# What are inter process profits?

• between
• among

• within
• during

## Inter Process Profits

Inter process profit represents the value added to the output over its cost, while being transferred from one process to another. Since the value addition is without incurring any cost, it would amount to or result in an amount of profit equal to the value addition.

## Transfer price

The value attributed to the output at the time of transfer is called the transfer price.

This term is generally used in contexts where there is a certain element of profit included in the transfer value. Where there is no profit included, then the transfer price is nothing but cost.

## Transfer Profit

The profit revealed by an account which is on account of transfer of stock from that account to another at an inflated price. The amount of profit would be the amount of inflation i.e. the value added to the cost to arrive at the transfer price.

The Process account would contain a credit balance

## Example

Consider the following Process II where 340 units of output are being transferred to Process III as input at cost being approximately 66.2794 ($\frac{22,535}{340}$ ) per unit.

Process II a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount
To Process I a/c
To Material
To Direct Wages
450
15,875
2,000
3,680
2,576
By Normal Loss a/c
By Abnormal Loss a/c
By Process IV a/c
90
20
340
270
1,326
22,535
450 23,861   450 23,861

If the same output is valued at 75 per unit for the purpose of transfer, then

Transfer price = 75/unit.

Transfer value (Value attributed to output transferred)

 = number of units transferred × Transfer price = 340 units × 75/unit = 25,500

 = Transfer value − cost = 25,500 × 22,535 = 2,965

The process account with the transfer of output recorded at its transfer value instead of cost would be as below.

Process II a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount
To Process I a/c
To Material
To Direct Wages
To Profit and Loss a/c
450
15,875
2,000
3,680
2,576
2,965
By Normal Loss a/c
By Abnormal Loss a/c
By Process III a/c
90
20
340
270
1,326
25,500
450 23,861   450 23,861
Since the credit item is being recorded at a higher value, the account would show a profit equal to the increase in value.

This transfer profit is transferred to

• Costing Profit and Loss a/c under cost ledger accounting
• Profit and Loss a/c under integrated accounting

## Process Stock a/c in use

If the Process Stock a/c is in use, then the transfer of output from the current process to the subsequent process is done through the Process Stock a/c. In such a case the inflated value being credited to the Process Stock a/c, the transfer profit is also revealed by the Process Stock a/c and is thus transferred from the Process Stock a/c to the Profit and Loss a/c.

Process II Stock a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount

To Profit and Loss a/c

2,965

By Process III a/c

340

25,500

# Effect of inter process profits

On account of the output being valued at a transfer price instead of the actual cost, there is a possibility of a profit or loss arising on account of the transfer. This profit or loss would be available in the account from which the transfer has been made.

To view the difference between transfer at cost and transfer price, consider the data relating to a product that passes through 2 processes I and II to end up as a finished product.

## Transfer at Cost

• 500 units transferred at a cost of 80/unit from Process I to Process II.

Process I a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount
To Material
To Expenses
500 35,000
5,000
By Process II a/c
500
40,000
• 500 units transferred at a cost of 120/unit from Process II to Finished Stock.

Process II a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount
To Process I a/c
To Expenses
500 40,000
20,000

By Finished Stock a/c

500

60,000
• 500 units are sold @ 160/unit.

Finished Stock a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount
To Process II a/c
To Selling Expenses
To Profit and Loss a/c
500
60,000
8,000
12,000
By Sales a/c
500
80,000
Profit and Loss a/c
DrCr
Particulars Amount Particulars Amount
By Finished Stock a/c 12,000

The total profit of 12,000 @ 24/unit seems to have been made by the efforts of the selling department which is responsible for sales.

## Transfer at Transfer Price

Transfer price at Process I is 90/unit and Process II is 115/unit. If the output is transferred at the transfer price, then the process accounts would be as follows.

• 500 units transferred at the transfer price of 90/unit from Process I to Process II.

Process I a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount
To Material
To Expenses
To Profit and Loss a/c
500 35,000
5,000
5,000
By Process II a/c
500
45,000
500 45,000 500 45,000
• 500 units are received from Process I @ 90/unit and transferred at the transfer price of 115/unit from Process II to Finished Stock.

Process II a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount
To Process I a/c
To Expenses
500 45,000
20,000
By Finished Stock a/c
By Profit and Loss a/c
500
57,500
7,500
500 65,000 500 65,000
• 500 units are sold @ 160/unit.

