Reconciliation of Cost and Financial Accounts
What this domain tests
Cost and financial accounts record the same transactions on different bases, so their profits differ. Questions give the profit under one set of books plus a list of differences and ask for a reconciliation statement, or ask you to explain why the two profits differ.
Core rules
Start with the profit shown by one set of accounts; adjust first for items appearing in one set only, then for items valued differently.
- Items in financial accounts only: interest and dividend received, profit or loss on sale of fixed assets, income tax, donations, goodwill written off, discount on issue of shares.
- Items in cost accounts only: notional rent, notional interest on capital, imputed salaries.
- Valuation differences: stock valued at cost in cost books but at net realisable value in financial books; different depreciation bases; over- or under-absorbed overheads; abnormal losses treated differently.
- Direction rule: starting from cost profit, add back items that reduced cost profit but not financial profit, and deduct items that raised cost profit but not financial profit.
Worked example
Profit as per cost accounts ₹80,000. Add: notional interest on capital charged only in cost ₹6,000; loss on sale of investment written off only in financial accounts ₹3,000; income tax provided only in financial accounts ₹8,000 - total additions ₹17,000, giving ₹97,000. Less: dividend received credited only in financial accounts ₹5,000; factory overhead over-absorbed in cost ₹12,000; depreciation charged in cost in excess of the financial charge ₹6,000 - total deductions ₹23,000. Profit as per financial accounts = ₹74,000.
Traps
- Adjusting for an item that appears in both sets with the same amount.
- Getting the direction wrong on notional charges and notional income.
- Forgetting that over-absorption raises cost profit, so it must be deducted when starting from cost profit.