Reconciliation of cost accounts and financial accounts

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.

Reasons for the disagreement
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.

2. Item appearing only in the cost accounts.
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.

Proforma reconciliation statement
Profit as per cost accounts xxx
Add: expenses appearing only in the cost books xxx
Add: purely financial incomes xxx
Less: incomes appearing only in the cost books xxx
Less: purely financial charges xxx
Profit as per financial accounts xxx

Illustration
Dominion Ltd. operates separate cost accounting and financial accounting systems. Given below is the manufacturing and trading statements of the company for the year ended 30th June 2010:

The following information was extracted from the cost accounts:

Additional information:
(i) A notional rent of ksh. 8,000 per month has been charged in the cost accounts.
(ii) Production overhead was absorbed at the rate of 185% of direct wages.

Required:
Prepare:
(a) Control accounts in the cost ledger
(b) A statement showing the profit as per the cost accounts
(c) A reconciliation statement for the gross profit as per the accounts and as per the cost accounts and as per the financial accounts.
Solution
Ledger accounts in the cost books:


Activity 1
Millennium Fabricators Ltd is a company engaged in the manufacture of specialist marine engines. It operates a job costing accounting system which is not integrated with financial accounts.

At the beginning of the month of May 2010, the operating balances in the cost ledger were as follows:

Of the total wages paid ksh 12,500,000 was incurred in the assembly of manufacturing equipment ksh. 35,700,000 was indirect wages and the balance was direct wages.

Other production overhead costs incurred amounted ksh. 152,000,000. ksh. 30,000,000 or which was absorbed the manufacturing equipment under assembly while ksh7,500,000 was under absorbed overhead costs written off.

One of the engines manufactured the company is produced under license. During the month of May 2010 ksh 2,100,000 was paid as royalty for that particular engine.

Selling overheads and distribution overhead costs were ksh. 22,000,000 Sales were ksh. 410,000,000

The company‟s gross profit margin is 25% on factory cost.

At the end of May 2010, the stock of work in progress had increased ksh. 12,000,000. The manufacturing equipment under assembly was completed within the month and transferred out of the cost ledger at the end of the month.

Required:
Prepare:
a) Control accounts in the cost ledger
b) A statement showing the profit as per the cost accounts
c) Extract a trial balance at the of the period

Activity 2
The following are the transactions of XYZ Ltd. for the month of February 2010

1. Raw materials of ksh.455,000 were purchased on credit
2. Raw materials of ksh.5,000 were returned to the supplier
3. The total of stores requisitions for direct materials issued for the period was ksh. 412,500
4. The total issues for indirect materials during the period was ksh. 25,000
5. Gross wages of ksh. 462,500 were incurred during the period consisting of:
Wages paid to employees PAYE due to Inland Revenue ksh. 262,500
ksh. 150,000

NSSF contributions due ksh. 50,000
6. All the amounts in 5 were settled cash during the period.
7. The allocation of the gross wages for the period was as follows:
Direct wages        ksh.362,500
Indirect wages      ksh.100,000
8. The employers contribution to NSSF deductions was ksh.62,500
9. Indirect factory expenses of ksh.102,500 was incurred during the period.
10. Depreciation of factory machinery was ksh.75,000
11. Overhead expenses charged to jobs means of factory overhead
absorption rates was ksh.350,000 for the period.
12. Non-manufacturing overhead incurred during the period was ksh.100,000
13. The cost of jobs completed and transferred to finished goods stock was ksh.750,000
14. The sales value of goods withdrawn from stock and delivered to the customers was ksh.1,000,000 for the period
15. The cost of goods withdrawn from stock and delivered to customers was
ksh.625,000 for the period

Required:
Post the cost ledger accounts and prepare the costing profit and loss account.

Recommended texts for further reading
Costing T. Lucey
Costing, An Introduction, Colin Drury Wheldon‟s, “Costing Simplified”
Colin Drury, “Management and Cost Accounting”
Bhabatosh Banerjee, “Cost Accounting Theory and Practice”

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