Finished Stock a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount
To Process II a/c
To Selling Expenses
To Profit and Loss a/c
500
57,500
8,000
14,500
By Sales a/c
500
80,000
Profit and Loss a/c
DrCr
Particulars Amount Particulars Amount
To Process II a/c
To Balance c/d
7,500
12,000
By Process I a/c
By Finished Stock a/c
5,000
14,500
19,500 19,500
By Balance b/d 12,000

The net profit ultimately transferred to the Profit and Loss a/c is the same whether the transfer has been made at cost or at a transfer price. However, where the transfer has been made at a transfer price, there is a possibility of a profit or loss arising at each stage where a transfer has been made.

The net profit would seem to be on account of the collective contributions from all the processes involved in the operation unlike in case of transfer at cost where the net profit seems to be on account of the contribution from the Finished Stock a/c only.

# Effect of inter process profits

• ## Performance Evaluation

Where the standard cost of output of each process is known, using the standard costs as the transfer price would enable the efficiency of operation of each process to be revealed through the information relating to the inter process profit in the process account.

The profit or loss revealed by each process would be the cost variance.

• ## Profitability Analysis

In the absence of use of inter process profits, the finished stock a/c would get debited with the cost of the finished output. The sale of finished goods is recorded through the finished stock a/c. The profit on sale revealed by the Finished Stock a/c would be the profit on account of sale of the final product.

Since each process has a contribution in making the final product the profit may be distributed among the processes so as to assess the profitability of each process distinctly. This would be possible if a transfer price is set for each process.

Transfer at Cost
Particulars Process I Process II Finished Stock
a) Cost

b) Sale Price
c) Profit (b) − (a)

80
(80 + 40)
120
(120 + 16)
136
160
24
Transfer at Transfer Price
Particulars Process I Process II Finished Stock
a) Cost

b) Transfer/Sale Price
c) Profit (b) − (a)

80
90
10
(90 + 40)
130
115
−15
(115 + 16)
131
160
29

### Transfer Price = Cost + Profit

The transfer price may be set by adding up a certain amount of profit on cost of that process. In such a case, if the sale price is fixed, there is a possibility for the ultimate sale to be showing up a loss.

### Fixed Transfer Price

If the transfer prices are set at fixed value irrespective of the cost incurred, then it would be the same as using standard cost (+ a certain amount of profit) as transfer prices wherein the profit or loss at each process indicates efficiency.
• ## Decision Making

The idea of transfer pricing would also enable deriving information that would help in decision making.

If the input of an intermediary process which is the output of the prior process is capable of being bought from outside, then it would be prudent to check whether it is appropriate taking up the prior process or not.

Choosing the price at which the input is available from the market as the transfer price for the prior process would help derive the information that would be helpful in taking such a decision.

As long as there is some profit in the prior process on account of the transfer price being greater than cost, it would be beneficial to carry on the prior process. If the prior process generates a loss, then it would be an indicator that the input can be acquired at a lower cost from outside and as such carrying on the prior process is not appropriate.

Eg : The output of Process I which cost 80/unit is used as input in Process II. AS long as the price of the input used in process II from outside sources is ≥ 80 it would be appropriate to carry on Process I. Using the price as the transfer price in Process I would generate a profit when it is (≥ 80) and a loss when it is < 80.

### Transfer or Sell

If the output of a process capable of being sold, it would be prudent to check whether it is appropriate to sell it away or transfer it to subsequent process and carry on processing it. Whether the subsequent processes can be dropped at ease and the cost of such an event would also have to be taken into consideration in taking such a decision.

Choosing the price at which the output can be sold as the transfer price for the process would help derive the information that would be helpful in taking such a decision.

As long as there is some profit in the process on account of the transfer price being greater than cost, it would be beneficial to carry on the process. If the process generates a loss, then it would be an indicator that the selling the output would not be appropriate.

# Reserve for unrealised profits

## Unrealised Profit

The inter process profit that is generated at each process is generated immediately on recording the transaction relating to transfer which is a transaction of transfer within the organisation. This profit is notional profit and is not profit earned. This profit would be realised only after the transferred material passes through the subsequent processes and is finally sold.

## Illustration

500 units are transferred from process I to process II and from there to Finished product. Consider only 400 of these units to have been sold.

