Reasons for differences in Profit /Loss shown by Cost Accounts and Profit/ Loss shown by Financial Accounts

Cost Accounts and Financial Accounts are maintained for different purposes, using different principles and methods. Cost Accounting focuses on recording, analyzing, and controlling internal costs related to production, helping in decision-making. Financial Accounting, on the other hand, is concerned with the overall financial performance and position of the business, prepared as per accounting standards and statutory requirements. Since both systems treat items like overheads, stock valuation, depreciation, and incomes differently, the profit or loss figures may not match. A reconciliation statement is often required to identify and explain these differences systematically.

• Items Appearing Only in Financial Accounts

Some incomes and expenses are recorded only in financial accounts, not in cost accounts. Examples include interest received, profit or loss on asset sale, penalties, donations, and income from investments. These items affect the profit/loss in financial accounts but are ignored in cost records as they are not related to production. As a result, the net profit in financial accounts may be higher or lower than in cost accounts, depending on whether the net impact of these items is positive or negative.

• Items Appearing Only in Cost Accounts

Certain notional or imputed costs are considered only in cost accounts, not in financial accounts. For instance, notional rent for owned premises, interest on owner’s capital, or notional salary to the proprietor are included in cost accounts for decision-making and accurate cost estimation. These charges increase the cost of production but are not actual expenses, so they are excluded in financial accounting. This leads to a difference in profit as shown in both sets of accounts.

• Over- or Under-Absorption of Overheads

In cost accounting, overheads are absorbed based on predetermined rates, which may not match actual expenses incurred. If overheads are over-absorbed, the cost account will show higher profit, and if under-absorbed, it will show lower profit. Financial accounts, however, record actual overheads only. This difference in treatment leads to variations in profit or loss between the two accounting systems and must be adjusted during reconciliation.

• Valuation of Stock

Cost and financial accounts often use different stock valuation methods. In cost accounts, inventory may be valued at cost of production, while financial accounts may use cost or market value, whichever is lower, following the conservatism principle. Also, the inclusion or exclusion of certain overheads affects stock values. As opening and closing stocks directly affect the cost of goods sold and profit, any valuation difference causes a mismatch in reported profit.

• Depreciation Methods and Approaches

Depreciation is charged differently in both systems. Financial accounts use methods like Straight Line Method (SLM) or Written Down Value (WDV) as per statutory norms and accounting standards. Cost accounts may use a machine-hour rate or other production-based methods. The amount of depreciation charged affects the total cost and thus the profit or loss reported. Hence, the difference in depreciation treatment results in variation in profit figures between cost and financial accounts.