Why do profits differ in cost accounts and financial accounts, and how do I prepare a reconciliation statement?
GradeHunt_TeamGradeHunt Team · · CA Intermediate
I'm practising reconciliation of cost and financial accounts for CA Inter Costing. I understand the format but I get confused about which items are added and which are deducted.
Profits differ because the two sets of books record some items differently or not at all.
Main reasons:
1. Items only in financial accounts: interest received, dividends, profit or loss on sale of fixed assets, fines and penalties, preliminary expenses written off.
2. Items only in cost accounts: notional rent or notional interest on own capital.
3. Different valuation: stock valued differently, overheads absorbed at a predetermined rate in cost accounts while financial accounts charge the actual amount, depreciation charged by different methods.
How to reconcile (starting from profit as per cost accounts):
- ADD items that increase financial profit relative to cost profit: incomes only in financial accounts, overheads over-absorbed in cost accounts, notional expenses charged only in cost accounts, closing stock valued higher in financial accounts, opening stock valued lower in financial accounts.
- DEDUCT items that reduce financial profit relative to cost profit: expenses only in financial accounts, overheads under-absorbed in cost accounts, opening stock valued higher in financial accounts, closing stock valued lower in financial accounts.
A simple way to avoid sign errors: for each item, ask "does this make the financial profit bigger or smaller than the cost profit?" Bigger means add, smaller means deduct. If you start from financial profit instead, reverse every sign.
Exam tip: always state your starting figure clearly ("Profit as per cost accounts") and give a one-word reason next to each item. If the closing figure does not match, the reasons make it easy for you to spot the wrong sign.
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