Reconciliation between costing and financial profit or loss

Reconciliation of Cost and Financial Accounts:

When two set of books i.e. one for financial aspects and one for costing purposes are maintained at the same time in an organization, two different reports with respect to profit or loss may arise i.e. one reported by financial accounting and the other reported by costing records. When profits (or loss) are different for the same period, a curiosity arises that why there is a difference at all when both set of records are for the same period and for same transactions etc. Therefore it becomes necessary that profit or loss shown by the two sets of records is reconciled.

The benefits and objectives of reconciliation between Cost and Financial records are:

        i.            It conspicuously i.e. clearly shows the comprehensive reasons i.e. items of differences.

     ii.            It establishes the arithmetical accuracy of both the set of records.

   iii.            It provides a means of cooperation and coordination and timely rectification of any inadvertent errors.

Reasons for difference:

1.     Items shown only in financial books:

(a)   Purely Financial Charges

(i)                Loss on sale of capital assets

(ii)              Discount on bonds, debentures etc

(iii)            Losses on investments

(iv)            Expenses on company formation and incorporation

(v)              Interest on Bank Loans and mortgages

(vi)            Fines and Penalties

(vii)          Provision for bad and doubtful debts

(viii)        Damages payable at law

(ix)            Amounts written off like goodwill, discount on debentures, preliminary expenses etc

(x)              Loss due to theft, pilferage, fire and other abnormal items.

(b) Purely Financial Incomes

(i)                Profit arising from sale/transfer of capital assets

(ii)              Rent Receivable

(iii)            Dividend and interest received on investments

(iv)            Interest received on bank deposits

(v)              Transfer fee received

(vi)            Income Tax refunds and interest thereon

(c)  Appropriation of Profits

(i)                Dividends paid

(ii)              Transfer to reserves

(iii)            Charitable Donations

(iv)            Income Tax

(v)              Any other item which appears in profit and loss appropriation account i.e. transfer to any statutory reserve

(vi)            Revaluation reserves

2.     Items shown only in Cost Accounts

(i)                Notional rent i.e. charge in lieu of rent when premises are owned and no rent is payable

(ii)              Interest on capital employed but not actually paidi.e.the notional cost of capital employed

(iii)            Notional salaries

(iv)            Depreciation on fully depreciated assets which are still in use

3.      Under-absorption or over-absorption of overheads: In cost accounts, overheads are recovrered at predetermined rate whereas in financial accounts these are recorded at actual cost. This may give rise to a difference between overheads absorbed in cost and actual overhead cost incurred. Such differences should be written off to Costing Profit and Loss Account.

However, when under or over absorbed overheads are not written off to Costing Profit and Loss Account, it results in the amount recovered in cost accounts being different from the actual amount shown in financial accounts and a need for reconciling arises.

4.      Different bases of stock valuation: In cost accounts valuation of stock is done on the basis of method adopted in the stores i.e.  LIFO, FIFO or Average etc. On the other hand, valuation of stock in financial books is invariably on the basis of ‘cost or market price whichever is lower’.

5.      Different methods of Depreciation: The rates and methods adopted for charging depreciation in cost and financial records may be different. Cost accounting lays emphasis on the actual need while financial accounting is tied with applicable statutory laws. As a result profit or loss will differ.

Proforma of Reconciliation between profit as per costing and financial books:

Item/Particulars	Amount(Rs.)	Amount(Rs.)
PROFIT AS PER COST ACCOUNTS
Add:
(i)                Over Absorption of Overheads
(ii)             Items charged only in cost accounts
(iii)           Financial incomes not recorded in cost accounts
(iv)           Overvaluation of opening stock in cost accounts
(v)              Undervaluation of closing stock in cost accounts
Less
(i)                Under absorption of overheads
(ii)             Purely financial Charges
(iii)           Under Valuation of opening stock in cost accounts
(iv)           Overvaluation of closing stock in cost accounts
PROFIT AS PER FIANCIAL ACCOUNTS

Illustration:

