# Reconciliation of Cost and Financial Accounts
When cost and financial accounts are kept separately (the non-integrated system), each produces its own profit figure, and the two rarely agree. To make the cost accounts reliable, the two profits must be reconciled.
## Why and How
- Reconciliation requires sufficient detail to locate the differences and identify their causes.
- Each item of difference is then added to or subtracted from the profit shown by one set of accounts to arrive at the profit shown by the other.
- The reconciliation can be presented either as a Reconciliation Statement or as a Memorandum Reconciliation Account.
## The Three Causes of Difference
Differences arise for exactly three reasons. Learning these categories is the key to the whole topic.
### (a) Items Recorded in Financial Accounts ONLY
These appear in financial books but never enter cost accounts.
Purely Financial Expenses:
- Interest on loans / bank mortgages
- Expenses and discounts on issue of shares, debentures, etc.
- Capital losses, e.g. loss by fire not covered by insurance
- Losses on sale of fixed assets and investments
- Income tax, donations, subscriptions
- Expenses of the company's share transfer office
Purely Financial Incomes:
- Interest received on bank deposits, loans, investments
- Dividends received
- Profit on sale of fixed assets and investments
- Transfer fees received
- Rent receivable
### (b) Items Recorded in Cost Accounts ONLY (Notional Items)
These are charged in costing to reflect true economic cost, even though no actual cash is paid:
- Charges in lieu of rent where the premises are owned
- Interest on capital at a notional figure (not actually incurred)
- Salary for the proprietor at a notional figure (not actually incurred)
- Notional depreciation on assets already fully depreciated (book value nil)
### (c) Items Treated DIFFERENTLY in the Two Sets
Some items appear in both sets but are valued/treated differently — for example different methods of stock valuation, depreciation, or overhead absorption (under/over-absorbed overheads).
## How the Causes Affect Profit
| Cause | Effect on the two profits |
|---|---|
| (a) Financial expenses | Reduce financial profit but not cost profit |
| (a) Financial incomes | Raise financial profit but not cost profit |
| (b) Notional charges | Reduce cost profit but not financial profit |
| (c) Different treatment | Profits differ by the valuation gap (e.g. over-absorption raises cost profit) |
When reconciling, start from one profit and adjust each item so as to cancel the reason it differs, arriving at the other profit.
## Key Takeaway
Every reconciling item falls into one of three buckets: financial-only, cost-only (notional), or treated-differently. Classify the item correctly first; the direction of adjustment (add or subtract) then follows logically.