Need for Reconciliation12th May 2021 1 By indiafreenotes
Reconciliation of Cost and Financial Accounts is process to find all the reasons behind disagreement in profit which is calculated as per cost accounts and as per financial accounts. There are lots of items which are shown in the profit and loss account only when we make it as per financial accounting rules. There are lots of items which are shown in costing profit and loss account only when we calculate profit as per cost accounting.
Suppose, we have taken the profit or loss as per financial accounts, we adjust it as per cost accounts. In the end of adjustments, we see same profit as per cost accounts. If we have taken profit as per cost account, we have to adjust items as per financial accounts. For this purpose, we make reconciliation Statement.
(a) Items included only in financial accounts
There are number of items which appear only in financial accounts, and not in cost accounts, since they neither do nor relate to the manufacturing activities, such as, Purely financial charges, reducing financial profit
- Losses on capital assets
- Stamp duty and expenses on issue and transfer of stock, shares and bonds
- Loss on investments.
- Discount on debentures, bonds, etc.
- Fines and penalties,
- Interest on bank loans.
- Purely financial income, increasing financial profit
- Rent received
- Profit on sale of assets
- Share transfer fee
- Share premium
- Interest on investment, bank deposits.
- Dividends received.
- Appropriation of profit donations and charities.
(b) Items included only in the cost accounts
There are very few items which appear in cost accounts, but not in financial accounts. Because, all expenditure incurred, whether for cash or credit, passes though the financial accounts, and only relevant expenses are incorporated in cost accounts. Hence, only item which can appear in cost accounts but not in financial accounts is a notional charge, such as:
(i) Interest on capital, which is not paid but included in cost accounts to show the notional cost of employing capital
(ii) Rent i.e. charging a notional rent of premises owned by the proprietor.
In those concerns where there are no separate cost and financial accounts, the problem of reconciliation does not arise. But where cost and financial accounts are maintained independent of each other, it is imperative that periodically two accounts are reconciled. Though both sets of books are concerned with the same basic transactions but the figure of profit disclosed by the former does not agree with that disclosed by the latter.
Thus, reconciliation between the results of the two sets of books is necessary due to the following reasons:
- To find out the reasons for the difference in the profit or loss in cost and financial accounts and to indicate the position clearly and to be sure that no mistakes pertaining to accounts have been committed.
- To ensure the mathematical accuracy and reliability of cost accounts in order to have cost ascertainment, cost control and to have a check on the financial accounts.
- To contribute to the standardisation of policies regarding stock valuation, depreciation and overheads.
- To facilitate coordination and promote better cooperation between the activities of financial and cost sections of the accounting department.
- To place management in better position to acquaint itself with the reasons for the variation in profits paving the way to more effective internal control.
Methods of Reconciliation:
Reconciliation of costing and financial profits can be attempted either:
(a) By preparing a Reconciliation Statement or
(b) By preparation a Memorandum Reconciliation Account.