From the following figures, prepare a reconciliation statement:

Item	Rs.
Net profit as per financial books:	63,780
Net profit as per costing books	66,760
Factory overheads under recovered in costing	5,700
Administrative overheads recovered in excess	4,250
Depreciation charged in financial accounts	3,660
Depreciation recovered in costing	3,950
Interest received but not included in costing	450
Income tax provided in financial books	600
Bank interest credited in financial books	230
Stores adjustments (credited in financial books only)	420
Depreciation on stock charged in financial accounts only	860
Dividends appropriated in financial accounts	1200
Loss due to theft	260

Solution:

Item/Particulars	Amount (Rs.)	Amount (Rs.)
Profit as per costing Records		66,760
Add:
Administrative overheads recovered in excess	4,250
Depreciation overcharged in cost books (3,950 – 3,660)	290
Interest received but not included in cost books	450
Bank interest credited in financial books only	230
Stores adjustment adjusted in financial books	420	5,640
		72,400
Less:
Factory overhead under recovered	5,700
Income Tax provided in financial books	600
Dividends appropriated in financial books	1,200
Depreciation of stock in financial books	860
Loss due to theft	260	8,620
		63,780

Meaning of Management Accounting:

The term management accounting refers to accounting for the management. Management accounting provides necessary information to assist the management in the creation of policy and in the day-to-day operations. It enables the management to discharge all its functions i.e. planning, organization, staffing, direction and control efficiently with the help of accounting information.

OBJECTIVES OF MANAGEMENT ACCOUNTING

The objectives of management accounting are:

(1) to assist the management in promoting efficiency. Efficiency includes best possible services to the customers, investors and employees.

(2) to prepare budget covering all functions of a business (i.e. production, sales, research and finance).

(3) to analysis monetary and non-monetary transactions.

(4) to compare the actual performance with plan for identifying deviations and their causes.

(5) to interpret financial statements to enable the management to formulate future policies.

(6) to submit to the management at frequent intervals operating statements and short-term financial statements.

(7) to arrange for the systematic allocation of responsibilities.

(8) to provide a suitable organization for discharging the responsibilities.

In short, the objective of management accounting is to help the management in making decisions and implementing them efficiently.

Management accounting has various facets. The field of management accounting is very wide. The main purpose of management accounting is to provide information to the management to perform its functions of planning directing and controlling. Management accounting includes various areas of specialization to render effective service to the management.

Financial Accounting deals with financial aspects by preparation of Profit and Loss Account and Balance Sheet. Management accounting rearranges and uses the financial statements. Therefore management accounting does not exclusively maintain factual data for itself. It is closely related and connected with financial accounting. Thus, management accounting is dependent on financial accounting which limits its scope.

Cost accounting is an essential part of management accounting. Costaccounting, through its various techniques, reveals efficiency of various divisions, departments and products. It also provides information regarding cost of products process and jobs through different methods of costing. Management accounting makes use of all this data by focusing it towards managerial decisions.

FUNCTIONS OF MANAGEMENT ACCOUNTING

Main objective of management accounting is to help the management in performing its functions efficiently. The major functions of management are planning, organizing, directing and controlling. Management accounting helps the management in performing these functions effectively.

 Presentation of Data

Traditional Profit and Loss Account and the Balance Sheet are not analytical for decision making. Management accounting modifies and rearranges data as per the requirements for decision making through various techniques.

Aid to Planning and Forecasting

Management accounting is helpful to the management in the process of planning through the techniques of budgetary control and standard costing. Forecasting is extensively used in preparing budgets and setting standards.

 Decision Making

Management accounting provides comparative data for analysis and interpretation for effective decision making and policy formulation.

Communication of Management Policies

Management accounting conveys the polices of the management downward to the personnel effectively for proper implementation.

Effective Control

Standard costing and budgetary control are integral part of management accounting. These techniques lay down targets, compare actual with standards and budgets to evaluate the performance and control the deviations.

Incorporation of non-financial information

Management accounting considers both financial and non-financial information for developing alternative courses of action which leads to effective and accurate decisions.

