Inter

• between
• among

Intra

• within
• during

Inter Process Profits

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 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 ($\frac{\mathrm{22,535}}{340}$ ) per unit.

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)

Value added in transfer

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

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.

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

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

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.

• 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.

  Make or Buy

  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.

Unrealised Profit

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 amount of unrealised profit

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

Excluding Unrealised Profit

• 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

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.

Inter process profits included in stock in a process

Stock reserve to be created