CMA Intermediate · Cost Accounting

Reconciliation of Costing and Financial Profit for CMA Inter

Reconciliation of costing and financial profit explains why profit in cost books differs from profit in financial books. You start from one profit, add or subtract each difference (items only in one set of books, or valued differently), and reach the other profit. A memorandum reconciliation account does the same in ledger form.

What this chapter covers

Companies often keep cost accounts and financial accounts separately. Both record the same business, yet they usually show different profits. This chapter teaches you to explain that gap, line by line, and to prove that the two profits agree once every difference is accounted for.

The differences come from three sources: items that appear only in financial accounts, items that appear only in cost accounts, and items treated differently in the two sets.

Financial charges and losses reduce financial profit and are absent from cost accounts. Examples are interest paid and losses on sale of investments.
Appropriations are not charges against profit. They are shares of profit that is already earned. Examples are income-tax, dividends and transfers to reserves. They are also absent from cost accounts.
Purely financial incomes, such as interest and dividends received, raise financial profit and are absent from cost accounts.
Cost-only items are notional charges such as rent of own premises or interest on own capital charged to costs.
Items treated differently include stock valuation, depreciation and overheads under- or over-absorbed.

You learn to spot which category each item falls in and whether it raises or lowers profit.

The chapter links to the rest of the paper. It uses overhead absorption, stock valuation methods and the cost sheet you have already studied. It also tests your accounting basics, so it is a good place to check that your concepts from other chapters are firm.

This chapter is compact and its logic is mechanical, so it is a reliable source of marks once you learn the pattern. The same few adjustments appear again and again, in both MCQs and numerical questions. The MCQs test whether you know the direction of an adjustment, and the written question rewards a clean statement where each line earns a step mark. A student who practises ten or so problems can usually solve any question from this chapter, even under time pressure.

Reconciliation of Costing and Financial Profit: topics in the order to study them

1Need for Reconciling Cost and Financial AccountsStart here to understand why two profits exist and why management wants them reconciled, before touching any numbers.
2Causes of Difference in Cost and Financial ProfitYou must classify every item (only in financial books, only in cost books, or valued differently) before you can build any statement.
3Preparing the Reconciliation StatementWith the causes clear, you apply them in the standard format, starting from one profit and adjusting to the other.
4Memorandum Reconciliation AccountStudy it last because it shows the same adjustments in ledger form, and it is easier once the statement method is automatic.

How to prepare Reconciliation of Costing and Financial Profit

Treat this chapter as a classification exercise first and a calculation exercise second. If you can place each item correctly, the arithmetic is simple.

Make a one-page list of causes in three groups: only in financial accounts, only in cost accounts, and treated differently. Write the effect of each on profit.
Learn the direction rule for the statement. When you start from cost profit, items that reduce financial profit are deducted and items that increase it are added. Reverse everything if you start from financial profit.
Learn the treatment of under-absorbed and over-absorbed overheads. Under-absorption means cost accounts charged less than actual, so cost profit is higher than financial profit on this item. Over-absorption is the opposite.
Handle stock differences carefully. The adjustment is the difference between the two sets of books, not the stock value itself. Compare opening and closing stock in financial books with those in cost books. If closing stock in financial books is higher than in cost books, financial profit is higher. If opening stock in financial books is higher than in cost books, financial profit is lower.
Solve problems in the statement format first. Write the starting profit, then additions, then deductions, then the final profit, and check that it matches the given figure.
Redo the same problems using the memorandum reconciliation account to see that both methods give the same result.
Before the exam, solve at least two past-style problems against the clock, and practise MCQs that ask only for the direction of one adjustment.

Common mistakes in Reconciliation of Costing and Financial Profit

Adding an item when it should be deducted, or the reverse.
Fix: Before each line, ask whether the item raises or lowers the other profit. Write that one-line reason beside the item until the habit is firm.
Mixing up under-absorbed and over-absorbed overheads.
Fix: Remember that under-absorbed means cost accounts charged too little, so cost profit is higher. Over-absorbed means the opposite.
Adjusting for stock differences using only closing stock.
Fix: Compare financial and cost books for both opening and closing stock. Use only the difference in each case, treat the two effects separately and then combine.
Including financial-only items such as income-tax or dividends in the cost side.
Fix: Use the classification list. Financial charges and losses (such as interest paid and loss on sale of investments) and appropriations (income-tax, dividends, transfers to reserves) are both absent from cost accounts. Purely financial incomes are also kept out.
Ignoring notional charges that appear only in cost accounts.
Fix: Read the question for words like notional, imputed or own capital, and treat these as cost-only items.
Presenting the statement without headings or a final check.
Fix: Use a clear heading, group additions and deductions separately, and show the final profit agreeing with the other set of books.

Last-day revision: Reconciliation of Costing and Financial Profit

Cost profit and financial profit differ because of items in only one set of books or valued differently.
Financial charges and losses, such as interest paid on debentures and losses on sale of assets or investments, reduce financial profit and are absent from cost accounts.
Appropriations, such as income-tax, dividends and transfers to reserves, are not charges against profit. They also appear only in financial accounts.
Purely financial incomes such as interest received and dividends received raise financial profit but are not in cost accounts.
Notional charges, like rent of own premises, appear only in cost accounts.
Under-absorbed overhead: cost profit is higher than financial profit on this item.
Over-absorbed overhead: cost profit is lower than financial profit on this item.
Stock differences are the difference between the two sets of books: if closing stock in financial books is higher than in cost books, financial profit is higher; if opening stock in financial books is higher than in cost books, financial profit is lower.
Starting from cost profit: add items that increase financial profit and deduct items that decrease it.
Starting from financial profit, the direction of each adjustment is reversed.
Abnormal losses and gains charged only in financial accounts are deducted or added accordingly.
The memorandum reconciliation account is a ledger-style check, not part of the double entry.
Finish by checking that the reconciled profit equals the profit shown in the other set of books.

Reconciliation of Costing and Financial Profit practice questions

Reconciliation of Costing and Financial Profit in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Reconciliation of Costing and Financial Profit: frequently asked questions

Why do cost profit and financial profit differ?

They differ because some items appear in only one set of books, and some items are valued differently in the two sets. Examples are interest paid, notional rent, stock valuation and overhead absorption. A reconciliation statement explains each difference.

Should I start the statement from cost profit or financial profit?

Start from whichever profit the question gives, unless it asks for a specific direction. The adjustments are reversed when you change the starting point, so decide the direction before you write the first line.

Is the memorandum reconciliation account part of the double entry?

No. It is a memorandum account, used only to reconcile the two profits in ledger form. It does not change the cost or financial ledgers.

Are MCQs from this chapter numerical or theory based?

Both types can appear. Many MCQs ask whether an item is added, deducted or ignored in the reconciliation, and some ask for a small calculation, such as the effect of under-absorbed overheads on profit.