Ascertainment of Profits as per Financial Accounts and Cost Accounts

Profit is the primary objective of every business organisation. It reflects the efficiency of management and the overall performance of business operations. However, profit is not a single uniform concept. In accounting, profit can be ascertained in two different ways—through Financial Accounts and through Cost Accounts.

Although both systems aim to calculate profit, the purpose, scope, principles, and treatment of expenses and incomes differ, leading to different profit figures. Understanding the ascertainment of profit under both systems is essential for students, accountants, managers, and decision-makers.

Ascertainment of Profit as per Financial Accounts

Financial accounts are prepared to record, classify, and summarize business transactions in monetary terms. They are prepared in accordance with Generally Accepted Accounting Principles (GAAP) and statutory requirements.

The main objective of financial accounting is to determine:

• Overall profitability

• Financial position of the business

Method of Ascertainment of Profit (Financial Accounts)

Profit as per financial accounts is determined by preparing:

• Trading Account

• Profit and Loss Account

Trading Account

The Trading Account is prepared to calculate Gross Profit or Gross Loss.

Items Included

• Opening Stock

• Purchases

• Direct Expenses (wages, carriage inward, power)

• Sales

• Closing Stock

Formula

$$\text{Gross Profit}=\text{Sales}-\text{Cost of Goods Sold}$$

Profit and Loss Account

The Profit and Loss Account is prepared to calculate Net Profit or Net Loss.

1. Expenses Included

• Office and administrative expenses

• Selling and distribution expenses

• Financial charges

• Depreciation

• Interest and taxes

2. Incomes Included

• Commission received

• Interest received

• Rent received

• Dividend income

Features of Profit as per Financial Accounts

• Shows actual profit or loss

• Includes all operating and non-operating items

• Based on historical costs

• Prepared for external users

• Governed by legal and accounting standards

Importance of Financial Profit

• Helps shareholders assess returns

• Assists creditors in judging solvency

• Used for taxation purposes

• Required for statutory reporting

• Shows overall business performance

Ascertainment of Profit as per Cost Accounts

Cost accounting deals with the classification, recording, and allocation of costs relating to production and sales. It focuses on cost control, cost reduction, and efficiency measurement.

Profit as per cost accounts is calculated through:

• Cost Sheet

• Costing Profit and Loss Account

Method of Ascertainment of Profit (Cost Accounts)

Preparation of Cost Sheet

A cost sheet determines:

• Prime Cost

• Factory Cost

• Cost of Production

• Cost of Sales

Profit = Sales − Cost of Sales

Elements Considered in Cost Accounts

• Direct material

• Direct labour

• Direct expenses

• Factory overheads

• Office overheads

• Selling and distribution overheads

Features of Profit as per Cost Accounts

• Shows operational profit

• Based on estimated or standard costs

• Excludes purely financial items

• Used for internal management

• Helps in pricing and cost control

Importance of Cost Profit

• Assists in fixing selling prices

• Helps control costs

• Improves operational efficiency

• Aids in decision-making

• Facilitates budgeting and forecasting

Reasons for Difference between Financial Profit and Cost Profit

The profit shown by financial accounts and cost accounts rarely matches due to differences in scope, principles, and treatment of costs and incomes.

Items Included Only in Financial Accounts

These items are purely financial in nature and do not affect cost of production:

• Interest on capital

• Dividend received

• Rent received

• Profit on sale of assets

• Loss on sale of assets

• Income tax

• Donations and fines

These items increase or decrease financial profit only.

Items Included Only in Cost Accounts

These are notional or imputed costs, included to show true cost:

• Imputed rent of owned premises

• Notional interest on capital

• Notional salary of owner-manager

These items affect cost profit only.

Difference in Overhead Absorption

• Financial Accounts → Actual overheads

• Cost Accounts → Absorbed overheads

This leads to:

• Over-absorption

• Under-absorption

Difference in Stock Valuation