Reasons of difference in profitability of cost and financial records


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Reasons of difference in profitability of cost and financial records

Difference in the profitability of cost and financial records may be due to the following reasons.

  1. Items included in the financial accounts but not in cost accounts.
    1. Purely financial income- such as interest received on bank deposits, interest and dividend on investments, rent receivables, transfer fee received, profit on the sale of assets etc.
    2. Purely financial charges – such as losses due to scraping of machinery, losses on the sale of investments and assets, interest paid on the bank loans, mortgages, debentures etc., expenses of company’s transfer office, damages payable at law etc.
    3. Appropriation of profit – the appropriation of profit is again a matter which concerns only financial accounts. Items like payment of income tax and dividends, transfer to reserve, heavy donations, writing off of preliminary expenses, goodwill and patents appear only in profit and loss appropriation account and the costing profit and loss a/c is not affected.

 

  1. Items included in cost accounts only:

 

There are certain items which are included in cost accounts but not in financial accounts. They are: Charges in lieu of rent where premises are owned, interest on capital employed in production but upon which no interest is actually paid.

 

  1. Under/Over absorption of overhead expenses:

 

In cost accounts, overheads are absorbed at predetermined rates which are based on past data. In the financial accounts the actual amount incurred is taken into account. There arise a difference between the actual expenses and the predetermined overheads charged to product or job.

 

If overheads are not fully recovered, which means that the amount of overheads absorbed in cost accounts is less than the actual amount, the shortfall is called as under recovery or under absorption. If overhead expenses recovered in cost accounts is more than that of the actually incurred, it is called over absorption. Thus, both the over and under recovery may cause the difference in the profits of both the records.

 

  1. Different basis of stock valuation:

 

In cost accounts, the stock of finished goods are valued at cost by FIFO, LIFO, average rate, etc. But, in financial accounts stocks are valued either at cost or market price, whichever is less.

 

The valuation of work-in-progress may also lead to variation. In financial books only prime cost may be taken into account for this purpose whereas in cost accounts, it may be valued at prime cost plus factory overhead.

 

  1. Different basis of depreciation adopted:

The rates and methods of charging depreciation may be different in two sets of accounts.


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