The disagreement between cost and financial accounts results arise due to the following reasons:
1. Items shown only in financial account
2. Items shown only in cost account
3. Over or under absorption of overhead
4. Difference in valuation of stock
5. Difference methods of charging depreciation
6. Abnormal gain or loss
1. Items Shown Only In Financial Account
There are certain items of incomes and expenditures which are shown only in financial accounts not in cost accounts. As a result, the profit or loss as per cost accounts would be quite different from the profit or loss as per the financial accounts. These items of financial nature can be divided in three groups:
A. Items of expenditures shown only in financial account:
* Interest on capital
* Expenses on issue of shares and debentures
* Loss on revaluation
* Discount on debenture
* Penalties and fine
* Provision for bad and doubtful debts
* Loss on sale of fixed assets
* Donation
* Goodwill, preliminary expenses etc.
B. Items Of Income:
* Interest received, rent received, commission received, discount received
* Dividend received
* Share transfer fees
* Returned of income tax
* Gain of sale of fixed assets
C. Appropriation Of Profits:
* Income tax paid
* Dividend paid
* Transfer to general or specific reserves or funds
* Transfer to sinking fund
* Excess provision for depreciation
* Bonus
2. Items Shown Only In Cost Account
There are very few items, which are shown in cost accounts but not in the financial accounts as they do not represent any transaction with outsiders. These items are also responsible for the disagreement of the results shown by the two sets of accounts. These items are:
* Rent or depreciation of the own building of the proprietor
* Remuneration of the proprietor
* Depreciation on fully depreciated assets
* Interest on capital employed in production
* The losses due to defective and spoilage
3. Over Or Under Absorption Of Overhead
In cost account, overheads are charged on the basis of predetermined percentage. But in financial account they are charged with the actual amount. This results over or under absorption of overheads in cost account and may be the main reason for difference in profits disclosed by cost account and financial account.
The effect of over or under absorption of overhead to profit is shown below:
Overhead..........................................Result
Over subscription.............................Less Profit
Under subscription...........................More Profit
4. Difference In Valuation Of Stock
In financial account, stocks are valued at cost or market price, whichever is lower, but in cost account, stocks are valued only at its cost price. This result in some difference in result i.e. profit or loss.
5. Difference Methods Of Charging Depreciation
There are different methods of charging depreciation. In financial account, depreciation may be calculated on straight line or diminishing balance method as per Income Tax Act. But in cost account, depreciation is calculated on the basis of use of the asset (generally machine hours). The difference in depreciation methods also results in disagreement in profit or loss of these two accounts.
6. Abnormal Gains And Losses
Abnormal gains and losses are shown in financial account while they are completely excluded from cost account. Goods lost by fire, theft, accident or costs of abnormal idle time are examples of abnormal losses, which are shown in financial account but not in cost account. Such abnormal gains and losses also lead to disagreement of cost and financial account results.
