The vital differences between the two branches of accounting are manifested in the variation of the profit figure of one from the other through the cumulative impact of the following factors:
Items Shown Only In Financial Accounts
There are certain items which are included in financial accounts but find no place in cost accounts. These may be items of expenditure or appropriation of profit or items of income. The items may be classified as under:
Purely Financial Charges:
- Loss on sale of fixed assets.
- Loss in investments.
- Discount on issue of shares.
- Interest on bank loan, mortgages, debentures etc.
- Expenses of the company’s share transfer office.
- Damages payable.
- Penalties and fines.
- Losses due to scrapping of machinery.
- Remuneration paid to the proprietor in excess of a fair reward for services rendered.
Purely Financial Income:
- Rent receivable, (when rent is receivable from subletting part of business premises – then it can also be included in cost accounts).
- Interest received on bank deposits.
- Profit made on sale of investments, fixed assets etc.
- Transfer fees received.
- Interest, dividends etc. received on investments.
- Brokerage received.
- Discount, commission etc. received.
Appropriation of Profits
- Donations and charities paid.
- Taxes on income and profits.
- Dividend paid.
- Transfer to reserves and sinking fund.
- Additional provision for depreciation of building, plant etc. and for bad debts.
- Amounts written off – goodwill, preliminary expenses, underwriting commission, discount on debentures issued, organisation expenses etc.
- Capital expenditure specifically charged to revenue.
Items Included In Cost Accounts Only
There are certain items which are excluded from financial accounts but are included in cost accounts:
- Interest on capital employed in production but upon which no interest is actually paid. It is included in cost books in order to show the nominal (notional) cost of employing the capital rather than investing it outside the business.
- Charge in lieu of rent where premises are owned.
- Depreciation on asset even when the book value of the asset is reduced to negligible figure.
- Salary of the proprietor where he works but does not charge salary.
Over Or Under Absorption of Overheads
In cost accounts, recovery of overheads is based on an estimate or pre-determined ratio e.g. percentage on prime cost, percentage on sales etc. which may be more or less than the actual amount incurred. In financial accounting the actual expenses of overheads are recorded. If overheads are not fully absorbed i.e. the amount in cost accounts is less than the actual amount, the short fall is called under absorption. On the other hand, if overhead expenses in cost accounts are more than the actual, it is called over-absorption. Thus under or over absorption of overheads leads to difference in two accounts. The under recovery or over recovery of overheads may be carried forward to the next period or may be charged by a supplementary rate (positive or negative) or transferred to costing profit and loss account. In case, the under recovery or over recovery of overheads has been carried forward to the next period, the profit as shown by the cost accounts will be different from the profits as shown by the financial books and adjustments will have to be made on this account. Some cases, selling and distribution expenses are ignored in cost accounts and as such costing profit will be higher and thus requiring reconciliation.
Adoption of Different Basis of Valuation of Stock
- Raw Material: In financial accounts, stock of raw material is valued at cost or market price whichever is less, while in cost accounts stock can be valued on the basis of FIFO or LIFO or any other method. Thus the value of stock may be different in both the books.
- Work-in-progress: Difference may also exist regarding the mode of valuation of work-in-progress. It may be valued at prime cost or factory cost or cost of production. The most appropriate mode of valuing is at factory cost in cost accounts. In financial accounts, work-in-progress may be valued after considering a part of administrative expenses also.
- Finished Goods: In financial accounts stock of finished goods is valued at cost or market price whichever is lower. In cost accounts, finished goods are generally valued at total cost of production.
Thus the method of valuation of stock gives rise to different results in the sets of books.
Different Methods of Charging Depreciation
The methods of charging depreciation may be different in cost books as well as in financial books. The method of providing depreciation under financial accounting is totally governed by Companies Act or tax provisions so that diminishing balance method or fixed installment method is generally followed. However in cost accounts machine hour rate or production hour or unit method may have been followed.
Abnormal Gains and Losses
Abnormal gains or losses may completely be excluded from cost accounts or may be taken to costing profit and loss account. If it is excluded, costing profit/loss will differ from financial profit/loss and adjustment will be required. In case, if these are transferred to costing profit and loss account, the profit or loss shown by cost accounts will agree with the profit or loss of financial accounts. In such a case no adjustment will be required. Examples of such abnormal gains and losses are, abnormal wastage of materials, e.g. by theft, fire etc., cost of abnormal idle time, cost of abnormal idle facilities, exceptional bad debts, abnormal gain in manufacturing through processes etc.
