Manufacturing

Question 1

What is a transfer price?

Answer 1

Cost of Production + Manufacturing Profit. It is then transferred to the SOPL.

Question 2

What type of inventory is valued at transfer price?

Answer 2

Finished goods.

Question 3

Why do we value finished goods at transfer price? Give TWO reasons.

Answer 3

1. To determine/calculate the factory’s contribution to gross profit. Thus we can calculate the cost made by making the units instead of buying them.
2. factory management may be entitled to a bonus based on the appraisal of performance. The contribution to profit is an important indicator of performance.

Question 4

Why is inventory valued at the lower cost or NRV?

Answer 4

This is to prevent inflated figures on a company’s balance sheet. It prevents the business from overstating the value of their inventory, on their financial statements. This is in line with the prudence concept - assets should not be overstated.

This true and fair view of the position of the business, allows stakeholders to take informed decisions.