Chapter 12. Reconciliation of Cost and Financial Accounts – Cost Accounting

12

Reconciliation of Cost and Financial Accounts

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

  1. Appraise the need for reconciliation between cost and financial accounts.

  2. Identify the causes of difference between cost and financial accounts.

  3. Prepare a reconciliation statement (memorandum reconciliation account).

  4. Enumerate the advantages of reconciliation.

  5. Explain the meaning of certain key terms.

Some organizations maintain separate set of books of account for financial accounting and cost accounting purposes. As already explained in previous chapters, such a system is referred to as ‘non-integral system’. As the objectives of these two systems vary, the profit shown by financial books will vary from the profit disclosed by cost books. Financial accounts are dealing with the ascertainment of profit or loss for the entire operation of an organization, whereas cost accounts are concerned with ascertaining cost per unit, profit or loss made by product or product divisions and preparation of various cost statements. This difference resulted in different results of profits. Hence, a necessity arises to reconcile the difference and analyse the causes of difference. This chapter aims at analysing the causes of difference and preparing a reconciliation statement.

12.1 NEED FOR RECONCILIATION

The reconciliation between the results shown by two sets (financial and cost) of books is essential due to the reasons explained below:

  1. Reasons for the difference in the profit or loss in cost and financials accounts can be spotted out.
  2. It ensures the mathematical accuracy of cost accounts.
  3. It facilitates the standardization of policies units with respect to stock valuation, depreciation and overheads.
  4. It ensures coordination between the two.
  5. It ensures effective control, as remedial measures are taken immediately for the reasons of variance.
12.2 CAUSES OF DIFFERENCE

The following are the causes of the difference between profit shown in the cost accounts and financial accounts.

12.2.1 Items Shown Only in Financial Accounts

Some items are included in financial accounts. But they have no place in cost accounts. These items may be grouped into the following categories:

  1. Purely financial charges (expense, loss)
  2. Purely financial income (profit, gains)
  3. Appropriation of profits.

12.2.1.1 Purely Financial Charges

These include:

Causes of difference between profit shown in cost and financial accounts

  1. Losses on sale of fixed assets
  2. Loss in investments
  3. Fines, legal damages and penalties
  4. Interest on debentures and other borrowings
  5. Issue and transfer expenses relating to bonds, debentures, shares, etc.
  6. Damages payable
  7. Discount on issue of debentures
  8. Premium on redemption of debentures
  9. Any other proper expense or loss.

12.2.1.2 Purely Financial Income

This includes:

  1. Profit on sale of fixed asset
  2. Profit on investment
  3. Rent receivable
  4. Interest, received on deposits
  5. Interest, dividends received
  6. Discount received
  7. Commission and brokerage received
  8. Transfer fees received
  9. Any income or gain.

12.2.1.3 Appropriation of Profit

  1. Transfer to reserve or any other fund
  2. Amount written off from fictitious assets—preliminary expenses, underwriting commission, etc.
  3. Dividends paid
  4. Donations and charities paid
  5. Amount written off from intangible assets—goodwill
  6. Additional provision—for doubtful debts, depreciation
  7. Income tax and related profit-based taxes
  8. Capital expenditure, specially charged to revenue.

12.2.2 Items Included in Cost Accounts Only

The following items are not shown in financial accounts but shown in cost accounts only:

  1. Notional interest on capital (i.e. interest actually not paid on capital employed but is included in cost books to show the nominal cost of employing the capital)
  2. Notional rent (charge in lieu of rent where premises are owned)
  3. Other notional costs—such as depreciation on asset even when book value is of negligible amount—salary of the proprietor—he works but does not charge salary.

12.2.3 Items Treated Differently in Cost Accounts and Financial Accounts

  1. Overheads: In financial accounts, actual overheads incurred is charged to the profit and loss accounts, whereas in cost accounts, predetermined rates are used for absorption of overhead. There may be difference between the amount of overhead absorbed and the actual overhead incurred. The unabsorbed (under-recovery or over-recovery) overheads may be carried forward to the next year or may be charged by a supplementary rate or transferred to costing profit and loss account. Selling and distribution overheads are not charged to cost accounts.
  2. Stock:
    1. Raw material: Valuation of stock differs in both the books. In cost accounts, stock of raw material is valued on cost, whereas in financial accounts, stock is valued at the lower of cost or net realizable value.
    2. Work-in-progress: In cost accounts, work-in-progress is valued at prime cost or factory cost or cost of production, whereas in financial accounts, it is valued after considering a part of administrative expense too.
    3. Finished goods: In cost accounts, finished goods are valued at the total cost of production. But in financial accounts, it is valued at cost or market price whichever is lower.
  3. Depreciation: In financial accounts depreciation is calculated as a fixed charge per annum (straight line method or diminishing value method) in accordance with the provisions of companies” act. In cost accounts, machine hour rate or production hour or unit method may be followed.
  4. Abnormal gains and losses: Abnormal gains or losses may be excluded from cost accounts or included by transferring to costing profit and loss account. If it is excluded, difference may arise and need some adjustments. On the other hand, if it is included no difference will occur and no need for any adjustments.
12.3 PROCEDURE FOR RECONCILIATION OF COST AND FINANCIAL ACCOUNTS
  1. The reasons (as discussed above) for disagreement of profits should be ascertained first. As notional figures will not affect the costing profit and loss account, they should be ignored while making the reconciliation.
  2. If profit as per cost accounts (or) loss as per financial accounts is taken as the BASE, to reconcile the profits the following Proforma may be used.

12.3.1 Proforma: Reconciliation Statement

Profit As Per Cost Accounts Rs.
x x
Rs.

Add:

 

 

1. Over-valuation of opening stock in cost accounts

 

2. Over-valuation of closing stock in financial accounts

 

3. Items of income included in financial accounts but not in cost accounts

 

4. Over-absorption of overheads in cost accounts

 

5. Items of expenditure included in cost accounts but not in financial accounts

 

6. Excess expenditure shown in cost accounts over corresponding items in financial accounts

 

7. Excess income shown in financial accounts over corresponding income in cost accounts

 

Less:

 

x x x

1. Under-valuation of opening stock in cost accounts

 

2. Under-valuation of closing stock in financial accounts

 

3. Items of income included in cost accounts but not in financial accounts

 

4. Under-absorption of overheads in cost accounts

 

5. Items of expenditure included in financial accounts but not in cost accounts

 

6. Excess expenditure shown in financial accounts over corresponding items in cost items

 

7. Excess income shown in cost accounts over corresponding items in financial accounts

x x x

Profit as per financial accounts

 

000

Important Note

If profit as per financial accounts (or) loss as per cost accounts is taken as the BASE, items added will have to be deducted, and items deducted will have to be added. The procedure is to be REVERSED in such case.