• ### Transfer at cost

When the transfers are at cost, profit would be recorded only when there is sale and at the time of sale. As such all profit credited to the profit and loss account would be realised profit.

Transfer at Cost
Particulars Process I Process II Finished Stock
a) Cost

b) Sale Price
c) Profit (b) − (a)
d) Output Produced (units)
e) Output Transferred (units)
f) Output Sold (units)
g) Closing Stock
(d) − (e)
(d) − (f)
i) Value of Closing stock (g) × (a)

80

500
500

0
(80 + 40)
120

500
500

0
(120 + 16)
136
160
24
500

400

100
13,600
Finished Stock a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount
To Process II a/c
To Selling Expenses
To Profit and Loss a/c
500
60,000
8,000
9,600
By Sales a/c
By Balance c/d
400
100
64,000
13,600
500 77,600 500 77,600

The unsold stock of 100 units is valued at the actual cost in the Finished Stock a/c i.e. 136/unit.

Profit and Loss a/c
DrCr
Particulars Amount Particulars Amount
By Finished Stock a/c 9,600
• ### Transfer at Transfer Price

When the transfer is at a price other than cost there may be profit or loss at the time of transfer. This profit or loss is transferred to the profit and loss account at the time of recording the transfer.

Transfer at Transfer Price
Particulars Process I Process II Finished Stock
a) Cost

b) Transfer/Sale Price
c) Profit (b) − (a)
d) Output Produced (units)
e) Output Transferred (units)
f) Output Sold (units)
g) Inter Process Profit (c) × (e)
h) Closing Stock
(d) − (e)
(d) − (f)
i) Value of Closing stock (h) × (a)

80
90
10
500
500

5,000

0
(90 + 40)
130
125
−5
500
500

−2,500

0
(115 + 16)
141
160
19
500

400

100
14,100
Finished Stock a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount
To Process II a/c
To Selling Expenses
To Profit and Loss a/c
500
62,500
8,000
7,600
By Sales a/c
By Balance c/d
400
100
64,000
14,100
500 78,100 500 78,100

The unsold stock of 100 units is valued at the cost ascertained using transfer values in the Finished Stock a/c i.e. 141/unit.

Profit and Loss a/c
DrCr
Particulars Amount Particulars Amount
To Process II a/c
To Balance c/d
2,500
10,100
By Process I a/c
By Finished Stock a/c
5,000
7,600
12,600 12,600
By Balance b/d 10,100

Profit included in the value of closing Finished stock

 = Inter process profits added to the stock before it reached Finished Stock = Inter process profit added in Process I + Inter process profit added in Process II = 10/unit + (−5/unit) = 5/unit

Cost value of closing Finished stock

 = Value (including inter process profits) − Inter Process Profits included = 141/unit − 5/unit = 136/unit

The inter process profits included in the value of closing finished stock have been transferred to the Profit and Loss a/c from Process I and Process II at the time of transfer of output to process II and finished stock respectively. This inter process profit included in the value of closing stock would be unrealised profit.

If the closing finished goods is valued at actual cost (100 × 136), the profit shown by Finished stock account would be lesser by the inter process profit included in its value (100 × 5) when it is valued at transfer costs (100 × 141).

Finished Stock a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount
To Process II a/c
To Selling Expenses
To Profit and Loss a/c
500
62,500
8,000
7,100
By Sales a/c
By Balance c/d
400
100
64,000
13,600
500 77,600 500 77,600

The unsold stock of 100 units is valued at the cost in the Finished Stock a/c i.e. 136/unit.

Profit and Loss a/c
DrCr
Particulars Amount Particulars Amount
To Process II a/c
To Balance c/d
2,500
9,600
By Process I a/c
By Finished Stock a/c
5,000
7,100
12,100 12,100
By Balance b/d 9,600

## Identifying Unrealised Profit

The additional value included in the value of closing stock is on account of inter process profits included in them. It would be realised only when the stock has been sold. It has got into the value on account of transfer transactions being recorded at values other than cost. This additional value represents unrealised profits.

The amount of unrealised profit

= inter process profits included in the value of closing stock.

## Excluding Unrealised Profit

The unrelaised profit may be excluded by
• ### valuing closing stocks at actual cost

To ensure that the profit absorbed by the Profit and Loss account does not include unrealised profits, the values of closing stocks may be recorded at actual costs instead of at transfer prices.

