## Reconciliation of Cost and Financial Accounts

### Why Reconciliation is Needed

In a Non-Integral System, separate books are maintained for costing and financial transactions. The profit figures from both sets may differ — reconciliation identifies why.

Two purposes:

1. Identify reasons for the difference between Cost A/c and Financial A/c profits

2. Verify arithmetical accuracy and reliability of both sets of books

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### Reasons for Difference

#### 1. Under/Over Absorption of Overheads

Cost accounts use a predetermined overhead rate; financial accounts record actual overheads.

Situation	Cost A/c Profit	Financial A/c Profit
Over absorption in Cost A/c	Less	More
Under absorption in Cost A/c	More	Less

> Logic: Over-absorbed means cost A/c charged more overhead than actual → lower profit in cost A/c. Financial A/c shows actual (lower) overhead → higher profit.

#### 2. Different Bases for Stock Valuation

Financial A/c: stock valued at cost or market price, whichever is lower
Cost A/c: stock valued at cost only

Situation	Cost A/c Profit	Financial A/c Profit
Over-valuation of Opening Stock in Cost A/c	Less	More
Under-valuation of Closing Stock in Cost A/c	Less	More
Under-valuation of Opening Stock in Cost A/c	More	Less
Over-valuation of Closing Stock in Cost A/c	More	Less

#### 3. Different Depreciation Methods

Financial A/c: SLM (Straight Line Method) or WDV (Written Down Value) method
Cost A/c: Machine Hour Rate method

Differences in depreciation charged will cause a profit difference.

#### 4. Items Only in Financial Accounts (Not in Cost Accounts)

Incomes: Profit on sale of fixed assets
Expenditures: Loss on sale of investments, preliminary expenses written off
Appropriations: Dividend distribution tax, income tax

These items increase or decrease financial profit but have no effect on cost profit.

#### 5. Items Only in Cost Accounts — Notional Expenses (Not in Financial Accounts)

Expenses imputed in cost accounts but not recorded in financial books:

Notional interest on owner's capital (treated as if the capital were borrowed)
Notional rent on premises owned by the business

Notional expenses reduce cost account profit but have no effect on financial profit.

Worked example

### Example 1

Profit Effect — Over/Under Absorption:

Suppose overhead absorbed in cost accounts = ₹1,20,000 but actual overhead incurred = ₹1,00,000.

Over-absorption = ₹20,000
Cost A/c has charged ₹20,000 more than actual → Cost A/c profit is lower by ₹20,000
Financial A/c reflects actual overhead → Financial A/c profit is higher by ₹20,000

Reconciliation entry: Add back ₹20,000 over-absorbed overhead to cost profit (or deduct from financial profit) to reconcile.

### Example 2

Profit Effect — Stock Valuation Difference:

Suppose closing stock is valued at ₹50,000 in cost accounts but at ₹45,000 in financial accounts (market price < cost).

Cost A/c closing stock is over-valued by ₹5,000
Higher closing stock → lower cost of goods sold → more profit in cost accounts
Financial A/c uses lower market price → closing stock ₹45,000 → less profit in financial accounts

Reconciliation: Deduct ₹5,000 from cost profit (or add to financial profit) to reconcile.

### Example 3

Notional Expense Adjustment:

Cost accounts include notional rent of ₹12,000 on owned premises.

This expense reduces cost account profit by ₹12,000
Financial accounts do not record this → financial profit is higher by ₹12,000

Reconciliation: Add back ₹12,000 notional rent to cost profit to arrive at financial profit.

⚠️ Common exam mistakes

Confusing the direction of profit effect for over-absorption: over-absorbed overhead REDUCES cost A/c profit (not increases it), because more cost was charged than actually incurred.
Forgetting that income tax and dividends appear ONLY in financial accounts — they are appropriations, not costs, and must never be included in cost accounts.
Treating notional expenses (e.g., notional rent) as appearing in financial accounts — they appear ONLY in cost accounts.
For stock valuation: mixing up opening vs closing stock effects. Higher opening stock → higher cost of goods sold → LOWER profit; higher closing stock → lower COGS → HIGHER profit.
Assuming depreciation differences only exist when the amount differs — the method difference (SLM vs Machine Hour Rate) itself is the cause even if amounts happen to be the same in a given period.

Reference:

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