Co ordination

The targets of different departments are communicated to them and their performance is reported to the management from time to time. This continual reporting helps the management in coordinating various activities to improve the overall performance.

DISTINGUISH BETWEEN MANAGEMENT ACCOUNTING AND COST ACCOUNTING

Cost accounting and Management accounting are tow modern branches of accounting. Both the systems involve presentation of accounting data for the purpose of decision making and control of day-to-day activities. Cost accounting is concerned not only with cost ascertainment, but also cost control and managerial decision making. Management accounting makes use of the cost accounting concepts, techniques and data. The functions of cost accounting and management accounting are complimentary. In cost accounting the emphasis is on cost determination while

management accounting considers both the cost and revenue. Though it appears that there is overlapping of areas between cost and management accounting, the following are the differences between the two systems.

Purpose

The main objective of cost accounting is to ascertain and control the cost of products or services. The function of management accounting is to provide information to management for efficiently performing the functions of planning, directing, and controlling.

Emphasis

Cost accounting is based on both historical and present data, whereas management according deals with future projections on the basis of historical and present cost data.

Principles and Procedures

Established procedures and practices are followed in cost accounting. No such prescribed practices are followed in Management accounting. The analysis is made and the resulting conclusions are presented in reports as per the requirements of the management.

Data Used

Cost accounting uses only quantitative information whereas management accounting uses both qualitative and quantitative information.

Scope

Management accounting includes, financial accounting, cost accounting, budgeting, tax planning and reporting to management, whereas Cost accounting is concerned mainly with cost ascertainment and control.

DISTINGUISH BETWEEN MANAGEMENT ACCOUNTING AND FINANCIAL ACCOUNTING

The following are the main differences between financial accounting and management accounting.

Objectives

The main objective of financial accounting is to supply information in the form of profit and loss account and balance sheet to outside parties like shareholders, creditors, government etc. But the objective of management accounting is to provide information for the internal use of management.

Performance Analysis

Financial accounting is concerned with the overall performance of the business. On the other hand management accounting is concerned with the departments or divisions. It report about the performance and profitability of each of them.

Data Used

Financial accounting is mainly concerned with the recording of past eventswhereas management accounting is concerned with future plans and policies.

Nature

Financial accounting is based on measurement while management accounting is based on judgement. Because of this, financial accounting is more objective and management accounting is more subjective.

Accuracy

Accuracy is an important factor in financial accounting. But approximations are widely used in management accounting. This is because most of the information is related to the future and intended for internal use.

Legal Compulsion

Financial accounting is compulsory for all joint stock companies but management accounting is only optional.

Monetary Transactions

Financial accounting records only those transactions which can be expressed in terms of money. On the other hand, management accounting records not only monetary transactions but also non- monetary events, namely technical changes, government polices etc.

Control

Financial accounting will not reveal whether plans are properly implemented. Management accounting will reveal the deviations of actual performance from plans. It will also indicate the causes for such deviations.

DISTINGUISH BETWEEN COST ACCOUNTING AND FINANCIAL

ACCOUNTING

Differences between Cost Accounts and Financial Accounts are listed below:

Objective

The main objective of cost accounting is to provide cost information to management for decision making. The main objective of financial accounting is to prepare Profit and Loss A/c and Balance Sheet to report to owners and outsiders.

Legal Requirement

Cost accounts are maintained to fulfil the internal requirements of the management as per conventional guideline. Financial records are maintained as per the requirement of Companies Act and Income Tax Act.

Classification of Transactions

Cost accounting records and analyses expenditure in an objective manner viz., according to purpose for which costs are incurred. Financial accounting classifies records and analyses transactions in a subjective manner i.e., according to nature of expenses.

Stock Valuation

In cost accounts stocks are valued at cost. In financial accounts, stocks are valued at cost or realisable value, whichever is lesser.

Analysis of Profit and Cost

Cost accounts reveal Profit of Loss of different products, departments separately. In financial accounts, the Profit or Loss of the entire enterprise is disclosed into.