12.3.2 Memorandum Reconciliation Account

Reconciliation can be done by preparing a memorandum reconciliation account, which is another approach to reconcile the differences between two sets of accounts. This is only a memorandum account and does not form part of the double-entry system of booking. This is only a record to observe the differences between cost accounts and financial accounts.

 

Proforma—Memorandum Reconciliation Account

Illustration 12.1

Model: From profit and loss A/c—Preparation of reconciliation statement

The financial profit and loss account of a manufacturing company for the year ended 31 March 2010 is as follows:

The net profit shown by the cost accounts for the year is Rs. 26,250.

In comparison with the two sets of accounts, it is found that:

  1. The amounts charged in the cost accounts in respect of overhead charges are as under:

     

    Works overhead:

    Rs. 9,100

    Office overhead:

    Rs. 5,600

    Selling and distribution overhead:

    Rs. 7,125

     

  2. No charge has been made in the cost accounts with respect to debenture interest.

You are required to reconcile the profits shown by the two sets of accounts.

 

[B.Com, Bharathidasan University, Tiruchirapalli]

Solution

  1. First, we have to determine the method to be adopted to reconciliation. Here, reconciliation statement approach is adopted. Proforma is drawn.
  2. Base: Net profit as per cost accounts.
  3. With this, adjustment is made with items to be added and items to be deducted.
  4. Net result will be profit as per financial books is arrived at.
Reconciliation Statement

Illustration 12.2

Model: Memorandum reconciliation statement

A manufacturing company disclosed a net loss of Rs. 1,73,500 as per their cost accounts for the year ended March 31, 2010. The financial accounts however disclosed a net loss of Rs. 2,55,000 for the same period. The following information was revealed as a result of scrutiny of the figures of both the sets of accounts.

  Rs.

(i) Factory overheads under-absorbed

20,000

(ii) Administration overheads over-absorbed

30,000

(iii) Depreciation charged in financial accounts

1,62,500

(iv) Depreciation charged in cost accounts

1,37,500

(v) Interest on investments not included in cost accounts

48,000

(vi) Income tax provided

27,000

(vii) Interest on loan funds in financial accounts

1,22,500

(viii) Transfer fees (credit in financial books)

12,000

(ix) Stores adjustment (credit in financial books)

7,000

(x) Dividend received

16,000

You are required to prepare a memorandum reconciliation account.

 

[I.C.W.A. (Inter)—Modified]

Solution

 

Memorandum Reconciliation Statement

Illustration 12.3

Model: Base profit as per financial account

The audited final accounts showed a profit of Rs. 61,000, whereas costing records showed a profit of 73,400. From the following additional information, you are required to reconcile the two accounts:

 

Profit and Loss Account for the Year Ended 31 March 2010

 

The cost accounts showed the following:

  1. The stock balance of Rs. 3,70,000
  2. Direct wages absorbed Rs. 1,65,000
  3. Factory overheads absorbed Rs. 84,000
  4. Administration expenses charged @ 3% of sale value
  5. Selling expenses charged @ 3% of sales value.

Solution

In this problem, profit as per financial accounts is to be taken as the base.

Hence, the procedure is reversed that was followed in illustration no. 12.1. Items added have to be deducted and items deducted have to be added.

 

Reconciliation Statement

Illustration 12.4

Model: Determination of profit with respect to raw materials, work-in-progress and finished goods—opening and closing level

In the reconciliation between cost and financial accounts, one of the areas of differences is for different methods of stock valuation. State, with reasons, in each of the following circumstances whether costing profit will be higher or lower than the financial profit:

Items of Stock Cost Valuation Rs. Financial Valuation Rs.

Raw materials (opening)

20,000
25,000

Raw materials (closing)

25,000
20,000

Work-in-progress (opening)

25,000
20,000

Work-in-progress (closing)

20,000
25,000

Finished stock (opening)

30,000
40,000

Finished stock (closing)

30,000
40,000

[B.Com (Hons)—Delhi—Modified]

Solution

NOTE: The stock of raw materials, work-in-progress and finished goods should be adjusted depending on their effect on profit.

The following are the basic principles:

  1. Opening stock – Lower value → Higher will be the Profit
  2. Opening stock – Higher value → Lower will be the Profit
  3. Closing stock – Lower value → Lower will be the Profit
  4. Closing stock – Higher value → Higher will be the Profit

These principles are applicable to all stocks (irrespective of the form whether they are raw materials or work-in-progress or finished goods).

Apply these principles and find the effect on costing profit as follows:

  1. Raw material – Opening stock – Lower value → Higher profit

    Closing stock – Opening stock: Rs. 25,000 – 20,000 = Profit will be higher by Rs. 5,000

  2. Raw material – Closing stock – Higher value → Higher profit

    Opening stock – Closing stock: Rs. 25,000 – Rs. 20,000 = Profit will be higher by Rs. 5,000

  3. Work-in-progress – Opening stock – Higher value →Lower profit

    Opening stock – Closing stock: Rs. 25,000 – Rs. 20,000 = Profit will be lower by Rs. 5,000

  4. Work-in-progress – Closing stock – Lower value – Lower profit

    Closing stock – Opening stock: Rs. 25,000 – Rs. 20,000 = Profit will be lower by Rs. 5,000

  5. Finished goods – Opening stock – Lower value – Higher profit

    Profit will be higher (40,000 – 30,000) by Rs. 10,000

  6. Finished goods – Closing stock – Lower value – Lower profit

    Profit will be lower by Rs. 10,000 (40,000 – 30,000)

Illustration 12.5

Model: Preparation of costing profit and loss account to reconcile profits

The following is the summary of trading and profit and loss account of a manufacturing company for the year ended 31 December 2009:

In cost accounts, the following allocations are made:

  1. Factory expenses at 20% on prime cost
  2. Administration expenses at Rs. 6 per unit of production
  3. Selling and distribution expenses at Rs. 8 per unit of sales.

