Reconciliation of Cost and Financial Accounts for CMA Inter

Understand Reconciliation of Cost and Financial Accounts

Key rules to remember

Cost profit to financial profit

Financial profit = Cost profit + Income only in financial books − Expenses only in financial books + Over-absorbed overhead − Under-absorbed overhead + Excess of cost-book charges over financial-book charges (e.g. notional costs) − Excess of financial-book charges over cost-book charges + Excess of financial closing stock over cost closing stock − Excess of financial opening stock over cost opening stock

Stock sign rule: for closing stock, add the excess of financial closing stock over cost closing stock, and deduct it if the financial closing stock is lower. For opening stock use the opposite sign: deduct the excess of financial opening stock over cost opening stock, and add it if the financial opening stock is lower. Treat every other item by asking: does it raise or lower the profit in the books I am moving to?

Financial profit to cost profit

Cost profit = Financial profit + Expenses only in financial books − Income only in financial books + Under-absorbed overhead − Over-absorbed overhead ± Stock valuation differences ± Notional items and depreciation differences

Exactly the reverse of the previous rule, so every sign flips. Going from cost profit to financial profit, add over-absorbed overhead and deduct under-absorbed overhead. Going from financial profit to cost profit, add under-absorbed overhead and deduct over-absorbed overhead.

Memorandum reconciliation account rule

Debit: items that reduce profit in the target books. Credit: items that increase profit in the target books. Opening figure is the profit of the starting books.

Balancing figure should equal the profit in the other set of books. If it does not, an item is missing or has a wrong sign.

Stock difference effect

Higher closing stock → higher profit. Higher opening stock → lower profit.

Use this to sign stock valuation differences correctly.

Overhead absorption difference

Under-absorption = Actual overhead − Absorbed overhead (if positive). Over-absorption = Absorbed overhead − Actual overhead (if positive).

Financial books bear the actual overhead. If the cost books absorb less than the actual overhead (under-absorption), cost profit is higher, so deduct it from cost profit to reach financial profit. If the cost books absorb more (over-absorption), cost profit is lower, so add it to cost profit to reach financial profit. In the reverse direction, from financial profit to cost profit, add under-absorbed overhead and deduct over-absorbed overhead.

How to solve Reconciliation of Cost and Financial Accounts questions

1. 1Read the question and note the starting profit and the profit you must reach. Check whether the start is the cost profit or the financial profit.
2. 2List every item given and tag it: only in financial books, only in cost books, or treated differently.
3. 3Ignore items that appear identically in both sets of books, such as normal production costs charged equally.
4. 4Decide the effect of each item on the profit of the books you are moving to. Income in financial books only raises financial profit; an expense only there lowers it.
5. 5For overheads, compare actual with absorbed. Under-absorption lowers financial profit relative to cost profit; over-absorption raises it.
6. 6For stock, compare the two valuations. A higher closing stock gives a higher profit; a higher opening stock gives a lower profit.
7. 7Write the statement (starting profit, additions, deductions, final profit) or the memorandum account (debit and credit sides) with clear labels.
8. 8Check that the final figure agrees with the profit in the other set of books. If given, tick it against the question.

Quickest way: Direction-and-sign method

Common mistakes in Reconciliation of Cost and Financial Accounts

• Adding a financial expense to cost profit when moving to financial profit.

  Students learn 'add back expenses' for the reverse direction and apply it blindly.

  Fix: Always ask which way you are moving. Going from cost profit to financial profit, an expense only in financial books is deducted.

• Including appropriations such as dividend paid or transfer to reserve in the reconciliation as if they were normal expenses without noting their nature.

  They appear in the profit and loss appropriation section and look like any other item.

  Fix: Treat them as items only in financial books. Include them only if the starting profit is before appropriation, and follow the profit definition given in the question.

• Getting the sign wrong on stock differences.

  Students forget that opening and closing stock have opposite effects on profit.

  Fix: Remember: higher closing stock raises profit, higher opening stock lowers profit. Work out each stock difference separately.

• Mishandling under- and over-absorbed overhead.

  Students confuse which books carry actual overhead and which carry absorbed overhead.

  Fix: Write out which books charged what. Financial books bear the actual overhead. Going from cost profit to financial profit, add over-absorbed overhead and deduct under-absorbed overhead. Going from financial profit to cost profit, add under-absorbed overhead and deduct over-absorbed overhead.

• Forgetting notional items such as notional rent or interest on own capital.

  They are not in the financial books, so students scan the financial side only.

  Fix: Check the cost side of the data too. A notional charge lowers cost profit only, so add it to cost profit to reach financial profit.

• Not showing a check that the account balances to the other profit.

  Students rush and stop at the last item.

  Fix: Finish with the target profit and compare it with the given figure. A mismatch signals a missing item or a wrong sign.

Worked examples