Accounting period

Cost report are continuous process and are prepared as per the requirements of managements, may be daily, weekly, monthly, quarterly, or annually. Financial reports are prepared annually.

Emphasis

Cost accounting lays emphasis on ascertainment of cost and cost control. Financial accounts emphasis is laid on the recording of transactions and control aspect is not given importance.

Nature

Cost accounts lay emphasis on both historical and predetermined costs. Financial accounts are maintained on the basis of historical records.

Cost Sheet

MEANING AND DEFINITION OF COST SHEET

A cost sheet is a statement prepared to show the different elements of cost. Preparation of cost sheet is one of the functions of cost accounting. The expenses of a product are analyzed and classified under different heads in the form of statement. This statement is called cost sheet.

PURPOSE OF COST SHEET

1. It provides details of total cost under logical classification.

2. It provides cost per unit in difference stages.

3. It helps in comparison and control of cost.

4. Cost sheet is helpful in estimation of cost for preparation of tender and quotations.

5. It acts as basis for fixation of selling price.

General cost classification in a cost sheet comprises classification of costs into prime cost and Overheads. As:

total costs = direct costs + indirect costs, and

or

total costs = prime costs + indirect costs (as prime cost = direct costs)

or

total costs = prime costs + overheads (as overheads = all indirect costs)

or

total costs = prime costs + {factory overheads + office & administrative overheads

                                                  + selling & distribution overheads}

On functional basis overheads can be classified as works or factory overheads, office & administrative overheads and selling & distribution overheads.

Here it is to be noted that overheads can also be classified as fixed and variable overheads, but in a cost sheet, overheads are generally classified on functional basis i.e. works or factory overheads, office & administrative overheads and selling & distribution overheads.

Another notable feature is that cost compilation moves through various levels and each level given a separate name and tells what costs are added up to that level. The levels are:

(i)                Prime cost:direct material + direct labour + direct expenses)

(ii)             Works cost or factory cost: Prime cost + factory overheads

(iii)           Cost of production: Works cost + office and administrative overheads

(iv)           Cost of goods sold: Cost of production + adjustment of finished stock

(v)              Cost of sales: Cost of goods sold + selling and distribution overheads

(vi)           Sales: Cost of sales + profit

Treatment of Stocks

Stock is considered of three types:

(a)  Stock of Raw Material

(b)  Stock of Work-in-Progress

(c)  Stock of finished goods

(i)                In order to calculate the value of cost of raw materials consumed, use the relationship:

Opening stock of Raw Material

Add: Purchases

Less: Closing Stock of Raw Material

(ii)             Work in progress (WIP) is also known as semi finished stock: To calculate factory cost and value WIP, we use following relationship:

Prime Cost:	XX
Add: Factory Overheads	XX
Current Manufacturing Costs	XX
Add: Opening WIP	XX
Total Goods processed during the period	XX
Less: Closing stock of WIP	XX
Work Cost or Factory Costs	XX

(iii)           Stock of Finished Goods. In cost sheet stock of finished goods are adjusted after calculating cost of production because finished goods represents all costs incurred till production process. From cost of production, opening stock of finished goods is added and closing stock of finished goods is deducted to arrive at cost of goods sold as under:

Cost of Production	XX
Add: Opening Stock of finished goods	XX
Cost of Goods available for sale	XX
Less: Closing Stock of finished goods	XX
Cost of Goods Sold	XX

Direct material is the cost of material of which the final product is composed or made of. It is material which can directly be allocatedto a cost centre or cost object in a conveniently and economically feasible way.

Direct material includes raw material required to produce the goods. It also include:

(i) components, parts used in a product like tyres in a car

(ii) Any material used in production and completely loosing its identity in the final product. For example, fertilizers used in production of crops

(iii) Primary packing material.Example: wrapper of a biscuit pack.

Material cost includes cost of procurement, freight inwards, taxes & duties, insurance etc. directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks, refunds on account of modvat, cenvat, GST and other similar items are deducted in determining the costs of direct material.