You are required to prepare a costing profit and loss account of the company and to reconcile the profit disclosed with that shown in the financial account.

Solution

STAGE I: Preparation of Costing and Profit and Loss Account.

 

Costing Profit and Loss Account as on 31 December 2009
Particulars   (Rs.-‘000)

Step 1: Materials consumed

 

5,480

Step 2: Wages

 

3,020

Step 3: Prime cost (Add: Step 1 + Step 2)

 

8,500

Step 4: Total works cost (Step 3 + Step 4)

 

1,700

Step 5: Total works cost (Step 3 + Step 4)

 

10,200

Step 6: Less: Closing work-in-progress: Rs.

 

 

(i) Materials

128

 

(ii) Wages

72

 

(iii) Factory expenses

40

240

Step 7: Works cost (completed units) (Step 5 – Step 6)

 

9,960

Step 8: Administration expenses:

 

744

Sales + closing stock: (1,20,000 + 4,000) units × Rs. 6

 

 

Step 9: Cost of production (Step 7 + Step 8)

 

10,704

Step 10: Less: Closing finished stock (at proportionate

 

346

Cost of production:

 

 

Step 11: Cost of goods sold (Step 9 – Step 10)

 

10,358

Step 12: Selling and distribution expenses (1,20,000 units × Rs. 8 per unit)

 

960

Step 13: Cost of sales

 

11,318

Step 14: Net profit (Step 15 – Step 13)

 

682

Step 15: Sales (1,20,000 × Rs. 100 per unit)

 

12,000

STAGE II: Preparation of Reconciliation Statement

Particulars Rs. (Rs. “000)

Step 1: Profit as per cost accounts (Ref: Stage I: Step 14)

 
682

Step 2: Add:

 
 

(i) Over-absorption of factory expenses

40
 

    (Rs. 1,700 – Rs. 1,660)

 
 

(ii) Over-absorption of selling expenses

60
 

    (Rs. 960 – Rs. 900)

 
 

(iii) Dividend received

36
316

Step 3: Less:

 
818

(i) Under-absorption of administration expense

20
 

    (Rs. 764 – Rs. 744)

 
 

(ii) Preliminary expenses written off

80
 

(iii) Goodwill written off

40
 

(iv) Difference in valuation of finished stock

26
166

Step 4: Profit as per financial accounts

 
652

Illustration 12.6

Model: Reconciliation under both methods

During the year ended 31 March 2010, the profit of the company stood at Rs. 72,900 as per financial books. The cost books showed a profit of Rs. 103,900 for the same period. You are required to reconcile the profit as shown by two sets of accounts:

 

Rs.

1. Opening stock overstated in cost accounts

7,000

2. Closing stock understated in cost accounts

9,200

3. Factory overheads under-recovered in cost accounts

5,000

4. Administration expenses over-recovered in cost accounts

1,500

5. Selling and distribution expenses under-recovered cost accounts

3,300

6. Depreciation over-recovered in cost accounts

3,000

7. Interest on investment not included in cost accounts

10,000

8. Obsolescence loss relating to machineries charged in financial accounts

4,900

9. Income tax provided in financial accounts

50,000

10. Bank interest credited in financial accounts

3,000

11. Stores adjustments (debited in financial book)

1,500

Solution

Method 1: Reconciliation Statement

 

Profit Reconciliation Statement
Particulars Rs. Rs.

Step 1: Net profit as per financial accounts

 

72,900

Step 2: Add:

 

 

    (i) Under-recovery of factory overheads in cost accounts

5,000

 

    (ii) Under-recovery of selling and distribution expenses in cost accounts

3,300

 

    (iii) Obsolescence expenses not debited in cost accounts

4,900

 

    (iv) Income tax provisions not debited in cost accounts

50,000

 

    (v) Stores adjustments not debited in cost accounts

1,500

64,700

Step 3: Less:

 

1,37,600

    (i) Over-recovery of administration expenses

1,500

 

    (ii) Over-recovery of depreciation

3,000

 

    (iii) Opening stock over-stated in cost accounts

7,000

 

    (iv) Closing stock understated in cost accounts

9,200

 

    (v) Interest on investments not credited in cost accounts

10,000

 

    (vi) Bank interest in financial accounts

3,000

33,700

Step 4: Net profit as per cost accounts

 

1,03,900

Method II: Memorandum Reconciliation Account

NOTE: Students may opt any method to reconcile the profit shown in two sets of books.

Illustration 12.7

Model: Preparation of cost sheet, trading and profit and loss account and then reconciliation statement.

In a factory, works overheads are absorbed at 60‥ of works cost. You are required to prepare

  1. Cost sheet
  2. Trading and profit and loss account and
  3. Reconciliation statement

From the following information:

 

Rs.

 

Materials

4,00,000

Factory: Rs.1,80,000

Wages

3,00,000

Office: Rs. 1,76,000

Factory expenses in finance book

2,00,000

 

Office expenses in finance book

1,70,000

 

Stock at the end is 10% of the output sales are

10,40,000

 

[B.Com (Hons) – Delhi – Modified]

Solution

STAGE I:

 

Cost Sheet

 

Rs.

Step 1: Materials

4,00,000

Step 2: Wages

3,00,000

Step 3: PRIME COST (Add: Step 1 & Step 2)

7,00,000

Step 4: Factory overhead

1,80,000

Step 5: FACTORY COST (Add: Step 3&Step 4)

8,80,000

Step 6: Office overhead

1,76,000

Step 7: COST OF PRODUCTION

10,56,000

Step 8: Less: Closing Stock 10% of Rs. 10,56,000

1,05,600

 

9,50,400

Step 9: Profit

89,600

Step 10: Sales

10,40,000

STAGE II:

 

Preparation of Profit and Loss A/c
Profit and Loss A/c for the Year Ended

STAGE III:

 

Reconciliation Statement
  Rs. Rs.

