An Introduction
Reconciliation brings individuals together to mend fences or reach an understanding. Two siblings who heal their connection after some conflict exemplify reconciliation. A cost reconciliation statement examines the profits or losses reported by expense financial accounts categories.
It is a declaration that identifies the root reasons for the net loss or profit that differs between financial and cost accounts and makes the necessary corrections to eliminate them. The reconciliation process ensures the integrity and accuracy of financial data. A thorough reconciliation process also ensures that no illegal changes were made to transactions while they were being processed.
Need for Reconciliation of Cost and Financial Accounts
The issue of reconciliation does not exist in cases where there are no distinct cost and financial accounts. However, in cases where financial and cost accounts are kept separate from one another, the two accounts must be reconciled regularly.
Even though the same fundamental transactions are covered by both sets of books, the figure of the profit declared by the former and the latter are at odds with one another.
Due to the following factors, a reconciliation of the two pairs of books' outcomes is required:
To determine the causes of the variance in the loss or profit in financial and cost accounts, to clearly state the situation, and to ensure that no accounting errors have been made.
To guarantee the mathematical dependability and accuracy of the accounting system to perform cost estimation, cost control, and a review of the financial accounts.
To ensure consistent methods for calculating depreciation, equity value, and overhead.
To improve cooperation and coordination between the operations of the finance department's cost and financial sections.
Need for Reconciliation Accounts
Reconciling Statement
To get at the records of the same accounts held by a third party, a reconciliation statement first starts with the company's record of the outstanding balance, adds and deducts reconciling elements in a series of extra columns, and then applies these changes. The bank reconciliation aims to clarify the discrepancies between the two variants of the accounts and to give an independent confirmation of the accuracy of the balances in the corporate account.
The reconciliation statement includes a breakdown of the discrepancies between the two accounts, making it simpler to identify reconciling items that may be incorrect and require modification. Both internal and external auditors might benefit from using reconciliation statements.
Below are some other reconciliation types we normally encounter in the financial world.
Credit card reconciliation. Credit card reconciliation is similar to bank account reconciliation.
Balance sheet reconciliation.
Cash reconciliation.
Reconciliation Statement
Example of Reconciliation of Cost and Financial Accounts
Mark's son’s & Co. has a balance per pass book of $1,000 as of 31st March 2019. It has a balance as per Cash Book as of 31st March 2019 of $1050. Further details are listed below:
A cheque of $300 was deposited but not collected by the bank.
Bank charges of $50 were recorded in Passbook but not in Cash Book.
Cheese worth $200 was issued but not presented for payment.
Bank interest of $100 was recorded in Passbook but not in Cash Book.
From the above, prepare a statement reconciling the cost and financial accounts figures.
Solution:
Conclusion
Reconciliation is a basic accounting process that verifies the money spent or earned equals the money leaving or into an account after a fiscal period. Reconciliation may be achieved through two methods: documentary analysis and analytics review. Account reconciliation is essential for firms and individuals since it allows them to check for fraudulent behaviour and prevent financial statement problems. As part of standard accounting operations, reconciliation is often performed at regular periods, such as quarterly or monthly.
FAQs on Reconciliation of Cost and Financial Accounts
1. What is the primary purpose of reconciling cost and financial accounts?
The primary purpose is to identify, understand, and explain the reasons for any difference between the profit or loss shown by the cost accounts and that shown by the financial accounts. This process ensures the reliability and accuracy of both sets of records and helps management in decision-making by verifying the cost data used for control and analysis.
2. What does a Reconciliation Statement for cost and financial accounts show?
A Reconciliation Statement is a formal document that systematically explains the discrepancies between two profit figures. It starts with the profit as per one set of accounts (e.g., cost accounts) and then adds or subtracts the specific items that are treated differently in the other set, ultimately arriving at the profit as per the second set (e.g., financial accounts). It provides a clear bridge between the two results.
3. What are the key differences between cost and financial accounting that lead to discrepancies in profit?
The main differences stem from their objectives and the principles they follow:
Objective: Financial accounting aims to present the overall financial performance to external stakeholders (like investors), while cost accounting focuses on providing detailed cost information for internal management decisions.
Principles: Financial accounts are bound by legal requirements and Generally Accepted Accounting Principles (GAAP), whereas cost accounts follow principles tailored for cost control and efficiency.
Scope of Items: Financial accounts include purely financial items (e.g., interest on investments, loss on sale of assets), which are typically excluded from cost accounts. Similarly, cost accounts might include notional costs (like rent on owned premises) that have no place in financial accounts.
4. Why is reconciliation only necessary in a non-integrated accounting system?
Reconciliation is required only when a non-integrated (or interlocking) accounting system is used. In this system, cost accounts and financial accounts are maintained independently in separate ledgers. Because they record and treat transactions differently, their profit figures naturally diverge. In an integrated accounting system, however, both cost and financial data are recorded in a single, unified set of books, ensuring there are no differences in profit to reconcile.
5. What are the common causes for differences between profits shown in cost and financial accounts?
The differences in profit arise mainly from three categories of items:
Items shown only in Financial Accounts: These are purely financial charges or incomes, such as loss on sale of fixed assets, interest received on bank deposits, dividends received, or penalties and fines.
Items shown only in Cost Accounts: These include notional costs not actually paid, like notional rent for a company-owned building or notional interest on capital employed.
Items with different valuations: The valuation of stock or the calculation of depreciation may be done using different methods. For example, stock might be valued at prime cost in cost accounts but at cost or market price (whichever is lower) in financial accounts.
6. How is a Reconciliation Statement typically prepared?
A Reconciliation Statement is prepared by taking the profit from one set of books as the starting point and adjusting it to arrive at the profit from the other set. The typical procedure is:
1. Start with the profit as per cost accounts.
2. Add expenses/losses recorded only in financial accounts and any over-absorption of overheads from cost accounts.
3. Subtract incomes recorded only in financial accounts, expenses recorded only in cost accounts (e.g., notional rent), and any under-absorption of overheads.
4. The final figure should match the profit as per financial accounts.
7. If both cost and financial accounts are maintained correctly, why can the profit figures still differ?
A difference in profit does not necessarily indicate an error. Even with perfect bookkeeping, the profits will differ because the fundamental purpose, principles, and scope of cost and financial accounting are different. Financial accounting provides a true and fair view for external reporting, including all financial transactions. Cost accounting is a management tool focused on operational efficiency, and it may exclude certain financial items while including notional costs to better reflect the true cost of production. Therefore, the difference is an expected outcome of two distinct systems serving different purposes.