Direct labour cost represent labour costs incurred on employees/workers engaged directly in main production process or core business activity. This labour cost is directly responsible for converting raw material into finished goods. Direct labour compensates for the time and efforts consumed in making the product. Direct costs can be logically and conveniently attributed or allocated or charged to the production process. In other words, it can also be said that production process or rendering of the main service is not possible at all without such labour costs. In a manufacturing unit, wages paid to machine operator or wages paid to a carpenter in a furniture unit or wages to a mason in construction unit are examples of direct labour.

It includes:

(i)                Salary and wages

(ii)             Allowances and incentives

(iii)           Payment for overtime (normal or at the instance of customer)

(iv)           EPF and ESI

(v)              Leave with pay, free or subsidized food

Direct expenses: Direct Expenses are the expenses other than direct material or direct labour which can be identified or linked with the cost centre or cost object.Examples  of direct expenses  are:

• expenses for special moulds, dies, designs, drawings etc. required in a particular cost centre

• hiring charges for tools and equipments for a cost centre

• royalties in connection to a product

• Job processing charges etc.

Indirect Material is the cost of material which cannot be directly allocable to a particular cost centre or cost object.Materials which are of small value and cannot be identified in or allocated to a product/service are classified as indirect materials.  

Examples:

• Consumable spares and parts

• Lubricants etc.

Indirect labour cost is the wages of the employees which are not directly allocable to a particular cost centre

Examples of indirect labour:

• Salaries of staff in the administration and accounts department

• Salaries of security staff etc.

Indirect expenses are the expenses other than of the nature of material or labour and cannot be directly allocable to a particular cost centres. Indirect expenses are not be allocable to a particular cost centre.

Examples – insurance, taxes and duties, 

Format of Cost Sheet:

M/S ……

                                   Cost Sheet for the period ………………..

                                    No. of Units produced………… & Unit Price………….

Particulars	Rs.	Rs.	Per Unit
Opening Stock of materials
Add: Purchases
Add: Carriage inwards
Add: Octroi and customs duty
Add: Other expenses on purchases
Less: Closing Stock of raw materials
Cost of Direct Material Consumed
Direct or Productive Wages
Direct or Chargeable Wages
PRIME COST
Add: Works or Factory Overheads
Indirect Materials
Indirect or Unproductive Wages
Leave Wages
Overtime
Fuel and Power
Rent & Taxes
Insurance
Factory Lighting
Supervision
Factory Stationery
Canteen
Welfare Expenses
Repairs
Grease and Oil
Works Salaries
Depreciation
-Plant & Machinery
-Factory Building
-Factory Furniture & other assets
Works Expenses
Gas & Water
Drawing Office Salaries
Technical officer/director’s salary
Laboratory Expenses
Works Telephone expenses
Internal Transport
Less Sale of Scrap
Add: Opening Stock of WIP
Less: Closing Stock of WIP
WORKS/FACTORY COST
Add: Office & Administrative Expenses
Office Salaries
Director’s fees/salaries
Office Rent and Rates
Office Stationery
Computer expenses
Printing
Sundry Office Expenses
Depreciation of Office building & other assets
Newspaper and Journals
Membership fees
Office Lighting
General Repair & Maintenance
Establishment Charges
Travelling Expenses
Conveyance
Postage & Courier
Legal Charges
Audit Fees
Professional fees
Telephone Expenses
Entertainment Expenses
COST OF PRODUCTION
Add: Opening Stock of Finished Goods
COST OF GOODS AVAILABLE FOR SALE
Less: Closing Stock of Finished Goods
COST OF GOODS SOLD
Add: Selling & Distribution Expenses
Advertising
Showroom Expenses
Cost of free Samples
Bad Debts
Salesmen’s salary and commission
Packing Expenses
Carriage Outward
Commission of Sales Agent
Counting House Salaries
Cost of Catalogues, Brochures and Pamphlets
Expenses of Delivery
Collection Expenses
Travelling Expenses of Salesmen
Cost of Tenders
Warehouse Expenses
Cost of mail deliveries
Warehouse Manager’s salaries
Sales Office Expenses
Depreciation and repairs of Delivery vehicles
COST OF SALES (or Total Costs)
PROFIT
SALES

It is important to keep in mind that there are certain items which are excluded for ascertaining costs. This is generally because of there financial nature and either no or very remote connection with the production process.