Step 1. Profit as per cost accounts

 

89,600

Step 2. Add: Over-recovery of office expenses in cost accounts

 

6,000

 

 

95,600

Step 3. Less:

 

 

    (i) Over-valuation of stock in cost accounts

15,600

 

    (ii) Factory expenses under charged cost accounts

20,000

35,600

Step 4. Profit as per financial accounts

 

60,000

Illustration 12.8

Model: Preparation of profit and loss A/c, cost of manufacture and reconciliation statement

The following data is extracted from a manufacturing company:

  Rs.

Stocks: 1 April 2009:

 

Raw materials

8,000

Finished goods

16,000

Stocks 31 March 2010:

 

Raw materials

12,000

Finished goods

4,000

Purchases of raw materials during the year

48,000

Wages

20,000

Sales

1,30,000

Works expenses

15,500

Office expenses

12,200

The selling price is fixed at cost plus 25%. You are required to prepare (1) profit and loss account, (2) a statement showing the cost of manufacture and percentage of each item of cost to total cost, calculating factory overheads at 25% on prime cost and office overheads at 75% on factory overheads and (3) a statement reconciling the profit shown by the cost accounts with that shown by the profit and loss account.

Solution

STAGE I:

 

Profit and Loss Account for the Period Ended 31 March 2010

STAGE II:

 

Statement Showing Cost of Manufacture

 

Statement of Profit as Per Cost books

 

RS.

RS.

Stock of finished goods (opening stock) as on 1.4.2009:

16,000

 

Add: Cost of production (refer the previous statement):

92,000

 

Less: Stock of finished goods (closing stock) (as on 31.3.2010):

1,08,000

 

 

4,000

 

Cost of goods sold

 

1,04,000

Add: *Profit (25% on cost of goods sold)

 

26,000

SALES

 

1,30,000

STAGE III:

 

Reconciliation Statement

Illustration 12.9

Model: Reconciliation statement from trading and profit and loss account

A manufacturing, trading, profit and loss, and profit and loss appropriation accounts of ABC Ltd for the year ending 31 March 2010 are as under:

The cost accounts revealed a profit of Rs. 69,574. In preparing this figure, stocks have been valued in cost account as follows:

  Opening Stock Rs. Closing Stock Rs.

Raw materials

14,100

15,950

Work-in-progress

9,876

10,600

Administration overhead has been ignored in cost accounts. Prepare a reconciliation statement.

Solution

 

Reconciliation Statement
Particulars Rs. Rs.

Step 1. Profit as per cost accounts

 

69,574

Step 2. Add:

 

 

    (i) Dividend received not credited in cost accounts

1,000

 

    (ii) Over absobed-opening stock-work in progress in cost accounts (Rs. 9,876 – 9,800)

76

 

    (iii) Under absorbed-closing stock- W.I.P in cost accounts (10,700 – 10,600)

100

1,176

 

 

70,750

Step 3: Less:

 

 

    (i) Administration overhead not charged in cost accounts

19,500

 

    (ii) Loss on sale of machinery

800

 

    (iii) Furies

300

 

    (iv) Under absorbed opening stock Raw Materials in cost accounts (Rs. 14,200 – Rs. 14,100)

100

 

    (v) Over absorbed closing stovk – Raw Materials in cost accounting (Rs. 14,950 – Rs. 14,900)

50

 

 

 

20,750

Step 4: Profit as per financial accounts

 

50,000

Illustration 12.10

Model: Control accounts for different overheads

The following is a summary of the trading and profit and loss account of ‘X’ Ltd for the year ended 31 December 2009:

The company manufactures a standard unit.

In the cost accounts, production overhead has been absorbed by production at 20% of prime cost, administration overhead Rs. 1.50 per unit and selling and distribution overhead at Rs. 2.00 per unit. The net profit shown by the cost accounts is Rs. 66,000.

You are required to prepare:

  1. Control accounts for production overhead, administration overhead and selling and distribution overhead
  2. A statement reconciling the profit disclosed by the cost records with that shown in the financial accounts

[I.C.W.A. (Inter) – Adapted]

Solution

Step 1:

Basic Calculations:

  1. Production overhead:
     

    Rs.

    (i) Materials

    6,98,000

    (ii) Wages

    3,81,000

    (iii) Prime cost (i + ii)

    (iv) 20% of Rs. 10,79,000

    Rs. 2,15,800

     

  2. Administration overhead recovered:

     

    62,000 units × Rs. 1.50 = Rs. 93,000

     

  3. Selling and distribution overhead recovered:

     

    (62,000 – 2,000) units × Rs. 2.00 = Rs. 1,20,000

     

  4. Cost of finished goods stock is calculated as follows:

     

      Per Unit
      Rs.

    (i) Materials:

    11.00

    (ii) Wages:

    6.00

     

    17.00

    (iii) Production overhead: 20 % of Rs. 17

    3.40

    (iv) Administration overhead: (Given)

    1.50

     

    21.90

Step 2:

STAGE II:

 

Preparation of Control Accounts for Overheads:
(a) Production Overhead Account
(b) Administration Overhead Account
(c) Selling and Distribution Overhead Account

Step 3:

STAGE III:

 

Reconciliation Statement

Illustration 12.11

Model: Preparation of reconciliation account

The Manufacturing Account for the Year Ended December 31, 2009

 

Manufacturing Account for the Year Ended December 31, 2009

The profit and loss account reveals a profit of Rs. 1,20,000 for the year 2009. In the cost accounts the valuations placed on stocks were:

    Rs.

Raw materials

Opening stock

50,600

 

Closing stock

59,200

Work-in-progress

Opening stock

31,000

 

Closing stock

39,800

Profit shown in the costing and profit and loss account is Rs. 1,19,400.

You are required to prepare reconciliation account.

Solution

Important Note

Reconciliation account is prepared in the same way as ‘preparation of statement of reconciliation.’ The only difference is that this is prepared in the account (‘T’-form) format. All items that have been added (to cost accounts profit as base) are shown in the credit side of this account and all the items that have been deducted are shown in the debit side of this account. The balancing figure represents profit as per financial accounts. (Reverse will be the procedure if the base differs.)

 

Reconciliation Account

Summary

The result—profit—shown by financial books will vary from the profit disclosed by cost books. This occurs because financial accounts are dealing with the ascertainment of profit or loss for the entire activities of an enterprise, whereas cost accounts are concerned with ascertaining cost per unit. Hence, the need arises for reconciliation of cost and financial accounts.

