Interlocking accounting is a type of financial accounting system that requires a business to keep its cost accounts separate from its financial accounts. In other words, in the interlocking accounting system, there exists no double entry between the cost and financial accounts of the company. Because of the separate cost and financial accounts, the company that uses this accounting system will have two profit balances, the financial profit and the cost profit.
One of the advantages of the interlocking accounting system is that the ledger where the business records the financial and cost transactions self balances. Additionally, since there are two sets of accounts that do not require reconciliation, interlocking accounting systems typically have lower clerical maintenance costs. Further, interlocking account systems minimize the possibility of mistakes because recording will take place in two separate ledgers that operate independently. An integrated accounting system also makes it easier to access and process information facilitating management decisions based on financial records.
Businesses typically do not reconcile the separate accounts used in the interlocking accounting system. Therefore, the separate accounts can use different accounting terminology. In other words, accountants will use terms in financial books that they do not included in the cost accounting books. Terms not duplicated across the financial books include dividends received, profits on sale of assets, interests received, loss on sale of assets, fines and interest on mortgage and loans.
Cost and financial accounts use different methods to determine the valuation of the company. In financial accounts, the company will typically use the lower of the cost or market price of the company’s stock. In the cost accounts, the company will use cost-based accounting measurement tools such as last in first out, first in first out, or averages. Cost accounts also can ignore abnormal items creating a disparity in profit since the inclusion of abnormal items will misrepresent the established cost.
The financial and cost accounts also typically use different methods of depreciation resulting in dramatically different profit figures between the two sets of books. In financial accounts, depreciation typically depends on the value of the depreciating asset. In the cost accounts, on the other hand, depreciation depends on the expected life of the depreciating asset.