Cost Accounting is a business practice in which we record, examine, summarize, and study the

company’s cost spent on any process, service, product or anything else in the organization. This
helps the organization in cost controlling and making strategic planning and decision on improving
cost efficiency. Management gets the idea where they have to control the cost and where they have
to increase more, which helps in creating a vision and future plan.

Cost Accounting

It is a process via which we determine the costs of goods and services. It involves the recording,
classification, allocation of various expenditures, and creating financial statements. This data is
generally used in financial accounting. This helps us calculate the costs of the various goods. It also
involves a suitable presentation of this data for the purposes of cost control and guidance to
the management.

Objectives of Cost Accounting

1. To correctly analyze the cost of both the process and operations.

2. Provide requisite data and help in fixing the price of products manufactured or services
rendered.

3. Present and interpret data for management planning, decision-making, and control.

4. Help in the preparation of budgets and implementation of budgetary control.

5. Aid management in the formulation and implementation of incentive bonus plans on the
basis of productivity and cost savings.

6. Organization of cost reduction programmes with the help of different departmental

managers.

7. To provide specialized services for cost audit in order to prevent errors and frauds.

8. To facilitate prompt and reliable information to management.

Advantages of Cost Accounting

1] Measuring and Improving Efficiency

Cost accounting allows for data that enables the firm to measure efficiency. This could be
efficiencies with respect to cost, time, expenses etc.
Standard costing is then used to compare actual numbers with the industry or economy standards
to indicate changes in efficiency.

2] Identification of Unprofitable Activities

Just because a firm is making overall profits, it does not mean all activities are profitable. Cost
accounting will help us identify the profitable and unprofitable activities of the firm.

3] Price Reduction

Sometimes during tough economic conditions, like depression, the prices have to be reduced. In
some cases, these prices are reduced to below the total cost of the product. This is to help the
company survive this tough period. Such decisions the management has to take are guided by cost
accounting.

4] Control over Stock

Another important advantage of cost accounting is that it helps with restocking and control over
materials. Cost accounting will help us calculate the most ideal and economic re-order level and
quantities.

5] Evaluates the Reasons for Losses

Every firm has to deal with periods of profits and losses. But now they must always evaluate or
investigate the reasons for the losses suffered.

7] Aids Future Planning

One of the biggest advantages of cost accounting is that it will help the management with future
plans they may have. For any production or selling plans, it is important to have detailed data
about the machines, the labour capacity, output levels, levels of efficiency of each process etc.

LIMITATION

1. Lack of uniformity:
Cost accounting lacks a uniform procedure. It is possible that two equally competent cost
accountants may arrive at different results from the same information. Keeping this limitation
in view, all cost accounting results can be as mere estimates.
2. Costly: 
There are many formalities which are to be observed by a small and medium size concerned
due to which the establishment and running costs are so much that it becomes difficult for their
concerned to afford us cost. Thus it can be used only by big concerned.

3. Ignorance of futuristic situation:

The contribution of cost accounting for heading futures situation has not been much for
example, it is has not evolved so far any tool for heading inflation situation.

4. Lack of double entry systems:

Under cost accounting, a double entry system is not adopted that does not enable to checks the
arithmetic's accuracy of the transaction and locate the errors.

5. Developing stage: 
Cost accounting is to development stage since its principle concepts and conversions are not
fully developed.

BASIS FOR
COST ACCOUNTING FINANCIAL ACCOUNTING
COMPARISON

Meaning Cost Accounting is an accounting Financial Accounting is an accounting

system, through which an organization system that captures the records of
keeps the track of various costs financial information about the business to
incurred in the business in production show the correct financial position of the
activities. company at a particular date.

Information type Records the information related to Records the information which are in
material, labor and overhead, which monetary terms.
are used in the production process.

Which type of cost Both historical and pre-determined Only historical cost.
is used for cost
recording?

Users Information provided by the cost Users of information provided by the

accounting is used only by the internal financial accounting are internal and
 BASIS FOR
COST ACCOUNTING FINANCIAL ACCOUNTING
COMPARISON

management of the organization like external parties like creditors, shareholders,

employees, directors, managers, customers etc.
supervisors etc.

Valuation of Stock At cost Cost or Net Realizable Value, whichever is

less.

Mandatory No, except for manufacturing firms it is Yes for all firms.
mandatory.