There are certain items which are purely financial items and some items are exclusively shown in cost books only. Some items are treated differently in cost and financial accounts—They are: Overheads; Stock: Raw materials, Work-in-progress, Finished goods, Depreciation, Abnormal gains and losses.

Reconciliation Statement: Proforma and methods of reconciling financial and cost accounts—Ref: Text.

Memorandum Reconciliation Statement: One more way of reconciling the differences between two sets of accounts—Proforma and method of preparation of Memorandum Reconciliation Statement: Ref: Text.

Method of determination of profit with respect to raw materials, work-in-progress and finished goods is explained in illustration 12.4.

Preparation of Cost Sheet, Trading and Profit Loss Account, and Reconciliation Statement—different approaches are explained in illustrations 12.5 to 12.11.

Key Terms

Memorandum Reconciliation Account: A statement prepared to reconcile the two profits—cost and financial accounts, presented in the form of an account.

Reconciliation Statement (Adjustment Method): A statement to ascertain the differences between costing and financial books and causes of difference between the two figures of profit.

QUESTION BANK

Objective-Type Questions

 

I: State whether the following statements are true or false

  1. System of maintaining separate books of account to record costing and financial transactions is termed as “integral system”.
  2. Under non-integral system, profit shown by the cost accountants is found to differ from the profit shown by the financial accounts.
  3. In cost accounts, the recovery of overheads is generally based on estimates.
  4. In financial accounts, stock of finished goods is valued at total cost of production.
  5. Appropriation of profits is included in cost accounts.
  6. Items of purely financial income are not shown in cost accounts.
  7. Notional items—such as interest on capital are always included in financial accounts.
  8. Abnormal gains or losses may be charged to costing profit and loss account.
  9. Where integral system of accounting is used, then the need for reconciliation will arise compulsorily.
  10. Preparation of reconciliation statement and the preparation of memorandum reconciliation account are one and same.

Answers:

 

1. False

2. True

3. True

4. False

5. False

6. True

7. False

8. True

9. False

10. False

 

 

 

II: Fill in the blanks with apt word(s)

  1. Cost and financial accounts are reconciled in _________ accounting system.
  2. The system of maintaining same set of books of account to record both costing and financial transactions is known as “ ______ ” accounting system.
  3. Appropriation of profits is _____ in cost accounts.
  4. Purely financial charges and incomes are ______ in financial accounts.
  5. Stock is valued at the lower of _____ or ____ in financial accounts, while in cost accounts it is valued at ______.
  6. Abnormal losses are _____ in financial accounts, where as they are ____ in cost accounts.
  7. Over/under-absorption is excluded from ________ accounts.
  8. Capital losses shown in financial accounts are _____ while reconciling costing profits with financial profits.
  9. If profit as per cost accounts is taken as the base, over-valuation of opening stock of inventory is to be _____ to it.
  10. _____ of depreciation in cost accounts is added to costing profits while reconciling with financial profits.

Answers:

  1. non-integral
  2. integrated
  3. not included
  4. included
  5. cost or net realizable value; cost
  6. included; not included
  7. cost
  8. deducted
  9. added
  10. overcharge

III: Multiple choice questions choose the correct answer

  1. Which subsidiary ledger is maintained in cost accounts:
    1. Work-in-progress ledger
    2. Sundry debtors ledger
    3. Sundry creditors ledger
    4. None of these
  2. The need for reconciling financial and cost accounts arise
    1. to comply with statutory obligations
    2. to facilitate audit work
    3. to fix standards
    4. to ensure the reliability of cost accounts
  3. Which of the following cost control account is not maintained in cost ledger?
    1. profit control A/c
    2. factory overhead control A/c
    3. stores ledger control A/c
    4. cost of sales A/c
  4. The reconciliation can be done by preparing
    1. profit and loss A/c
    2. trial balance
    3. memorandum reconciliation statement
    4. balance sheet
  5. Which one is not the reason for difference between two sets of accounts books (cost and financial)?
    1. items of purely financial manure
    2. capital expenditure
    3. items appearing only in cost accounts
    4. none of these
  6. National charges in cost accounts
    1. increase financial accounts profit
    2. decrease financial accounts profit
    3. decrease costing profit
    4. increase costing profit

Answers:

 

1. (a)

2. (d)

3. (a)

4. (c)

5. (b)

6. (c)

 

 

 

 

Short Answer Questions

  1. What do you mean by non-integral system of accounting?
  2. Why do you want to reconcile financial accounts and cost accounts?
  3. Give examples of purely financial items.
  4. Name the items of appropriation of profit that are not shown in cost accounts.
  5. Mention some items that appear only in cost accounts.
  6. How overheads are treated in financial and cost accounts?
  7. While reconciliation how overheads are treated?
  8. How stock is valued at financial accounts and cost accounts?
  9. How over- or under-valuation of stock is treated while reconciliation?
  10. While preparing a reconciliation statement, how would you deal with under or over charge of depreciation?
  11. What do you mean by reconciliation statement?
  12. Give any two reasons for the difference in cost and financial accounts.
  13. What is memorandum reconciliation statement?
  14. Distinguish between reconciliation statement and memorandum reconciliation statement.
  15. How will you deal with abnormal losses?

Essay Questions

  1. What do you understand by reconciliation of cost and financial accounts? Indicate the possible reasons for difference between them.
  2. Why is reconciliation of cost and financial accounts necessary? Give examples of purely financial and exclusively cost in nature.
  3. Explain the procedure of reconciling profit as shown by cost and financial accounts.
  4. Define the term ‘non-integrated account.’ Explain the system of non-integrated accounting and state the principal ledgers that are to be maintained.
  5. Reconciliation of cost and financial accounts in the modern computer age is redundant—Comment.
  6. Indicate the reasons why it is necessary for the cost and financial accounts of an organization to be reconciled and explain the main sources of differences which could enter into such reconciliation.
  7. Explain the procedure to reconcile cost accounts with financial accounts.
  8. Under what circumstances a reconciliation statement can be avoided? Give examples of some items, either debit or credit, which appear in the financial accounts but do not appear is cost accounts.
  9. The chief cost accountant of a company found to his surprise that the profit was the same as per cost accounts as well as the financial accounts. You are asked to find out the reasons for the same in your capacity as a junior cost accountant in that company. You are asked to analyse and suggest whether a reconciliation statement is necessary or not.
  10. At the end of an accounting period, it is found that the profit shown by the financial accounts falls considerably short of the profit according to the cost accounts. Indicate how the discrepancy may have arisen.

