Reconciliation of Profits
Reconciliation of profits disclosed by Financial Accounts and Costing Accounts in an interlocking system, While interlocking cost accounting system is applied, there will forever be differences between the profits appeared in the financial accounts and that appeared in the financial accounts even whether there are no errors in either accounts. This disparity in profits is caused via the different ways of recording accounting entries in the cost books and the financial books. As like this reason, the two profit figures in the set of the two accounts must be periodically reconciled whether they are to be meaningful. This reconciliation is done using accounts identify as the Memorandum Reconciliation Account. Differences among the profit figures in the financial books and the cost books are caused by factors like:
1.Items appeared merely by one set of Accounts that is Items appearing in the financial accounts and not in the cost books and vice versa.
(a) Item appeared only in the financial books involve:
- Losses on disposal of assets
- Stamp duty and other expenses on issues and transfers of capital stock or shares, debentures, bonds, etc
- Losses on investment
- Interest on bank loans
- Discounts on debentures and bonds.
- Dividends obtained
- Profits arising from sale of fixed asset
- Dividends paid
- Rent obtainable however excluding such portion receivable from sub-letting part of the business premises whether it has been involved in the cost accounts.
(b) Items shown only in the cost books: These are generally notional charges hence not real.
They involve as:
- Interest on capital working in production
- Notional rental charges of premises owned
The above two notional costs signifies the opportunity cost of using the capital in the business quite than investing it outside the business.
1. Different bases of Stock Valuation
In cost accounts stocks are valued differently, and financial accounts; the financial stock is valued on the lower of cost and total realizable value or mark value. The valuation of stocks in cost accounts is either based on weighted average or FIFO or LIFO. This employ of different bases in valuing stocks will affect the losses/profit appeared in the financial or cost accounts thus the need for reconciliation of the two.
2. Different Treatment of Overheads
In cost accounts, indirect expenses are recovered like overheads based on estimated expenditure and aligned along with the estimated level of production. Such results in beneath or over-absorption of overheads and this should be taken into account while reconciling the profits of the two sets of accounts. However in the financial accounts, indirect expenses are recorded on the real cost and charged to production account.