These are:

1.      Cash discount

2.      Interest paid

3.      Preliminary expenses written off

4.      Goodwill written off or raised

5.      Provision for taxation

6.      Provision for bad debts

7.      Transfer to reserve

8.      Donations

9.      Income tax paid

10. Dividend paid

11. Profit/Loss on sale of fixed assets

12. Damages and penalties

13. Pensions and gratuities

14. Discount on issue of shares/debentures

Questions/Illustrations:

1. Opening stock of raw material   : Rs.15,000/-; Closing Stock or raw material: Rs.35,000/- Purchases during the period: Rs.70,000. With the help of this information calculate the value of raw material consumed.

2. Find out the value of works cost with the help of following:

 Materials : Rs/40,000/-; Labour: Rs.30,000/-; Direct Expenses: Rs 15,000/-, Factory Overheads: Rs.35,000/-, Work-in-progress (opening): Rs.17,000/- and Work-in-progress (closing) Rs.7,000/-

3. Calculate Cost of Goods Sold with the help of following data:

Cost of production: Rs.85,000/-, Opening stock of finished goods: Rs.15,000/-, Closing stock of finished goods: Rs.25,000/-

4. Calculate figure of profit under following:

(a) Cost price: Rs.7,000/-, Profit: 20% of cost

(b) Cost price: Rs.7,000/-, Profit : 20% on sales

(c) Sales price: Rs.7,000/-, Profit : 20% on cost

5. With the help of given data prepare a cost sheet: Direct Labour: Rs.90,000/-, opening stock of raw material : Rs.30,000/-, General office & Admin expenses: Rs.32,000/- Closing Stock of finished goods: Rs.80,000/-, Manufacturing overheads: Rs.80,000/-, WIP(opening): Rs.50,000/-, Purchases of raw material: Rs.1,20,000/-, Selling expenses are 1/6 of cost of goods sold, Closing stock of raw material: Rs.25,000/-. The profit stood at Rs.60,400/-. You are also required to find out the profit percentage and sales value.

6. Prepare cost sheet from following:

Description	Amount (Rs.)
Opening stock of raw material	15,000
Sales
Factory Overheads	100% of direct wages
Material purchased	1,15,000
Closing stock of raw material	20,000
Office overheads	10% of works cost
Direct Expenses	15,000
Direct wages	30,000
Selling and Distribution expenses	@ 3/- unit
Opening Finished Goods   (2000 nos.)	26,500/-
Finished Goods produced (20000 nos)
Closing Finished Goods (3000 nos.)

Also find Selling price per unit assuming 20% margin on sales price/value. There was no closing or opening work-in-progress.

Q.7 In respect of a factory, the following particulars have been extracted for the year 2015:

  Cost of Material                  :Rs.6,00,000/-
  Wages                                 : Rs.5,00,000/-
  Factory Overheads              : Rs.3,00,000/-
  Administrative Overheads  : Rs.3,36,000/-
  Selling Charges                   : Rs.2,24,000/-
  Distribution Overheads       : Rs.1,40,000/-
   Profit                                  : 16% on sales
A work order is available in ensuing period, which will require Materials Rs.8,000/- and wages Rs.5,000/-. Following changes are also proposed/anticipated by management:
Rate of factory overheads has gone up by 20%, distribution charges have gone down by 10% and selling and administration charges gave gone each up by 15%. Factory overheads are recovered as a % of Direct wages. While remaining overheads are linked to Works cost.
You are required to work out the new price to be quoted by the management for the proposed work order if management wishes to earn 25% profit on cost.