Exercises

 

Part I (For B.Com Course)

[Model: Causes for difference given, reconciliation required]

1. Profit disclosed by a company’s cost accounts for the year 2009 was Rs. 50,000.

The following information is available:

  1. Overheads as per cost accounts were Rs. 8,500 while Rs. 7,000 was recorded as overheads in financial accounts.
  2. Director’s fees shown in financial accounts only Rs. 2,000.
  3. The company allocated Rs. 5,000 as provision for doubtful debts.
  4. Depreciation was shown as Rs. 750 in financial accounts whereas in cost accounts it was shown as Rs. 1,500.
  5. Share transfer fees received during the year was Rs. 2,000.
  6. Provision for income tax was Rs. 15,000.

Prepare cost and financial reconciliation statement.

 

[Madras University]

[Ans: Profit as per financial accounts: Rs. 32,250]

2. From the following prepare a reconciliation statement:

 

 

Rs.

Net profit as per financial records

64,450

Net profit as per cost records

86,460

Income tax provided in financial books

20,000

Bank interest credited in financial books

250

Works overheads under-recovered

1,550

Depreciation charged in financial books

5,600

Depreciation recovered in costing

6,000

Administrative overheads over-recovered

850

Obsolescence loss charged in financial books

2,850

Interest received not included in costing

4,000

Stores adjustments (credit in financial books)

240

Depreciation of stock charged in financial books

3,350

[Ans: Rs. 64,450]

3. X Ltd suffered a loss of Rs. 25,000 as per the financial accounts. In comparison with its costing records for the same year, the following differences were observed:

 

 

Rs.

Over-valuation of opening stock of materials in cost books

1,200

Under-valuation of closing stock of finished goods in financial books

3,000

Dormant materials written off (in financial books)

1,000

Under-absorption of overheads

4,000

Fines levied by municipality

500

Debenture interest paid

2,000

[Ans: Loss as per cost accounts: Rs. 15,700]

4. The profit as per cost accounts is Rs. 75,000. The following details are ascertained a comparison of cost and financial accounts:

  Cost Accounts Rs. Financial Accounts Rs.

(a) Opening stocks:

 

 

    Material

5,000

7,500

    Finished goods

9,000

8,000

(b) Closing stocks:

 

 

    Material

6,000

6,500

    Finished goods

10,000

8,500

(c) Interest charged

5,000

-

(d) Preliminary expenses written off

-

250

(e) Goodwill written off

-

750

(f) Dividend received

-

500

(g) Indirect expenses

37,500

40,000

Find out the profit as per the financial accounts by drawing up a memorandum reconciliation account.

 

[Sri Venkateswara University – Modified]

[Ans: Profit as per financial accounts: Rs. 74,500]

[Model: Profit as per cost accounts—Given profit as per financial accounts—Required]

5. The profit as per cost accounts is Rs. 82,650. The following details are ascertained after the comparison of cost and financial accounts:

  Cost Accounts Rs. Financial Accounts Rs.

(a) Opening stocks:

 

 

    Materials

16,300

16,500

    Work-in-progress

10,000

10,500

(b) Closing stocks:

 

 

    Material

18,000

17,200

    Work-in-progress

8,000

7,600

    Finished goods

4,000

4,500

(c) The director’s fee is Rs. 500, interest paid Rs. 400, reserve for bad debts Rs. 250 and transfer fees collected Rs. 150, dividends received at Rs. 100 are recorded only in financial accounts.

(d) Rent charged in costing but not in financial accounts is Rs. 3,000

(e) Preliminary expenses written off is Rs. 6,500 (not charged in cost accounts)

(f) Overheads charged in financial accounts were Rs. 60,600, recovered in costing was Rs. 63,100

Find out profit as per financial accounts and draw up a reconciliation statement.

 

[Madras University – Modified]

[Ans: Profit as per financial accounts: Rs. 79,350]

6. Prepare a reconciliation statement from the following figures so as to ascertain the profit as per the financial accounts:

 

 

Rs.

Loss as per cost accounts

5,000

Closing stock undervalued in cost accounts

2,500

Goodwill written off

10,000

Profit on sale of machinery

60,000

Interest on bank loan

6,075

Works overheads over-recovered in cost accounts

11,075

 

[Madras University – Modified]

[Ans: Loss as per financial accounts: Rs. 52,500]

[Model: Profit as per financial accounts—Given Profit as per cost accounts—Required]

7. Prepare a reconciliation statement from the information given below:

 

 

Rs.

Profit as per financial accounts

55,650

Director’s fees not charged in cost accounts

1,950

A provision for bad and doubtful debts

1,710

Bank interest

90

Income tax

24,900

Overheads in the cost accounts were estimated at Rs. 25,500, the charges shown by the financial accounts were Rs. 24,960; depreciation of Rs. 2,400 was provided in the financial accounts.

 

[Madras University – Modified]

[Ans: Profit as per cost accounts: Rs. 85,980]

[Model: Trading, profit and loss A/c and cost sheet: Given]

8. Reconciliation statement: Required

The following is the profit and loss A/c of XY Ltd:

The profit as per cost accounts was Rs. 37,000. You are required to prepare reconciliation statement of the cost and financial profits using the following additional data:

  1. Factory overhead in cost accounts is absorbed at 100% on wages
  2. Closing stock is valued at Rs. 10,000 in costing
  3. Administration and selling overheads were recovered at 5% and 7% on sales respectively
  4. Depreciation was charged in costing at Rs. 3,000.

[Madurai Kamaraj University]

[Ans: Reconciliation: Rs. 37,000]

9. According to the costing books of Bright Co. Ltd, the net profit was Rs. 55,560. Prepare a reconciliation statement explaining the reasons for the difference in profits from the following:

Profit and Loss Account for the Year Ended 31.12.2009

The costing records show the following:

 

 

Rs.

