What is Reconciliation? | Cost Accounting

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Meaning for Reconciliation:

The Financial Accounts are maintained for ascertainment of profit or loss of the concern as a whole for the accounting period under review and also financial position of the concern at the close of the financial year.

The Financial Accounts deal with the classification, recording and summarization of transactions of the concern and ends up with preparation of final statements viz. Profit and Loss Account and Balance Sheet for the accounting period.

The Cost Accounting will deal with the ascertainment of cost of product, absorption of overheads into product cost, ascertainment of division wise or product wise profit­ability etc. Different sets of accounts are maintained under Financial Accounting and Cost Accounting. The accounting principles, methods and practices are different under these two accounting systems.

The maintenance of different sets of accounts with different objects will cause to show different figures of profit or loss in Cost Accounts and Financial Accounts and it will necessitate to reconcile the two accounts periodically and a statement of reconciliation is prepared to show the reasons for difference in profit or loss shown by cost and Financial Accounts.

The Cost and Financial Accounts are maintained in different forms or follow different methods, principles and approaches and it will naturally result in difference in profit or loss ascertained in the Cost and Financial Accounts which necessitates the reconciliation of both the sets of accounts to identify the causes for deviation.

Need for Reconciliation:

The important reasons necessitating the reconciliation of Cost and Financial Accounts as follows:

(a) The reasons for difference in profit or loss in Cost Accounts and Financial Accounts is analyzed and highlighted.

(b) The accuracy of Cost Accounting methods and practices followed by the concern like absorption and recovery of overheads, depreciation allowance, inventory valuation is cross verified with the Financial Accounts.

(c) The reliability of Cost Accounting data and Financial Accounting data is verified by reconciling both the accounts.

(d) Reconciliation of Cost and Financial Accounts help in standardization of policies like inventory valuation, overhead absorption, depreciation provision etc.

(e) It promotes coordination and cooperation between Financial Accounting and Costing Departments in generating accurate and reliable accounting data for meeting statutory requirements and generation of data for managerial decision making.

(f) It helps the management in identification of reasons for deviation in profit between Cost Accounts and Financial Accounts for internal control and efficient management of opera­tions.

(g) It explains difference in profit or loss shown in Cost Accounts and Financial Accounts and any mistakes in preparation of accounts are brought out and ensures in arithmetical accuracy of both sets of accounts and increase the reliability of both the accounts.

(h) Reconciliation of both the accounts is necessary to ensure that there is no over or under recovery of overheads.

Reasons for Disagreement:

The difference in profit or loss ascertained in Cost Accounts and Financial Accounts is due to the following reasons:

Certain items shown only in Financial Accounts but not in Cost Accounts:

(a) Profit or loss on sale of fixed assets,

(b) Discount on issue or redemption of shares and debentures,

(c) Capital issue expenses,

(d) Preliminary expenses written off,

(e) Receipt of interest and dividends on investments,

(f) Cash discounts and bad debts,

(g) Miscellaneous income or expenditure not relating to business,

(h) Distribution of dividends,

(i) Payment of income-tax,

(j) Donations,

(k) Transfer of profits to reserves,

(l) Goodwill written off,

(m) Expenses relating to previous year,

(n) Profit or loss relating to transactions of abnormal or nonrecurring nature, and 

(o) Lay off wages and retrenchment compensation.

Certain items shown only in Cost Accounts but not in Financial Accounts:

(a) Notional rent on premises owned, and

(b) National interest on capital.

Disagreement due to under/over absorption of overhead items:

In Financial Accounts the actual overheads incurred will be accounted. But in Cost Accounts for ascertainment of cost of production and profitability of cost unit, predetermined overhead absorption rates like machine hour rate, direct labour hour rate, percentage of direct material, direct labour, prime cost, factory overhead, factory cost etc. are used for absorption of overheads.

The absorption of overheads in Cost Accounts may be under or over recovered than the actual overheads incurred.

Difference due to use of different methods of stock valuation:

(a) In Financial Accounts, the stock of raw materials is valued at cost or market value whichever is lower. Whereas in Cost Accounts stock may be valued under FIFO, LIFO, Simple average cost, weighted average cost, Standard cost etc.

(b) The finished goods are valued under Absorption Costing method in Financial Accounts. But in preparation of Cost Accounts, the finished stock may be valued under Absorption costing, Marginal costing, Standard costing etc.

Difference due to use of different rates of depreciation:

In Financial Accounts the amount of depreciation is charged as per the rates given in the Companies Act, 1956. But in Cost Accounts, appropriate and suitable method is used for calculation of the amount of depreciation.

Methods of Reconciliation:

The Cost Accounts and Financial Accounts are reconciled by preparing any of the following:

(a) Memorandum Reconciliation Account, and 

(b) Reconciliation Statement.

Memorandum Reconciliation Account:

It is an account not being a part of double entry system of bookkeeping. It is simply a method by which a record can be made of differences in Cost Accounts and Financial Accounts, in order to show why their respective profit figures are different. The debit and credit of normal account will not apply in preparation of Memorandum Reconciliation Account.

In this statement, profit under one set of accounts is taken as opening balance and all items of difference required to be deducted are debited and those to be added are credited to this account. The balancing figure of this account is the profit shown by the other set of accounts.

A format of Memorandum Reconciliation Account is given below:

Reconciliation Statement:

In preparation of reconciliation statement, profit shown by one set of accounts is taken as base profit and items of difference are either added to it or deducted from it to arrive at the figure of profit shown by other set of accounts.