The following points highlight the five major reasons for difference in profit or loss between cost and financial accounts.
Reason # 1. Items Shown Only in Financial Accounts:
(i) Purely financial charges, reducing financial profit:
(a) Loss on sale of fixed assets and investment
(b) Interest on bank loans, mortgage etc.
(c) Discount on shares, debentures, bonds etc.
(d) Expenses incurred on shares transfer
(e) Fines and penalties
(ii) Purely financial income, increasing financial profit:
(a) Profit on sale of fixed assets and investments
(b) Fees received on issue and transfer of shares etc.
(c) Rent receivable
(d) Interest received on bank deposits, loans etc.
(e) Dividends received on investment
(iii) Appropriations of Profit:
(a) Donations and charities
(b) Income tax
(c) Transfer to reserves
(d) Dividends paid
(e) Goodwill, preliminary expenses, underwriting commission etc. written off.
Reason # 2. Items Shown Only in Cost Accounts:
(i) Notional rent on premises owned
(ii) Interest on capital employed but not actually paid
(iii) Depreciation on fully depreciated assets still in use
(iv) Salary for the proprietor where he works but does not charge a salary
Reason # 3. Under or Over Absorption of Overheads:
In financial accounts the actual overhead incurred is taken into account. In cost accounts overheads are applied to cost units at a predetermined rate and the amount recovered may vary from actual overhead cost incurred. If these differences are written off to Costing Profit and Loss Account the profit figures will agree, otherwise, adjustments are necessary.
Reason # 4. Use of Different Methods of Stock Valuation:
In financial accounts, stock is valued at cost or market price whichever is lower. In cost accounts, stock of materials or finished goods may be valued on FIFO, LIFO, Simple average, Weighted average basis etc. and work-in-progress may be valued at prime cost or works cost. Different stock values result in some difference in profit or loss as shown by the two sets of account books.
Reason # 5. Use of Different Rates of Depreciation:
In financial accounts, depreciation may be calculated on straight line or diminishing balance method etc. whereas in cost accounts machine hour rate, production unit method etc. may be adopted. This will also cause a difference in the profit/loss figures.