount incurred.
Cost accounting absorbs overheads using predetermined rates based on:
Percentage of prime cost
Percentage of factory cost
Percentage of total cost of production
Rate per unit sold
Percentage of sales or gross profit
(c) Different Methods of Charging Depreciation
Financial accounting follows methods dictated by company law and tax provisions (e.g., diminishing balance or straight-line method).
Cost accounting may use:
Machine hour rate
Production hour or unit method
(d) Abnormal Losses or Gains
Excluded from cost accounts and transferred to the costing P&L account to prevent discrepancies.
Examples: abnormal wastage of materials, idle time costs, exceptional bad debts, or abnormal gains from production processes.
(ii) Items Appearing Only in Financial Accounts
(a) Purely Financial Charges or Expenses
Loss on sale of fixed assets or investments
Discount on shares or debentures
Interest on loans, mortgages, and debentures
Damages payable under law, fines, and penalties
Loss due to scrapping or theft
Goodwill and preliminary expenses written off
(b) Purely Financial Incomes
Interest received on bank deposits
Rent receivable
Transfer fee received
Dividend and interest on investments
Profits from the sale of capital assets
(c) Items from Profit and Loss Appropriation Account
Transfer to reserves
Income tax paid
Dividends paid
Charitable donations
Capital expenditure charged to revenue
Additional provisions for depreciation and bad debts
(iii) Items Recorded Only in Cost Accounts
Notional interest on own capital (not actually paid)
Fully depreciated assets still in use
Notional rent for owner-occupied buildings
Salary for proprietors working in the business without a formal salary
By choosing the appropriate cost accounting system, organizations can:
Streamline financial processes.
Enhance cost control.
Make informed strategic decisions.
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