Reconciling cost and financial profit

Profit shown by the cost records rarely matches profit in the financial statements. The difference is not an error as long as it can be explained item by item. The reconciliation statement does that, and it is a required part of the cost audit report.

Why the two profits differ

1. Items only in financial accounts — interest and dividend income, profit on sale of assets, provisions written back, penalties, donations, losses on sale of investments.
2. Items only in cost records — notional rent or interest charged for management purposes (rare in statutory cost records).
3. Different valuation of inventory — stock valued at cost in cost records and at lower of cost and net realisable value in financial accounts.
4. Over- or under-absorption of overheads — overheads absorbed at predetermined rates differ from actual.
5. Different depreciation bases — for example, cost records using technical life.
6. Abnormal items — excluded from product cost but present in financial results.
7. Non-covered activities — trading or other products outside the cost records.

Worked example

Good practice

• Reconcile quarterly, not only at year-end; differences are easier to trace when fresh.
• Keep a standing list of reconciling items with ledger references.
• Investigate any unexplained residual. A large unexplained difference usually means cost records are not fully integrated with the books.