When cost and financial accounts are separately maintained in the two sets of books, two profit and loss accounts will be prepared, one for the costing book and the other for the financial books. The profit or loss shown the costing books may not agree with that shown the financial books. It therefore becomes necessary to reconcile the two profits or loss figures.
Differences in profits or losses between cost and financial accounts may arise due to the following reasons.
1. Items appearing only in the financial accounts.
- Financial charges e.g. loss on sale of assets.
- Discount on bonds or debentures.
- Interest charged on bank loans.
- Fines and penalties.
- Profit on sale of assets.
- Rent receivable.
- Donations etc.
Charge for the use of premises which are owned the business where no rent is payable i.e. notional rent. This will be included in the cost books for purposes of product costing. Since no obligation to pay any third party is created, no entries will be made in the financial books in respect of notional rent.
Under or over absorption of overheads
In cost accounts, overheads are absorbed at a predetermined rate whereas in financial accounts, they are recorded based on the actual cost incurred. This may lead to a difference between overheads absorbed in the cost accounts and overheads actually incurred and charged in financial accounts. Such differences should be written off in the costing profit and loss account. However, where over or under absorbed overheads are not transferred to the costing profit and loss account, it results into a difference in the profits shown the two sets of books calling for reconciliation.
Different bases of stock valuation
In cost accounts stocks are valued according to the methods adopted like FIFO, LIFO, NIFO etc. On the other hand, valuation of stock in financial accounting is based on the principle of cost or realizable value whichever is lower.
Different charges for depreciation
Sometimes the depreciation charge in the costing books differs from the charge in the financial books.