Time of Reporting Details provided by cost accounting are Financial statements are reported at the
frequently prepared and reported to end of the accounting period, which is
the management. normally 1 year.

Profit Analysis Generally, the profit is analyzed for a Income, expenditure and profit are
particular product, job, batch or analyzed together for a particular period of
process. the whole entity.

Purpose Reducing and controlling costs. Keeping complete record of the financial
transactions.

Forecasting Forecasting is possible through Forecasting is not at all possible.

budgeting techniques.

Que. 2nd (A) ACTIVITY BASED COSTING

The activity-based costing (ABC) system is a method of accounting you can use to find the total
cost of activities necessary to make a product. The ABC system assigns costs to each activity
that goes into production, such as workers testing a product.
 Activity based costing is a managerial accounting method that traces overhead costs to
activities and then assigns them to objects. In other words, it’s a way to allocate indirect,
overhead costs to products or departments that generate these costs in the production
process.

What Does Activity Based Costing Mean?

ABC costing focuses on identifying activities, or production processes, that are used to process
a job. These individual activities are grouped together with similar processes into a cost pool
that relates to single activity cost driver.
The cost pools are then analyzed and assigned a predetermined overhead rate that will
eventually be assigned to individual jobs and products.
As you can see, this is a multi-step process, but activity-based costing is a much more accurate
way of assigning indirect costs. It’s difficult to determine how much electricity or heat one
department or job uses over another without some type of methodical allocation process.

Advantages of Activity Based Costing (ABC):

1. Accurate Product Cost:

ABC brings accuracy and reliability in product cost determination by focusing on cause and

effect relationship in the cost incurrence. It recognises that it is activities which cause costs, not

products and it is product which consume activities. In advanced manufacturing environment

and technology where support functions overheads constitute a large share of total costs, ABC

provides more realistic product costs.

2. Information about Cost Behaviour:

ABC identifies the real nature of cost behaviour and helps in reducing costs and identifying

activities which do not add value to the product. With ABC, managers are able to control many

fixed overhead costs by exercising more control over the activities which have caused these

fixed overhead costs.

3. Tracing of Activities for the Cost Object:

ABC uses multiple cost drivers, many of which are transaction based rather than product

volume. Further, ABC is concerned with all activities within and beyond the factory to trace

more overheads to the products.

4. Tracing of Overhead Costs:

ABC traces costs to areas of managerial responsibility, processes, customers, departments

besides the product costs.

5. Better Decision Making:

ABC improves greatly the manager’s decision making as they can use more reliable product cost

data. ABC helps usefully in fixing selling prices of products as more correct data of product cost

is now readily available.

6. Cost Management:

ABC provides cost driver rates and information on transaction volumes which are very useful to

management for cost management and performance appraisal of responsibility centres. Cost

driver rates can be used advantageously for the design of new products or existing products as

they indicate overhead costs that are likely to be applied in costing the product.

7. Benefit to Service Industry:

Service organizations, such as banks, hospitals and government departments, have very

different characteristics than manufacturing firms. Service organizations have almost no direct

costs, most of the costs are overheads and they do not hold stocks of service as the service is

consumed when it is produced. Traditional costing has generally been considered inappropriate
for these organizations, whereas ABC offers the potential of benefits from improved decision

making and cost management.

Demerits of Activity Based Costing (ABC):

1. Expensive and Complex:

ABC has numerous cost pools and multiple cost drivers and therefore can-be more complex

than traditional product costing systems. It can prove costly to manage ABC system.

2. Selection of Drivers:

Some difficulties emerge in the implementation of ABC system, such as selection of cost drivers,

assignment of common costs, varying cost driver rates etc.

3. Disadvantages to Smaller Firms:

ABC has different levels of utility for different organisation such as large manufacturing firm can

use it more usefully than the smaller firms. The level of technology and manufacturing

environment prevailing in different firms also affect the application of ABC.

4. Measurement Difficulties:

The main costs and limitations of an ABC system are the measurements necessary to

implement it. ABC systems require management to estimate costs of activity pools and to

identify and measure cost drivers to serve as cost allocation bases. Even basic ABC systems

require many calculations to determine costs of products and services. These measurements

are costly. Activity cost rates also need to be updated regularly.

Objectives of Activity Based Costing

The objectives of Activity Based Costing are given below.