(a) Closing stock

51,260

(b) Direct wages recovered during the year

33,440

(c) Works overhead recovered

37,120

(d) Administration overhead charged

30,920

(e) Selling expenses charged

1,480

[Ans: Reconciliation: Rs. 47,560]

[Model: profit and loss A/c—Given]

10. Cost sheet and reconciliation statement—Required.

From the following profit and loss account and additional information given, prepare (1) a cost sheet and (2) reconciliation statement.

 

Profit and Loss Account

In costing opening materials were shown at Rs. 7,000. The factory overheads were absorbed at Rs. 14,000. Administration overhead charges 10% of works cost and selling overhead was 10% of sales.

[Ans: Profit as per cost accounts: Rs. 71,900; Reconciliation: Rs. 71,900]

[Model: Overhead absorption on variability basis.]

11. The following is the profit and loss account of a firm

The normal output of the firm is 75,000 units. Works overhead is fixed to the extent of Rs. 18,000 and selling overhead is 50% variable. Administration overhead is fully fixed.

You are required to prepare a cost sheet and reconcile the profit there in units that shown by the financial accounts.

[Ans: Profit as per cost accounts: Rs. 15,000;

         Reconciliation = Rs. 5,000]

[Model: Work in progress]

12. Works overhead on wages basis

From the following information is derived from the records of a company, you are required to prepare

  1. A statement showing the profit as per cost accounts and
  2. A statement of reconciliation

Following is taken from financial records:

 

Profit and Loss A/c for the Year Ended

Following is taken from costing books:

Materials Rs. 25 per unit, labour cost is Rs. 16 per unit; the factory overheads are absorbed at 60% of labour cost and administration overheads at 20% of factory cost. Selling overheads are charged at Rs. 6 per unit sold. In cost accounts, the opening stock is valued at Rs. 45 per unit and the closing stock at Rs. 60 per unit. There is no opening or closing stock of materials or work-in-progress except that of finished goods.

 

[Karnataka University]

[Ans: Profit as per cost books: Rs. 39,600;

         Reconciliation: Rs. 34,000]

[Model: Work-in-progress (on unit basis)

13. X Ltd. provides the following profit and loss A/c for the year 2009.

 

Profit and Loss A/c of X Ltd for the Year Ended 31.12.2009

The production was 10,000 units of which 9,000 units were sold. Absorption of overhead in cost accounts was on unit basis. The pre-determined rates were works overhead at Rs. 2 per unit and the office overhead Rs. 1.50 per Unit.

Prepare: (1) Cost sheet and (2) Reconciliation statement

[Ans: Profit as per cost accounts: Rs. 27,750; reconciliation: Rs. 27,750]

[Model: Reconciliation A/c preparation]

14. Ascertain the figures (amount) in the profit and loss account by preparing memorandum reconciliation account:

 

 

Rs.

Profit as per cost books

3,00,600

Factory overheads under-recovered in cost books

8,000

Office overheads over-recovered in financial books

3,000

Depreciation shown excess in cost books

1,900

Interest on investments

990

Receipt of income from share transfer

240

Provision made for income tax

97,000

[Ans: Profit as per financial accounts: Rs. 2,01,730]

[Model: Information—Given]

15. Profit and loss A/c, cost sheet and reconciliation—Required

Find out the profit as per the costing records and financial accounts for product x from the following information and reconcile the result

  1. Number of units produced and sold 600 units
  2. Direct materials Rs. 3,600
  3. Direct wages Rs. 3,000
  4. Selling price per unit Rs. 25

The works on cost is charged at 80% of the direct wages and the office on cost at 25% on works cost. The actual works expenses amounted to Rs. 4,500 and the office expenses Rs. 3,900. There was no opening and closing stock.

 

[Madras University]

[Ans: Profit as per cost accounts: Rs. 3,750; Profit as per financial accounts: nil; Reconciliation: nil]

 

Part II: For Professional Courses & (B.Com (Hons); M.Com)

16. In a factory, works overheads are absorbed at 60% of works cost. Prepare (i) cost sheet (ii) trading and profit and loss A/c and (iii) reconciliation statement if the total expenditure consists of materials Rs. 2,00,000; wages Rs. 1,50,000, factory expenses Rs. 1,00,000 and office expenses Rs. 85,000.

10% of the output is stock at the end and sales are Rs. 5,20,000.

 

[B.Com (Hons) – Delhi]

[Ans: Profit as per cost accounts: Rs. 44,800 (cost sheet); Profit as per financial accounts: Rs. 30,000 (profit and loss A/c); Reconciliation: Rs. 44,800 + Rs. 3,000 – Rs. 7,800 – 10,000 = Rs. 30,000]

[Model: Overhead control accounts]

17. The following figures have been extracted from the cost records of a manufacturing unit:

Stores:

 

 

Rs.

Opening balance

30,000

Purchases

1,60,000

Transfers from work-in-progress

80,000

Issues to work-in-progress

1,60,000

Issues to repairs and maintenance

20,000

Deficiencies found in stock taking

6,000

Work-in-progress:

 

Opening balance

60,000

Direct wages applied

60,000

Overheads applied

2,40,000

Closing balance

40,000

Finished products: Entire output is sold at a profit of 10% on actual cost from work-in-progress.

Other wages incurred Rs. 70,000; overheads incurred Rs. 2,50,000.

Items not included in cost records: Income from investments Rs. 10,000; loss on sale of capital assets Rs. 20,000.

Draw up stores control A/c, work-in-progress control A/c; costing profit and loss A/c: profit and loss A/c and reconciliation statement.

 

[I.C.W.A. (Inter)]

[Ans: Balance in stores control A/c: Rs. 84,000; Balance in work-in-progress control A/c: Rs. 40,000;

         Balance in production overhead A/c: Rs. 30,000;

         Balance in wages control A/c: Rs. 10,000;

         Profit as per costing profit and loss A/c: Rs. 34,000;

         Net loss as per profit and loss A/c: Rs. 16,000;

         Reconciliation of cost and financial: Rs. 34,000 + Rs. 10,000 – 10,000 – 30,000 – 20,000 = (– Rs. 16,000)]

[Model: When both profits are not given]

18. The financial records of Modern Manufactures Ltd reveal the following data:

 

 

Rs. (in thousands)

Sales (20,000 units)

4,000

Materials

1,600

Wages

800

Factory overheads

720

Office and administration overheads

416

Selling and distribution overheads

288

Closing stock of finished goods (1,230 units)

240

Work-in-progress: (closing): [Rs. in′000]

 

Materials

48

 

Labour

32

 

Overheads (factory)

32

112

Goodwill written off

 

320

Interest on capital

 

32

Dividend received

 

10

Interest received

 

5

In the costing records, factory overhead is charged at 100% of wages, administration overhead at 10% of works cost and selling and distribution overhead at Rs. 16 per unit sold.