The closing stocks of a period become the opening stocks of the subsequent periods. Assume that the closing stocks are being maintained in the same account, the closing stock would be carried over as a balance in the process account itself.

If closing stocks are recorded at actual costs so as to avoid inclusion of inter process profits, then while the opening stocks are being taken back to the Process account at the beginning of the subsequent accounting period the value of stock being used as input would be the cost and not the transfer price at which it has been transferred earlier.

Finished Stock a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount

By Balance c/d

100

13,600

To Balance b/d
To Profit and Loss a/c
100
13,600
500

In such a case, the inter process profit that would have been included in its value has to be debited to the process account again.

• ### creating a Reserve for unrealised profit

Instead of recording closing stock at actual cost and then recording an additional transaction for revaluing the stock while it is brought forward in the subsequent period, a separate reserve account is created by charging profits to the extent of unrealised profits.

The closing stock would be recorded at cost based on transfer price for inputs.

Finished Stock a/c
DrCr
Particulars Quantity
(in Units)
Amount Particulars Quantity
(in Units)
Amount
To Process II a/c
To Selling Expenses
To Profit and Loss a/c
500
62,500
8,000
7,100
By Sales a/c
By Balance c/d
400
100
64,000
14,100
500 78,100 500 78,100

Profits transferred to the Profit and loss account would include the unrealised profits. A reserve for the amount of unrealised profit is created by charging profits thereby leaving the net profits as shown by the profit and loss account at a figure arrived at by taking the stock values at actual cost.

Journal
Particulars
Stock Reserve a/c
To Profit and Loss a/c
Dr
Profit and Loss a/c
DrCr
Particulars Amount Particulars Amount
To Process II a/c
To Stock Reserve a/c
To Balance c/d
2,500
500
9,600
By Process I a/c
By Finished Stock a/c
5,000
7,600
12,600 12,600
By Balance b/d 9,600

The stock reserve account shows a credit balance which is carried forward to the subsequent accounting period.

Stock Reserve a/c
DrCr
Particulars Amount Particulars Amount
To Balance c/d 500 By Profit and Loss a/c 500
12,600 500
By Balance b/d 500

The balance in the stock reserve account would be dealt with at the time of preparing the final accounts of the subsequent accounting period. Based on the amount of reserve , the current balance may be increased by charging the profits and creating an additional reserve or

If the amount of stock reserve to be maintained at the end

• is greater than the existing balance, the additional reserve required is brought in by charging the profit and loss account.
• is less than the existing balance, then the excess reserve is written off by transfer to the profit and loss account.
• is equal to the existing balance, then nothing needs to be done.

Thus the balance in the stock reserve account flows from one accounting period to another after being adjusted based on the balance to be maintained.

## in the Balance Sheet

Stock Reserve account has a credit balance and has to be shown on the liabilities side of the balance sheet.

Since the organisation needs to know the actual cost value of the closing stocks also, the reserve is shown as a deduction from the value of closing stocks that appear on the assets side of the balance sheet, thereby showing the stock values at cost.

Balance Sheet
Liabilities Amount Amount Assets Amount Amount

Finished Stock
− Stock Reserve

14,100
500

13,600

# Stock Reserve on Stocks in Multiple Processes

Where any process other than the first process has closing stocks of output, the value of the stock where inter process profits are being added in the prior processes may contain unrealised profits included in the value.

As such the stock reserve to be created would have to cover the unrealised profits relating to the stocks in all the processes and not just the Finished Stock.

Transfer at Transfer Price
Particulars Process I Process II Process III Process IV
a) Cost

b) Transfer/Sale Price
c) Profit (b) − (a)
d) Output Produced (units)
e) Output Transferred (units)
f) Output Sold (units)
g) Closing Stock
(d) − (e)
(d) − (f)
h) Value of Closing stock (g) × (a)
i) Inter Process Profit in Closing Stock (per unit)

j) Unrealised Profit (g) × (i)

50
62
12
1,200
1,100

100

(62 + 20)
82
100
18
900
700

200

12

2,400
(115 + 16)
141
160
19
800

750

50

14,100
30
(12 + 18)
1,500
(160 + 10)
170
200
30
750

600

150
14,100
49
(30 + 19)
7,350

Inter process profits included in stock in a process

 = Inter process profits added in all processes prior to the process

Stock reserve to be created

 = 2,400 + 1,500 + 7,350 = 11,250
Author : The Edifier