1. To rectify the inaccurate cost information.

2. To allocate the overheads on activity basis.

3. To help the management in taking quality and timely decision

(B) Inventory Control System

Definition: The Inventory control system is maintained by every firm to manage its inventories
efficiently. Inventory is the stock of products that a company manufactures for sale and the components
or raw materials that make up the product. Hence, an inventory comprises of the buffer of raw material,
work-in-process inventories and finished goods.

This system is quite inadequate for the larger firms that deal in several product lines and maintain a
heavy sales counter. Thus, self –operating or an automatic computer system is to be employed to keep
track on the inventory stock and place the order in case of a shortage

Just-in-Time System
Definition: The Just-in-Time or JIT is an inventory management system wherein the material, or the
products are produced and acquired just a few hours before they are put to use. The Just-in-time system
is adopted by the firms, to reduce the unnecessary burden of inventory management, in case the
demand is less than the inventory raised.

The objective of Just-in-time is to increase the inventory turnover and reduce the holding cost and any
other costs associated with it. This concept is again popularized by the Japanese firms, who place an
order for the material, the same day the product is to be produced.

The success of just-in-time depends on how you manage your suppliers. A lot of pressure is exerted on
them, as they have to be ready with an adequate quality material to supply it to the manufacturer, as
the need arises.

QUE 3RD

What is Labour cost?

Labour cost represents human contribution. Labour cost is sensitive in nature. The reason is that the
labour cost is fully based on the human behavior i.e. labour behavior.

The control of labour costs requires the control of the labour behavior. Therefore, the management
should study human behaviour, performance of labour, time and motion study, labour turnover, labour
approach in order to control the labour cost.
Labour cannot be stored for future reference. It is very much similar to the perishable nature of
materials. Some materials may loose its quality and not used for the purpose of production. Such
materials will be waste one. Likewise, once labour is lost, the same cannot be recovered and not
effectively used in the days to come.
Methods of Incentive Wage System

1. Halsey Premium Plan:

This plan known after F.A. Halsey is also called the Weir Premium Plan because it was first introduced in
the Weir Engineering Works in England. Under this plan, a standard time is fixed (on the basis of past
performance records and not on the basis of elaborate time study) for the completion of a job. A worker
who completes his job in less than the standard time is paid at this hourly rate for the time actual spent
on the job plus a bonus for the time saved.

Following are the basic features of this plan:

(i) Standard time of production is determined well in advance.

(ii) Standard rate of wages is also determined.

(iii) The workers, who complete their work within standard time, are paid the wages at the standard
rate.

(iv) The rate of bonus may be 33-1/3 or 50%.

Important merits of Halsey Premium plan are as under:

1. Every worker gets a guarantee of minimum wage.

2. This system is justified.

3. The workers are encouraged to do more and more work.

4. This system helps in maximum utilisation of time.

5. This system is useful for both the employers and workers.

Halsey Premium Plan suffers from the following demerits:

1. This system is not suitable from administrative point of view.

2. The basis of this system of wage payment is not scientific. It is based upon prejudice.

3. The workers become ignorant of work due to the reason that they get the guarantee of minimum
wages.
4. Due to the guarantee of minimum wages, it depends entirely upon the discretion of workers to do or
not to do extra work.

5. As the workers do not get full benefit of the time saved by them, they do not get due encouragement
to produce more.

Type #  2. Rowan Premium Plan:

This plan was introduced by James Rowan. Under this method, the standard time and the standard rate
of wage Payment are determined in the same manner as Halsey Plan. The workers, who complete their
work within standard time, are paid the wages at standard rate. The workers, who complete their work
in less time than the standard, are paid wages at the standard rate plus some bonus. This bonus is
calculated in proportion of time saved.

Basic Features of Rowan Plan:

1. Standard time of work is decided.

2. Standard rate of wage is decided.

3. The workers, who complete their work within standard time, are paid the wages according to
standard time.

4. The workers, who complete their work before standard time, are paid wages according to standard
rate plus some bonus.

5. Bonus is calculated in the ratio of time saved with standard time.

Merits of Rowan Premium Plan:

1. It checks over-speeding because the workers cannot get bonus more than 25% of the standard time.

2. This method of incentive wage plan is based upon scientific calculations.

3. The workers get higher bonus under this system.

Demerits of Rowan Premium Plan:

1. This system is difficult to understand. Therefore, the workers do not like it much.

2. Due to decreasing proportion of bonus, the workers do not get due encouragement to work more and
more under this system.
3. It may be possible under this system that the bonus of a very efficient worker and a less efficient
worker are the same.