Prepare a statement reconciling the profit as per cost records with the profit as per financial records of the company.

 

[B.Com (Hons)–Delhi)]

[Ans: profit as per cost accounts: Rs. 4,80,000;

         Profit as per financial A/c: Rs. 1,91,000;

         Reconciliation: Rs. 4,80,000 + Rs. 80,000 + Rs. 32,000 + Rs. 43,200 + Rs. 15,000 – Rs. 1,07,200 – Rs. 3,20,000 – Rs. 32,000 = Rs. 1,91,000 ]

19. The profit and loss account as shown in the financial books of a company for the year ended 31.3.2010 together with a statement of reconciliation between the profit as per financial and cost accounts is given below:

 

Profit and Loss Account for the Year Ended 31.3.2010

Statement of reconciliation of profit as per financial and cost accounts:

You are required to prepare the following accounts as they would appear in the costing ledger:

  1. Raw material control A/c
  2. Work-in-progress control A/c
  3. Finished goods control A/c
  4. Cost of sales A/c and
  5. Costing profit and loss A/c

[I.C.W.A. (Inter) – Modified]

[Ans:

  1. Direct material charged to work-in-progress control A/c: Rs. 4,92,450;
  2. Work completed transferred to finished goods control A/c: Rs. 8,88,900;
  3. Cost of goods sold transferred to cost of sales A/c: Rs. 10,53,900;
  4. Cost of sales transferred to costing profit and loss A/c: Rs. 12,73,900;
  5. Profit: Rs. 2,26,100]

20. From the following details, you are required to prepare (a) trading and profit loss A/c (b) cost sheet (c) overhead control accounts and (d) reconciliation statement:

 

 

Rs.

Materials used

6,00,000

Wages

4,80,000

Works expenses

1,20,000

Office expenses

1,50,000

Selling expenses

90,000

Discount on debentures written off

30,000

Sales

18,00,000

In cost accounts, works overheads are absorbed at 30% on wages; Office overhead is recovered at 20% on works cost; Selling overhead is at 7% on sales.

[Ans:

  1. Net profit: Rs. 3,30,000 (as per profit and loss A/c);
  2. Net profit: Rs. 2,05,200 (as per cost);
  3. Overhead control accounts: Works overhead:

    Over recovery: Rs. 24,000; Office overhead:

    Over recovery: Rs. 94,800; Selling overhead:

    Over recovery: Rs. 36,000;

  4. Reconciliation: (Rs. 2,05,200 + Rs. 24,000 + Rs. 94,800 +Rs. 36,000 – Rs. 30,000 = Rs. 3,30,000)]

21. The following figures have been extracted from the financial accounts of V Ltd. for the first year of its operations:

 

 

Rs.

Direct materials consumed

50,000

Productive wages

30,000

Factory overheads

16,000

Administrative overheads

7,000

Selling and distribution overheads

9,600

Bad debts written off

800

Preliminary expenses written off

400

Legal charges

100

Dividend received

1,000

Interest received on bank deposits

200

Sales (12,000 units)

1,20,000

Closing stock:

 

 

Rs.

Finished stock (400 units)

3,200

Work-in-progress

2,400

The cost accounts for the same period reveal that direct materials consumed was Rs. 56,000, factory overheads are recovered at 20% on prime cost, administration overheads are recovered at 60 paise per unit of production, selling and distribution overheads at 80 paise per unit sold.

Prepare profit and loss account both as per financial records and as per cost records. Also reconcile the profits as per the two records.

 

[C.A. (Inter) – Several Times]

[Ans: Profit as per financial books: Rs. 12,900; Profit as per cost books: Rs. 5,652; Reconciliation: Rs. 5,652 + 6,000 + 1,200 + 400 + 1000 +200 – 292 – 800 – 400 – 100 = Rs. 12,900]

22. The profit and loss account of Oil India (P) Ltd for the year ended 31 March 2010 is as follows:

As per the cost records, the works expenses have been estimated at a cost of Rs. 30 per kg and administration expenses at Rs. 15 per kg. During the year 6,000 kg were manufactured and 4,800 kg were sold.

Prepare a statement of costing profit and loss account and reconcile the profit with financial records.

 

[C.A (Inter); C.S (Inter)]

[Ans: Profit as per cost accounts: Rs. 1,10,400; Closing stock of finished goods: Rs. 2,12,400; Reconciliation: Rs. 1,10,400 + 30,000 – 48,000 – 32,400 = Rs. 60,000]

23. A firm of sports equipments commenced business on 1.4.2009 for 2 varieties of cricket bats, senior and junior. The following information has been extracted from the accounts records for the half-year period ended 30.9.2009:

 

 

Rs.

(i) Average material cost per piece of senior bat

80

(ii) Average material cost per piece of junior bat

60

(iii) Average cost of labour per piece of senior bat

140

(iv) Average cost of labour per piece of junior bat

110

(v) Finished goods sold:

 

Senior 300 pieces

 

Junior 700 pieces

 

(vi) Sale price:

 

Per piece of senior bat

500

Per piece of junior bat

390

(vii) Works expenses incurred during the period

1,20,000

(viii) Office expenses

68,000

You the required to prepare a statement showing:

  1. The profit per each brand—piece of bat, charge labour, and material at actual average cost, works expenses at 100% on labour cost and office expenses at 25% of works cost
  2. Financial profit for the half year ending 30.9.2009
  3. Reconciliation between profits as shown by cost accounts and financial accounts

[I.C.W.A. (Inter) – Modified]

[Ans: Profit as per cost accounts: Rs. 43,000; Profit as per financial accounts: Rs. 50,000; Reconciliation: Rs. 43,000 + 8,000 – 1,000 = Rs. 50,000]