4. Due to the guarantee of minimum wages the workers do not get due encouragement.

Type #  3. Taylor Differential Piece Rate System:

This system was introduced by Mr. F.W. Taylor. Under this system, standard time for every work is
determined on the basis of time and motion study. Two rates of wages are determined-as High rate and
Low rate. The workers, who complete their work within standard time or before standard time, are paid
wages according to the high rate. The workers, who complete their work in more time than standard
time, are paid the wage according to lower rate.

Basic Features of Differential Rate System:

1. The workers, who complete their work in more time than the standard time, are paid the wages at
lower rate.

2. Two rates of wages are determined i.e., Higher rate and Lower rate.

3. Standard time of the work is determined.

4. The workers, who complete their work within standard time or before standard time, are paid the
wages at high rate.

Merits of Taylor Differential Piece Rate System:

1. This system helps in reducing the cost of production per unit.

2. This system is based upon scientific calculations, proper work and job standardisation.

3. Most important merits of this system are that it rewards an efficient worker and penalises the
inefficient worker.

4. This system helps in eliminating the workers who are quite inefficient, because in the course of time,
they will try to get the work elsewhere.

5. This system is very easy to understand and to calculate.

Demerits of Taylor Differential Piece Rate System:

1. If the standard work of a worker is less than his normal capacity it causes great dissatisfaction among
the workers.

2. The greatest demerit of this system is that it does not guarantee minimum wages. Therefore, it is
opposed by the labour unions.

3. This system classifies the workers into two categories— efficient and inefficient.

4. This system helps in eliminating the workers who are quite inefficient, because in the course of time,
they will try to get the work elsewhere.

5. This system is very easy to understand and to calculate.

Type #  4. Gantt Bonus Plan:

This system was introduced by Mr. H.L. Gantt. Under this system, the minimum amount of wages to be
paid to the workers is determined. The workers, who complete their works within standard or before
standard time, are paid a bonus of 25% of their wages. The rate of bonus may be 33-⅓% also. The
workers, who complete their work in more than standard time, are also paid the wages determined
earlier.

Merits of Gantt Bonus System:

1. This system is easy to understand and calculate.

2. This system encourages the workers to complete their work in standard time.

3. This system is useful from the point of view of the employer also, because it causes economy in the
cost of production.

4. Under this system, a foreman or the supervisor also gets bonus in proportion to the bonus earned by
his workers. Thus, this system encourages harmonious relations between labour and capital.

5. Under this system, the workers get a guarantee of minimum wages so they feel assured.

Demerits of Gantt Bonus System:

1. The worker does not bother for more work because they get a guarantee for minimum wages.

2. This system is against the interests of labour unions.

3. If the standard performance is too high, it may cause dissatisfaction among the workers.

4. This system classifies the workers into two categories, efficient and inefficient.

Type #  5. Emerson Efficiency Plan:

This plan was introduced by Mr. Hemington Emerson. Under this plan of incentive wages, the wages are
paid at the standard rate and the amount of bonus paid to the workers depends on the individual
efficiency of the workers. Under this plan, the tools and equipment are standardised and the standard
time for completing the work is determined so that an average worker of average efficiency may also
complete the work within that standard time.

The efficiency of the worker is determined in the ratio of actual time taken by the worker with standard
time of the work.

Type #  6.  Bedaux Point Premium:

Under this plan, the standard time for every work is determined and this standard time is expressed in
minutes. Standard performance is expressed in terms of points. One minute of standard time for a
particular work is considered to be one point. Every point is equal to the standard rate wage per minute.
Under this plan, the standard time and standard wage rate, both are expressed in terms of point.

Type #  7.  Merric Differential Wage Multiple Piece Rate Plan:

This system is an improvement over the differential wage plan as introduced by F.W. Taylor.

(i) Upto 80% of standard performance;

(ii) Upto standard performance; and

(iii) Above standard performance.

Type #  8.  100% Bonus Plan:

Under this plan, the workers get a bonus at the rate of 100% of time saved by them.

(i) Standard time for every work is determined,

(ii) All the workers are given wages at a certain rate, whatsoever, the work may be,

(iii) All the workers get a guarantee of minimum wages,

(iv) The wages of a worker are calculated considering his efficiency.

(QUE 4TH)

Cost Allocation

• When items of cost are identifiable directly with some products or departments such costs are
charged to cost centres. This process is known as cost allocation.

• It is the charging of discrete, identifiable items of cost to cost centres or cost units.

• It is complete distribution of an item of overhead to the departments or products on logical or

equitable basis is called allocation.

• Where a cost can be clearly identified with a cost centre or cost unit, then it can be allocated to that
particular cost centre or unit.

• Allocation is the process by which cost items are charged directly to a cost unit or cost centre.

• Cost allocation calls for two basic factors – – Concerned department/product should have caused the
cost to be incurred – Exact amount of cost should be computable

Cost Allocation-

• Electricity charges can be allocated to various departments if separate meters are installed

• Depreciation of machinery can be allocated to various departments as the machines can be identified
• Salary of stores clerk can be allocated to stores department

• Cost of coal used in boiler can be directly allocated to boiler house division.

• Wages paid to workers of service department can be allocated to the particular department.

• Indirect materials used by a particular department can also be allocated to the department.

Thus allocation is a direct process of identifying overheads to cost units or cost centres. So the term
allocation means allotment of whole item of cost to a particular cost centre or cost object without any
division.

Cost Apportionment

• Cost Apportionment is the allotment of proportions of items to cost centers.

• When items of cost can not directly charge to or accurately identifiable with any cost centres, they are
prorated or distributed amongst the cost centres on some predetermined basis. This method is known
as cost apportionment.
• Wherever possible, the overheads are to be allocated. However, if it is not possible to charge the
overheads to a particular cost centre or cost unit, they are to be apportioned to various departments on
some suitable basis. This process is called as ‘Apportionment’ of overheads.

• Items of indirect costs residual to the process of cost allocation are covered by cost apportionment.

• The predetermination of suitable basis of apportionment is very important and usually following
principles are adopted- (i) Service or use (ii) Survey method (iii) Ability to bear

The basis for apportionment is normally predetermined and is decided after a careful study of
relationships between the base and the other variables within the organisation.

• A lot of quantitative information has to be collected and constantly updated or periodically reviewed
to improve upon the accuracy of apportionment.

• The basis selected should be applied consistently to avoid faults. The basis ultimately adopted should
ensure an equitable share of common expenses for the cost centres

• In simple words, distribution of various items of overheads in portions to the departments or products
on logical or equitable basis is called apportionment.

Apportionment of overhead costs

• Apportionment of overhead costs means to divide total cost of overhead among different
departments or branches or cost centers of a company.

• We need the steps of apportionment of overhead costs when there are many departments or cost
centers of any company because when we know the overhead cost of each department, we can find the
total cost of department.

• With this, we can compare the revenue of each department with their total cost.

• Then take decisions relating to particular department

Cost Absorption

• The ultimate aim of Overhead Accounting is to absorb them in the product units produced by the firm.
• Thus, the indirect costs or overhead will have to be distributed over the final products so that the
charge is complete.

• This process is known as cost absorption or ‘Absorption’ of overheads

• It means costs is absorbed by the production (or product units )during the period or charging each
unit of a product with an equitable share of overhead expenses.

• Usually any of the following methods are adopted for cost absorption-

– Direct Material Cost Percentage

– Direct Labour Cost Percentage

– Prime Cost Percentage

– Direct Labour Hour Rate Method

– Machine Hour Rate, etc.

Absorption’ of overheads

• Accurate absorption will help in arriving at accurate cost of production.

• Overheads are indirect costs and hence there are numerous difficulties in charging the overheads to
the product units

• The basis should be selected after careful maximum accuracy of Cost Distribution to various
production units.

• The basis should be reviewed periodically and corrective action whatever needed should be taken for
improving upon the accuracy of the absorption.

Under-absorption and Overabsorption of Overhead

Certain expenses may be direct expenses for certain costs centres but they are indirect for the
production departments. These do not form part of prime cost, but absorbed as overheads.

• The amount of overhead absorbed in costs is the sum total of the overhead costs allotted to individual
cost units by application of the overhead rate.

Under-absorption

• If the amount absorbed is less than the amount incurred , the difference denotes underabsorption. • It
is also termed as 'under recovery'

• It may be due to – Actual expenses exceeding the estimate; and / or – Output or the hours worked
may be less than the estimate

Over-absorption

• If the amount absorbed is more than the expenditure incurred this would indicate over-absorption,
which goes to inflate the costs.

• Over-absorption is also formed as 'over recovery'.

• It may be due to – Expense being less than estimate; and / or – Output or hours worked may be
exceeding the estimate

QUESTION 5TH

Job Costing Definition

Job costing is defined as a method of recording the costs of a manufacturing job, rather than process.

With job costing systems, a project manager or accountant can keep track of the cost of each job,
maintaining data which is often more relevant to the operations of the business.
Job Costing Meaning

Job costing, generally, means a specific accounting methodology used to track the expense of creating a
unique product. Due to the fact that certain projects, such as construction, require different
operations, accountants use this methodology to trace the expenses of each job in order to use this
information for analysis and tax needs. Job costing forms have spaces to include direct labor, direct
materials, and overhead.
Costs stay in the work-in-process account throughout the job. When the job is finally completed, they
are transferred to the finished goods account. By using this method, accountants can make sense of
complicated jobs which are moving towards the process of completion.
Indirect costs, like overhead, are applied as a fraction of direct costs. This is usually done in one of two
ways: an association with labor hours or using activity based costing. This way, either through use
of labor or certain tools, overhead will not be left out of the equation and a company can make sure to
cover all essential costs using job costing.

 Objectives of Job Costing:

The main objectives are of job costing are:

(1) The main objective of job costing is to ascertain the cost as well as the profit or loss on each job.

(2) Another objective of job costing is to find out those jobs which are more profitable and those which
are not profitable or less profitable.

(3) Control of costs, by comparing actual costs with estimated costs, is also one of the objectives of job
costing.

(4) Job costing is also intended to indicate, through the comparison of actual cost of a job with its
estimated cost, whether the estimation is incorrect or the actual cost is excessive.

(5) Another objective of job costing is to provide a basis for estimating or determining the cost of similar
jobs undertaken in future.

Limitations of Job Order Costing:

(1) It is expensive to operate as it requires considerable detailed clerical work.

(2) With the increase in the clerical work the chances of errors are increased.

(3) Job order costing cannot be efficiently operated without highly developed production control

system. The job costing requires intricate factory organization system.

(4) The costs as ascertained are historical as they compiled after incidence and therefore does not

provide control of cost unless it is used with standard costing system

What is Batch Costing?

Batch costing is another form of job costing. Under this method, homogeneous products are taken as
cost unit. A batch consists of a specific number of products or units or articles. The number varies from
one batch to another. Hence, batch cost is used to determine the cost per unit or article per unit.
The company may want to get lower cost of production. If so, the cost per unit will also be low. For
which, the company has to work out Economic Batch Quantity in the line of Economic Order Quantity.
The cost procedure in batch costing is very similar to job costing. Hence, production order number is
allotted to each batch.

Definition of Batch Costing

The batch cost is defined as

aggregated costs relative to a cost unit which consists of a group of similar articles which maintains its
identity throughout one or more stages of production.
disadvantages of Batch Costing:

The main disadvantages of batch costing are:

(1) Determination of a batch from various jobs often pose problem. It is difficult to come across absolute
homogeneity of jobs.

(2) When quantity of goods to be manufactured differs from customer to customer, again it becomes
difficult to determine the batch.

(3) If the production of a batch is wrongly undertaken, the whole batch of the articles are to be
discarded which will become a great loss to the manufacturer.

(ques 6th)Reconciliation of Cost and Financial Accounts

The term reconciliation applies to the reconciliation of the results of the business profit or loss as shown
by the financial accounting records and the cost accounting records.

When cost accounts and financial accounts are maintained separately, the profit shown by one set of
books may not agree with that of the other set.

In such a situation, it is necessary to reconcile the results (profit/loss) shown by two sets of books. Such
reconciliation proves arithmetical accuracy of data, explains reasons for the difference in the two sets of
books and affords reliability to them.

Causes Or Reasons For Difference In Profits Or Losses Between Cost Account And Financial Account
The disagreement or difference between cost and financial accounts results (profit or loss) arise due to
the following reasons:

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.